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Laws on Residential Rents in Lebanon. 2014.
Sunday 5 October 2014
Government regulation of residential rent has existed in Lebanon since the country's formation. Densely populated cities all over the world have had, at one point or another, to intervene in order to protect the security of the tenants, so Beirut is no exception. The typical example is New York City, which still has 68% of its rents stabilized or controlled, the latter group having more stringent rent controls than Lebanon.
Two concerns have, in the past, guided Lebanese legislators in their search for a compromise between tenants and their lessors. One was the security of the tenants, which was achieved by automatically renewing rental contracts, and regulating rent levels, and this has been a constant for more than 70 years, in more than 50 rental laws enacted since the formation of the Lebanese state and until 2014. The other concern of the legislators was to ensure a steady supply of new rental housing units, by maintaining sufficient profitability for investors in this sector.
The rent law of 9/5/2014
The new rent law (the Law) of 9/5/2014 totally disregards the interests of the tenants and advocates brutal changes in rent levels that cumulate in our case-study to around 2500% increase over the old rent after 6 years, to be distributed in this manner: 375% (which equals 15% of the rent differential) per year for each of the first 4 years, and 500% (20% of the rent differential) per year for each of year 5 and 6. Rents would be stabilized at their levels in year 6 for a period of three years, at the end of which the rental contracts would be terminated and the lessors could evict the tenants from their homes with no compensation.
The true beneficiaries of the subsidies
In order to assuage the critics who would decry the inhumanity of a decision that will put tens of thousands of families in the street, the legislators have included in their proposal a fund to subsidize the "needy" tenants. This, however, is clearly a discriminatory measure. There are people who are poorer than these tenants, some with much greater need for help. Why doesn't the government also give them subsidies, grants and donations? Can we become a welfare state when we can't even pay well-deserved raises to public employees? On the basis of what criteria was the prioritization of social needs made?
The truth of the matter is that the owners will be the sole beneficiaries of these subsidies. After all, the money will go directly to the pockets of the owners, whereas the needy tenants will keep paying the same rents until the end of the subsidy program, at which time their contracts are eventually terminated and they are faced with eviction.
On how the new law defines a "needy tenant".
The new law defines a "needy" tenant as one whose household income is below three times the minimum wage (approximately 3 X 675,000 LBP = 2,015,000LBP or $1,344). The subsidy will only partially cover the rent differential for those tenants whose household income is between 2 to 3 times the minimum wage, (between $896 and $1,344). For those whose income is below 2 times the minimum wage ($896), the subsidy covers the whole differential.
Those tenants whose income is more than 3 times the minimum wage (3 X $448 = $1344), are not "needy" according to the new law and the Constitutional Council. A family whose total household income is $1,400/month will not receive any subsidy, and will find itself, in less than six years-time, forced to pay a rent that may well exceed its total income, or to relocate. Where will they go? Where can they find lodging they can afford, given the huge increases in real-estate prices that resulted from speculative inflows rather than from the growth of local effective demand? To add insult to injury, they will have to incur higher direct taxes, through increases in VAT, for example, in order to finance the subsidies that will go directly in the pockets of the people who put them in the street. These tenants belong for the most part to the lower middle class or average middle class, that is, to the most productive and dynamic elements of society.
Additional burden on the citizen-taxpayer
More generally, the subsidy deception will only add to the injustice, as these subsidies will be financed through additional taxes that, in the highly regressive Lebanese system of taxation, will put a greater burden proportionately on the poorer and productive classes. People who are neither tenants nor lessors will have to pay higher taxes in order to help resolve a conflict that in no way concerns them. Legislators are acting in this regard as if public expenditures have no effect on the citizen-taxpayer, as if they were financed by manna from heaven. The truth of the matter is that every consumer, every taxpayer will suffer to feed this fund. Or, even worse, the money will have to come from greater indebtedness, which means that our children will eventually have to pay for the passage of this unjust law that rewards the rich and punishes the poor and lower middle classes.
