In Ghana,
landlords often require two or more years’ rent payment in advance from
prospective tenants. In other words, current tenants are likely to have paid a
two-years rent in advance to landlords. The difficulty in raising the capital (lump)
sum to pay rent in advance and the poor conditions of tenancies subsequently has
received much attention in recent times. What is rent advance in the first
place? Rent in advance is literally the payment of rent at the beginning of the
period. The amount paid is the capital sum of rents for the entire period or a
period lesser than the entire tenancy or lease period.
My colleague
Richmond Ehwi, a PhD Researcher at the University of Cambridge, UK, has
recently waved into the discussion by suggesting key explanations for the
current rent advance situation in Ghana and ways to improve the landlord-tenant
relationships and conditions in the private rented market. Income risk as he
puts it is a key reason for landlords requiring rents payments in advance. He
brilliantly points out a reason for this income risk, which he attributes to
information asymmetry between landlords and tenants due to the lack of information
referencing systems. As he put it, elsewhere in the UK, landlords can easily
obtain and verify the information prospective tenants supply them about their
ability and willingness to pay their rents.
Ability can be proxied by the employment status and income level of the
tenant. The tenant’s willingness to pay or his character as referred to in
credit analysis is based on his historical performance with rent payments. This information collected and stored in an
rental information system is used by landlords to screen applications from
prospective tenants and thus enable them allocate their accommodation more
efficiently – to tenants who are able and willing to pay for it.
This means that a
rental information system, which holds information on landlord and tenant
characteristics and performance, is fundamental to the efficient operation of
the rental property market. In its absence, landlords face agency risks like
adverse selection and moral hazard. Agency risk is the probability of loss
(cost) due to an agent's pursuance of his or her own interests instead of those
of the principal. While adverse selection refers to a situation where sellers
have information that buyers do not, or vice versa, about some aspect of
product quality, a moral hazard when a person takes more risks because
someone else bears the cost of those risks. Both tenants and landlords face
adverse selection and moral hazards. A moral hazard for instance may arise when
a tenant defaults on rent payment and sometimes abscond. So, Landlords guard
against income (rent) losses by requiring the payment of lump sum rent often
covering the entire tenancy period in advance. This would save them time and
efforts in chasing tenants for rents.
I will like to
complement Richmond’s work by extending it with neoclassical and institutional
explanations of the current rent in advance situation. The explanations will be
separated into two parts. Part one will present a neoclassical view of the
phenomenon while part two will deal with the institutional approach.
A Neoclassical View of Conditional Rent
Payments
Neoclassical
economics is the mainstream framework for analysing economic phenomenon in the
field of economics. Developed in the 1900s by William Stanley Jevons, Carl
Menger and Leon Walras and becoming a popular economic paradigm in the 20th
century, it relates supply and demand to an individual’s rationality and his
ability to maximize utility or profit. This idea works on the principle that
competition leads to the efficient allocation of resources. Therefore, per
economic analysis, the interaction between demand and supply of a good or
service, which in this case is residential accommodation, will determine its
price and conditions under which is it supplied or demanded. When supply exceeds demand, a surplus
results, which can only be cleared with a reduction in the price of the good or
service. A surplus in accommodation puts tenants in an advantageous position
because they have options and can dictate price. In other words, the tenants
become price makers and the landlord a price taker in the event of a surplus
accommodation. However, when demand exceeds supply, a shortage of the good or
service in question results, which may lead black market conditions,
preferential and conditional sales. A shortage of accommodation reverses the
relationship, making a landlord a price maker and a tenant a price taker
accompanied by the conditions of a shortage. Figure 4.9 illustrates the
relationship between the price mechanism (interplay of demand and supply) and
the shortage or surplus of residential accommodation.