There is no economic or social justification for such a huge transfer of wealth from poor to rich, and from productive to non-productive classes. It should be noted here that owners of rented apartments should not be confused with real estate developers and contractors who do have an important productive function to perform.
Bureaucratic solution
It should be stressed, finally, that the bureaucratic aspects of the proposed law are simply nightmarish. To begin with, a file will have to be opened for each of the tens of thousands of housing units that are classified as "old rents", and unless lessors and their tenants can agree on a value for the property, an appointed committee (the Committee) will be put in charge of estimating the property value (V). The new rent (NR) is then calculated at 5% of (V).
The Law stipulated that the decisions of these committees were not subject to appeal, but the Constitutional Council declared this to be unconstitutional. It is interesting that the same non-appeal clause existed in Law 117/91 that established Solidere. Under Law117/91, committees estimated the value of property to be expropriated to the benefit of Solidere, and there was no recourse even in cases of abuse of power. Law 117, however, was not amended at the time to remove this clause. Does it mean that the Constitutional Council now finally recognizes that fundamental provisions of Law 117 were unconstitutional, and could this lead to legal actions by the owners and tenants expropriated under Law 117 to have their case reviewed by the tribunals?
The decision of the Constitutional Council, while correct, in so far, and only in so far, as the committees are concerned, means that there will be recriminations, counter-estimates, appeals, conflicts, abuses and administrative chaos. The committees will have also to determine who is needy by estimating the household incomes. Given the tribalism, nepotism and corruption that have plagued the public sector, and the high proportion of undeclared income in some cases, one can imagine the abuse, favoritism and mishandling that will occur in the implementation of this process. This indicates how fundamentally flawed this new law is, since invalidating one unconstitutional article in it, will result in bureaucratic havoc.
Inequitable allocation of government resources
Most importantly, can the government find the money for these subsidies? The government is incapable of paying long overdue increases in wages and salaries in the public sector. Its ratio of debt to GDP is among the highest in the world. It is incapable of providing water to its citizens, and let us not hasten to blame the heavens for the lack of tap water. The water is scarce, true, but it is here. It is just arriving by trucks and not through the normal distribution network. No money to pay the workers and no money to improve the water distribution networks, but money can be drawn from the pockets of the poor and lower middle classes to give to the idle rich. Our rulers make Queen Marie-Antoinette look like Mother Theresa in comparison.
I present below a quick evaluation of the social and economic aspects of Decision No. 6/2104 rendered by the Constitutional Council on the constitutionality of the new rent law of 9/5/2014. I conclude with a proposal for a simple and fair solution to the crisis.
On how the CC characterizes the old system of rental laws
The characterization by the Constitutional Council (CC) of the old system of rent laws as "laws of exception" or "special laws" is one of the arguments used by the CC to deny the old tenants the legal security (sécurité juridique) given them by more than 50 laws enacted before 2014 and to justify the reversal of these laws that gave tenants a secure lodging. In the words of the CC: "…the old residential building rent law is more a loi spéciale than a law of exception, because of its continuity after starting exceptionally after the second world war, as a result of the scarcity in residential housing and the reduction in supply; this explains why the tenant was considered the sole and absolute victim, at the expense of the owner, and why the property owners abandoned rental housing and moved instead in the housing sales market." (Official Gazette, Supplement to issue No. 34, 19/8/2014, page 5).
A number of comments on the CC characterization are in order:
Clearly there is a difference of opinion among members of the CC as to how to characterize the old system of rent laws. One opinion is that they are laws of exception. The quoted passage from the CC report rebuffs this argument by admitting the continuity of these laws. More than 50 laws over more than 70 years reiterating the same kind of rent controls and regulations, can not be considered exceptions. They are the rule. In order to get around this problem, the CC introduces the concept of special law, which according to them is a more correct characterization of the old system of rental laws. Special laws are coercive in their nature and are in response to exceptional circumstances, and therefore, temporary in their nature. They also would normally require a higher majority for their enactment than normal legislation. Does the old system of rent laws fit this characterization?
The old system of laws did not require higher majorities then normal for their enactment. The more than 50 Lebanese rental laws were, routinely enacted with normal majorities.
There was nothing exceptional or special about them, as they all reiterated the same principles: security to the tenants by automatically renewing their contracts, government intervention in determining increases and decreases in rent levels after the initial contract was freely signed by both parties, and finally lessors could reclaim their apartments only in certain special situations and only against a substantial compensation (usually a multiple of 7 to 12 times the differential between old and new rents. After 1992, compensation was estimated at 25%-50% of the value of the apartment if vacant). Each law covered a limited period of time, true. This, however, was not because state regulation of the housing market was in response to exceptional circumstances, but in order to allow legislators to adjust the levels of rent to the normally evolving conditions in a densely populated area, while still respecting the principles mentioned above.
The statement by the CC "..after starting exceptionally after the second world war, as a result of the scarcity in residential housing and the reduction in supply,.." contains many inaccuracies:
1-Regulation of rental laws was not started exceptionally after the war as was claimed in the CC report. Laws regulating rents predate the war and others were started at its beginning (Decision N.213 of 12/10/1936, Law of 11/5/1938, legislative decree No. 25 of 5/1/1940, legislative decree 134 of 31/12/1941 and legislative decree 288 of 11/12/1942 are examples of such legislation).
2-There was no exceptional scarcity due to the Second World War as the CC statement claims. Exceptional scarcity and limited supply of rental units would have resulted in steep increases in real estate prices and rent levels and, therefore, in government intervention aiming at decreasing rent levels. The rent regulations during and after the war, however, aimed at increasing rents very substantially, and not at decreasing them! It is only in 1948 and 1951 that legislators used mixed measures, increasing rents for some categories and reducing them for others. There was, thus, no particular scarcity in the early period of rent controls as the CC claims in order to justify its characterization of the old system of laws as 'special laws". In any case, scarcity of land and property is the rule in densely populated areas, which is why there was constant arbitration by the Lebanese state of tenant-owner relations.
3-The property owners did not abandon the rental housing market as a result of government regulations, as the CC claims. Tens of thousands of rental contracts were initially signed after this early period. The CC does not have its facts right. Housing sales became prevalent only after the enactment of Law 160/92 that freed all new rents from state regulation. People in need of housing were strongly reluctant to be put at the mercy of their lessors, who had the right after 3 years (the contract period) to ask for any rent increase. After 1992, families in need of housing, bought apartments instead of renting, when they could afford to do so. Those who rented in the category of new rents had to be rich enough to afford it, and lived in total apprehension as to what their next rent levels will be. As to the others, those who could not afford to buy or rent, they are probably trying to get an immigrant visa to a country that has a bit more respect for the welfare of its citizens and for the principle that the right to housing is a fundamental right. The facts indicate that the old system of laws managed to maintain a steady supply of rental units and that it was rent deregulation that impeded the growth of residential rental housing.
There was no coercion in the old system of laws. Owners freely chose to enter the regulated rental housing market, and were flocking in great numbers into it, in the full knowledge of what they were getting into, and they did so because it was a highly profitable investment, as will be shown below.
Conclusion on the characterization of the old system of laws
The old system of rental laws was not composed of laws of exception, as the continuity in legislation does not allow such an interpretation. The CC characterization of the pre-2014 laws as "special law" is based on inaccurate facts: regulation of rents started well before the Second World War, there was no exceptional scarcity at the time, owners did not stop investing in regulated rental housing, and the owners were not coerced into their relation with the tenants but freely decided to enter into such relations under the arbitration of the state.