Source: Mankiw (2014). Principles of
Macroeconomics
Within this
neoclassical framework, landlord’s demand for two-years rent advance is the
outcome of a shortage of residential accommodation. A market solution to this
problem is to increase the supply of accommodation to provide alternatives to
tenants and thus reduce the market power of landlords. A shortage will
classically lead to an inefficient allocation of resources where the highest
bidders will always win. Rational landlords will always seeks tenants who can
pay more and those unemployed would as a result be homeless without help from
family, landlords or the government. This is clear market failure situation; condition
even neoclassical economists would agree might require some form of government
intervention. Thus, an alternative solution is for the government to fix the
rent on accommodation through legislation like rent (price) controls. Although this alternative may be easier,
government failure, a situation where government intervention in the economy to correct a market failure creates inefficiency and
leads to a misallocation of scarce resources can worsen the situation. In the
case of Ghana, both solutions have been tried. Attempts to increase supply of houses
by both governments and private investors have been pursued historically. Examples
of government supply include Dansoman Estates, Sakumono Estate, Chirapatre
Estate among others.
In 1986, the
government passed the Rent Control Law (P.N.D.L [1] 138) to control the rent payable on single or two-roomed residential
accommodation. This law applied to housing supplied by both the private-rented
market and the state housing corporations such as the Tema Development
Corporation and State Housing Corporation. In fact, the whole idea of rent
regulation goes back to the 1963 Rent Act (Act 220). While these legislative
remedies protect tenants from landlord exploitation, they worked to the detriment
of landlords and investors. Rent controls sometimes destroy the expected return
landlords and investors expect from their investments in housing. Therefore, as
a disincentive to investment, many investors switched to the delivery of
high-end housing, which was unregulated (Willis and Tipple, 1990; Malpezzi,
Tipple and Willis, 1990). Adverse regulation in rent controls can therefore be
considered as a form of government failure believed to be exerting a path
depending effect on the delivery and financing of low and middle-income housing
as has been identified elsewhere by Malpass and Murie (1994) and Mullins
and Murrie (2006).
The adverse effects of rent control are often less apparent
to the general population because these effects occur over many years. Figure 2 presents a stylised neoclassical
economic analysis of the effect of rent control on housing supply and demand in
the short and long run. In the short run, landlords have a fixed number of houses
or accommodation to rent, and they cannot adjust this number quickly as market
conditions change. Moreover, the number of people searching for housing in a
city may not be highly responsive to rents in the short run because people take
time to adjust their housing arrangements. Therefore, the short-run supply and
demand for housing is relatively inelastic (cannot change easily or change is
marginal).
Panel (a) of Figure 2 shows the short-run effects of
rent control on the housing market. As with any price ceiling, rent control
causes a shortage. Yet because supply and demand are inelastic in the short
run, the initial shortage caused by rent control is small. The primary effect
in the short run is to reduce rents. The long-run story is very different
because the buyers and sellers of rental housing respond more to market
conditions as time passes. On the supply side, landlords respond to low rents
by not building new apartments and by failing to maintain existing ones. On the
demand side, low rents encourage people to find their own apartments (rather
than living with their parents or sharing apartments with roommates) and induce
more people to move into a city. Therefore, both supply and demand are more
elastic in the long run.
Panel (b) of Figure 2 illustrates the housing market
in the long run. When rent control depresses rents below the equilibrium level,
the quantity of apartments supplied falls substantially, and the quantity of
apartments demanded rises substantially. The result is a large shortage of
housing. In cities with rent control, landlords use various mechanisms to
ration housing. Some landlords keep long waiting lists. Others give a
preference to tenants without children. Still others discriminate on the basis
of race. Sometimes, apartments are allocated to those willing to offer
under-the-table payments to building superintendents. In essence, these bribes
bring the total price of an apartment (including the bribe) closer to the
equilibrium price.
Conclusion
As a result of
the inability of successive governments to develop housing policies that
stimulate private investment in housing to increase the supply of affordable
housing when government provision has failed due to corruption (Arku, 2009),
have been inadequate or unaffordable to the low and middle-income households,
who are originally targeted by such housing schemes (Sarfoh,
2010), we have recorded huge housing deficits,
over two million according to Ministry of Works and Housing. The result is that
we have more many chasing few rental accommodation, which gives landlords
options among tenants and hence the preferential and rent in advance conditions
required. Therefore, a selfless and dispassionate government that is skilful in
the use of policies and the market mechanism to deliver adequate and affordable
housing is what Ghana lacks.
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