The correct characterization of the old system of laws is that of continuity in legislation and constant jurisprudence (jurisprudence constant) as more than 50 laws reiterated the same principles protecting the tenants from eviction or from unbridled increases in rent levels. These were brutally reversed by the 2014 law. True, the European Court for Human Rights considers that a dynamic and progressive interpretation of laws could reverse a constant jurisprudence. This reversal, however, according to the Court, has to be motivated and justified, in order to be legitimate. It is on this issue of justification and motivation that both the 2104 law and the CC report fail to substantiate their claim that the old laws were unbalanced and unfair to the owners, and fail thereby to establish the legitimacy of the reversal. A few remarks are needed here, before I turn to the fundamental question of the fairness of the old system of laws.
On legitimate expectations of owners and tenants
The CC argument that the tenants should have known better, and that they should have expected that the laws would be reversed, and prepare for this eventuality, is a biased judgment. One can more easily argue that it is the owners, professional investors, who should have known better, and in truth they did know better, and when they freely chose to enter the regulated rental market, after years and years of constant jurisprudence regulating the market, they did so with the expectation that their relation with their tenants would continue to be regulated by the state. They planned for this contingency, as any investor worth their salt would, and only entered the market under conditions that secured a high rate of return on their investment.
The tenants had "legitimate expectations" that the constant jurisprudence would be maintained. It took a defunct and illegitimate parliament to pass a law that reversed the laws and decrees enacted for more than 70 years. The new rent law is no more legitimate than its proponents in the parliament, as it is a fruit of the poisoned tree.
On the matter of the arbitration of tenant-owner relations
The fact that the CC failed to convene to render a decision concerning the constitutionality of the law passed by the members of parliament to extend their own mandate without the consent of the electorate, has weakened its credibility, as it leaves the CC open to the accusation of "denial of justice" (déni de justice).
Furthermore, the CC has given itself the prerogative of arbitrating a social conflict, though normally, disputes between two parties should be settled between themselves, or through arbitration with judges or lawyers they select. An entity like the Economic and Social Council, which, for reasons unknown, has been deactivated for years, should have been asked for its advice on an issue of such enormous social consequences. Tenants associations should have met with owners associations to discuss matters and offer proposals and counterproposals in trying to reach a compromise. In any case, tenants should have been a party to the elaboration of a new rent law. People can't really have a feel for an issue that no longer concerns them, no matter how moral they are in principle.
Judges have been the recipients of preferential treatment from the banks, receiving housing loans in Lebanese pounds at very low interest rates (between 1.628%. and 2.128% depending on the bank). They have for the most part secured their own housing. Even though one can only applaud initiatives that give judges security in their housing, this does not put them, however, in the best position to arbitrate a conflict between tenants and owners. It is a very normal reaction to become insensitive to a social issue if one no longer shares the concerns of one of the parties involved.
As to members of parliament who elaborated the new law, they apparently only heard the complaints of the owners, who they meet in the "salons" of high society, and have, unfortunately, become deaf to the suffering and anguish of the middle class they are helping to eradicate.
The crux of the matter in the question of constitutionality
In the final analysis, the arguments of the CC, whether in regard to allowing the reversal of constant jurisprudence, or in refuting the applicability of the principle of "sécurité juridique", are based on the premise that the old system of laws was unjust to the lessors and that the new law corrects this unfairness and proposes a more balanced solution.
The CC arguments that owners were victimized on the basis of abstract legal principles
The CC builds its case that the owners were victimized by the old system of laws, on the grounds that these laws were encroachments on the rights to private property and violated the principle of contractual freedom.
The principle of contractual freedom was reaffirmed in the context of rent contracts in Law of 22/7/92, but the text of the law itself contradicts the principle that it is trying to reaffirm, as it puts restrictions on some aspects of the rental contracts, namely their duration (three years minimum), and on the ability of the landlords to raise rent levels during this period.
The sanctity of private property is not absolute either. People can be forcibly dispossessed from a property if the action is publically useful and if the expropriated owner is compensated fairly.
So, deviations from these principles are routine occurrences.
The CC readily admits that the two principles suffer exceptions, but it maintains that measures that encroach upon them are only legitimate, if they are publically useful (d'utilité publique), and if they offer a fair and balanced solution in a situation involving two parties, and not resulting in one party abusing the other. They reject the "securité juridique" argument on the same basis, namely that the old system of laws was not balanced or fair. In order to avoid circular reasoning the CC would have to establish unfairness to owners on other grounds than on the basis of these abstract principles.
The implicit argument by the CC that rent differentials imply that owners were unfairly treated under the old system of laws
The CC presents its judgment that the old system of laws was not balanced and was unfair to owners as a self-evident truth without any substantiation.
Presumably, although they do not bother to explicitly say so, their evidence that the owners were abused is the existence of a large differential between regulated old rents and current unregulated rents for comparable premises. They imply, by their refusal to even discuss the issue, that they consider that rent differentials are more than prima facie evidence (enough evidence for a case), but are res ipsa loquitor (need explain no more). I shall show below that rent differentials do not contradict profitability, and that the owners who freely entered the rental market, knew what they were getting into, and managed to obtain very high profits from their leased apartments by extracting higher initial yields from their tenants as a premium for the security given them by the system of rent controls. This profitability was obtained even though the system inherently developed very high differentials between old and new rents over time.
The fallacy of using rent differentials as significant evidence
Comparing rents of apartments in the controlled rent category to new rents, or even to regulated rents initially contracted in a different time period, is like comparing apples to bananas. To make the case for the victimization of owners based solely on rent differentials, is not essentially different from saying that owners who sold their property 30 years ago are now victimized because the new owner managed to sell that same property at 20 times his purchase price, and that the old owners should now be compensated for this.
The fixation on rent differentials has also led legislators to make totally inequitable adjustments to rents. Thus, Law 160/92, enacted after the huge devaluation of the late eighties and early nineties, multiplied the older rents (with very high differentials) initially contracted before1954 by a factor of 165. Those initially contracted between 1984 and 1985 (with lower rent differentials) were multiplied by only 24, even though they suffered an immediate and enormous loss in their rental income, whereas the older rents had returned their initial capital a number of times already. This category of owners suffered from inequitable rent adjustments, and ironically this inequity resulted from the fallacy of equating rent differentials with reduced profitability.
Burden of the proof
Once it is established that rent differentials in the late years of an investment, are compatible with high profitability- and I hope that the evidence presented below will show that this was generally true- the case for prima facie evidence falls apart. The burden of proof will, then, lie squarely on the shoulders of the Council and the members of parliament to go one step further in their analysis and show that rent differentials did in fact cause actual losses to the owners or to certain categories of them.
The welfare of the owners is measured by the profitability of their investments, or lack thereof, in the regulated rental sector. The only rational way to determine if the owners suffered financially under the old system of laws is to consider their cash flows from the initial year of contract signature to the present, and to calculate their rates of return using traditional tools of financial analysis and planning. I shall endeavor to show below that the occurrence of large rent differentials over time, that was inherent in the old system of rent laws, did not prevent the investors in the regulated rent market from achieving a very high profitability, despite or because of the state arbitration of the tenant-lessor relationship. -
The situation of owners under the old system of rent laws.
Whereas owners expropriated by the state are forced to surrender their property to the state, lessors were not coerced into leasing to their tenants, but freely decided to enter the regulated housing market. Lessors had the option to invest in the furnished apartments sector which was not regulated, or they could have waited on their real estate holdings to increase in value, or they could have left their money in the bank, or bought stocks or bonds. They chose instead to enter in a long-term agreement with tenants, the terms of which were arbitrated by the state.
By depicting these investors as victims of the system, the CC is not doing justice to their business acumen. Our landlords are very sharp businessmen and my contention is not only that they should have known better, but that they knew very well what they were getting into, and that they only entered the regulated market because they found a way to make it highly profitable to do so.
Profits due to higher initial yields
Unlike some other countries where the rent levels in the initial rental contracts are controlled by the state, initial rent levels in Lebanon are determined by the market forces, that is, by free agreement between tenants and landlords. The crux of the matter, is that owners were able to make very high profits in the regulated rent market, as a result of their ability to extract a higher initial gross yield or ratio of rent (R) per apartment value (V) than in the unregulated market, because the tenants were willing to pay a premium for the security given them by the state regulatory controls. Some data and examples will clarify this.
Data on gross rental yields
Picketty's data shows that R/V, or gross yields, was 5% historically, but that it had fallen in the twenty-first century to an average of 4.5% (Capital in the 21th century. Harvard University Press, 2014. Pp. 54-55). In the unregulated rental market of today gross yields have fallen even more. The Global Property Guide gives the following figures for gross yields:
In central London gross yields vary between 2.09% and 3.25% depending on size. The yields are higher the smaller the apartment.
In non-central London, yields vary between 2.54% and 4.36%.
In Paris yields vary between 3.39% and 3.67%.
The Global Property Guide data on Beirut shows rental yields to have been between 3.7% and 4.7%, but have decreased considerably recently and now range between 2.7% and 3.5%.
Rent Law of 9/5/2014 calculates fair rent at 5% of the estimated value of the apartment.
Historical data on gross yields for regulated rents is not readily available, but a sample from my neighborhood indicates they were as high as 10% in the late sixties, and they may have been as high as 12% in the early seventies in other areas of Beirut. Table 1 below compares internal rates of return (IRR) for investments in regulated and unregulated residential rents under alternative assumptions about gross yields and average rates of increase of real estate prices. These are not meant to be exact figures (these will be given for apartments in my neighborhood in Table 2 below), but they give an understanding of how differences in yields can more than correct for the differentials in rents (between regulated and unregulated rents) that appear in the late years of the investment.
Illustrations of the significance of yields. Seven scenarios.
All examples begin with an investment of $20,000, the price of an apartment that is then leased. In the regulated rent examples, gross yields are 10% or 12%. Rents are then nominally fixed. Unregulated rents are assumed to have gross yields of 4% or 5% with rents increasing at annual rates of 3%, 5%, 6% or 6.5%. The investment period is considered to be 26 years, at the end of which the residual value of the apartment is estimated to be equal to V/R, or 1/yield, multiplied by the rent in Year 26. The rent for year 26 is then added to the residual value to obtain the cash flow for year 26.
The IRR's for the different scenarios are as follows:
For regulated rents, the IRR's are 10% and 12% respectively, for gross yields of 10% and 12%. This is expected as rents are assumed to be nominally fixed.
For unregulated rents and gross yields of 5%, the IRR's are 10.87% and 11.36%, for rents increasing at annual rates of 6% and 6.5% respectively. The results above show that the rates of return in the unregulated rental housing reach those in the regulated market only when gross yields in the former are 5% and the annual rent increases have a high average rate of 6 to 6.5%.
The rates of return in Table 1 for regulated markets are underestimated for three reasons:
1. Legislators would normally raise regulated rents after a few years have elapsed since the initial rental contracts are signed. This was neglected in our examples.
2. Sometimes old tenants leave, or the apartment becomes vacant for reasons of death, or the owners can reclaim the apartments for one of three reasons. This will push the rate of return for the lucky owner above the IRR's shown in the table.
3. The formula for calculating residual value is an acceptable approximation when calculating the value of the apartment in the unregulated market. It strongly underestimates the price that owners could obtain by selling the apartments to their tenants in the regulated rental market. Tenants may be willing to pay up to 50% of the price of their apartment - estimated at the current price it would fetch if vacant - for the security and mobility that ownership of their apartment will give them. This would raise residual values to $47,000 and $47,400 for scenarios 1 and 2, and raise the IRR to 11.08% and 12.83% respectively.
Indirect evidence for the existence of greater yields in the regulated sector.
In the absence of precise historical data, the scenarios shown in Table 1 remain hypothetical. They do, however, illustrate how the owners managed to obtain very high profitability under the old system of rental laws. They were able to extract a premium from the tenants for the security that state regulation gave them. The evidence for the existence of this premium is in the very large number of old tenants, and of regulated rental contracts that were freely signed by the owners. Owners kept returning to the regulated rent sector. This implied profitability that could have been obtained only through high yields.
Table 1
On how the owners managed to achieve high profitability in the regulated rent sector.
The owners squeezed their profits in the first years of their investment, knowing fully that rent differentials would grow with time. The returns of the early years of an investment weigh more than those of later years in the calculation of profitability (IRR). That is the explanation why the owners can achieve high profitability even though their rental incomes become very low in real terms in later years.
For the CC to justify the reversal of the constant jurisprudence that, for seventy years, and in more than 50 laws and decrees, reiterated the principles of state regulation of the relation between tenants and owners, the CC has to show that owners suffered financially under the old laws. The complaints of the children of the original owners, who inherited most of these regulated rents, are not evidence of injustice. Their frustration with the rent differential is even understandable. The fact is, however, that their parents, the original lessors, extracted most of the profits from their leases in the first years of their investment, leaving to their children apartments with rental incomes gradually falling relatively to similar vacant apartments.
Case-study of an apartment building in Beirut.
Table 2 presents a case-study for a typical apartment in one building of Gemmayzeh, for which precise historical data was available. The data, given in LBP and their USD equivalent (calculated on the basis of Central Bank series on historical exchange rates), indicate the following:
The apartment value was around $20,000 in 1967. At least it was offered at this price, but there were no takers at the time. It is valued today at around $600,000 if free of tenants.
The apartment was leased for $2,000 in 1968. Rent levels are shown in LBP and their USD equivalent, for the period 1968 to 2014. Gross yield was 10%.
Rent levels were changed following state dictated increases. Those increases initially were unsystematic responses to emerging differentials and devaluation of the LBP, but after Law 160/92 was enacted, they were linked to half the increases in the first portion of the cost of living adjustments to minimum wages.
There were different interpretations of the law of 2012 concerning rent adjustments for this date. The issue has not been settled yet. I adopted the interpretation giving the lowest figure of 12.85%, rather than the largest of 50%. This, in any case, does not affect the value of the IRR in any noticeable way.
Several variants of the residual value of the investment at end of year 2014 were calculated, but all were calculated under the assumption that the old system of laws was still in force and the new law had not been enacted. The variant shown in Table 2 assumes that the apartment could fetch half the value of a similar but vacant apartment, or $300,000, if sold to its tenant. This will become relevant in the next section of this article. The IRR's for variants using residual values of $20,000, $100,000, $150,000, $200,000, $250,000 and $300,000 were calculated at 8%, 8.94%, 9.34%, 9.65% , 9.92% and 10.16% respectively.
Burden of proof
Our case-study and our different scenarios have shown that rent differentials do not imply that the lessors were treated unfairly, and or even that they suffered an opportunity loss. In fact, it would take yields of 5% and average rent increases of 6-6.5% per annum, for rates of return in the unregulated market to become comparable to those in the regulated rent market in Lebanon. So what the CC presented (implicitly) as prima facie evidence of unfairness to the lessors, is invalidated by the facts that the owners freely and knowingly chose to enter the regulated rental market, and by imposing high initial gross yields on the tenants, managed to obtain high rates of return on their investments, despite the growth of large rent differentials over time.
In order to justify reversing seventy years of constant jurisprudence, the CC has to provide financial analysis of profitability, based on actual historical data, that shows that the owners or one sub-category thereof did suffer under the old system of old rental laws. The burden of proof lies squarely on their shoulders. Unless they are able to do so, and the evidence indicates this is unlikely to happen except in a few special cases, the whole edifice of their legal sophistry, crumbles into a set of circular and unsubstantiated arguments.
Numbers do not lie. Owners achieved very high profitability in the regulated rental market.
The results of Table 2, and for all the variants used in estimating the residual value, all show that owners managed a very high rate of return on their leases. These very high returns were obtained despite the very low rents that resulted from the huge devaluation of the Lebanese pound or from the growth of rent differentials over the years between free and controlled rents. Fixation on rent differentials and superficially looking at the very low levels of rent in our series, that reached levels as low as $8 to $9 per year, is obviously misleading. The proper and rational way of analyzing the situation of the owners under the old laws, is to calculate the IRR for their investments from the time of their initial contracts until today. The significance of the IRR and its importance can be seen more clearly in Table 3.
Whereas the value of apartments in the Gemmayzeh building increased by a factor of 30, from $20,000 to $600,000 in 46 years if left vacant, the $20,000 value of the leased apartment increased to an accumulated amount of $689,482 or by a factor 34.47 over the same period, under our unrealistically low estimate for residual value. This was calculated by multiplying the initial value by (1+IRR) raised to power 46. If we use for residual value, the amount of $300,000, or half the current value of the apartment if vacant, then the IV of $20,000 grows to an accumulated amount of $1,714,473, or by a multiple of 85.72. Investments in equity, which bring an average return historically of 7%, would have produced a multiple of only 22.5 times the IV. Investments in bonds (6%), or leaving money in a savings account (5%) would have brought even less (multiples of 14.6 and 9.43 respectively). The reason for considering an amount of $300,000 for residual value, will be justified in the next section.
Table 3
A simple and fair proposal to resolve the conflict between owners and their tenants
We now have the elements for the elaboration of a simple and fair solution to the residential rental housing problem.
The proposed solution is based on the indefinite extension of the amended law 160/92 subject to the additional conditions enumerated below. Law 160/92 after imposing strong increases in rents to correct for the devaluation of the Lebanese pound during the late 1980's, linked further increases in rents to cost of living raises in wages and salaries, thereby establishing a precise and systematic method of calculating rent increases. In addition to the extension of Law 160/92, the present proposal stipulates the following:
All current expenses will be paid by the tenants.
The rented apartments share in costs of rehabilitation of infrastructure, equipment purchases, renovation, will be fully born by the tenants. They will be given, however, the choice between making a lump-sum payment for the whole amount of their share in costs, or of incurring a rent increase equal to 10% of the same amount.
In both cases above, the tenants will have the right to participate in the decisions and oversee the execution of the works. The scope of the infrastructure works and of rehabilitation will be decided, however, by owners alone up to certain levels.
Municipal taxes should be imposed on the regulated apartments on the basis of the value of the apartment if vacant and not on the basis of current regulated rent levels.
Should the owners not be satisfied with the conditions of their lease under the extended Law1992/160, the proposed solution offers them the possibility of reclaiming their property against compensation. The owners can, at their sole discretion, offer the following deal to tenants: The owners will provide an estimate of the value of their apartment as if vacant. This estimate will not be subject to revision. The tenant, within one year of this offer, will be obligated to select one of the two following options: buy the apartment for half the estimated price or accept an indemnity equal to the same amount in order to vacate the premises and end the rental contract. The tenants will be given enough time to find the financing if they decide to buy, or to seek alternative housing if they accept the indemnity to vacate their old lodging.
Law 160/92 stipulates that compensation should be no less than 25% and no more than 50% of the value of the reclaimed apartment, but had stringent conditions under which an apartment could be reclaimed. It seems only fair that where owners are given unconditional and sole discretion in exercising the right to reclaim their property, the compensation should be calculated at 50% of the value of the property, the higher end of the range prescribed by Law 160/92.
Evaluation of the proposal if owners exercise their reclamation right.
The example shown in Table 2 will be used to evaluate the proposed solution, from both the tenant's and the owner's points of view. It is clear that under the conditions of the proposal, the residual value to use in calculating the owner's IRR is $300,731, as shown in Table 2. This is because the owner will gain $300,000 in net asset, whether the tenant chooses to buy or vacate the apartment.
1. The point of view of tenants.
Tenants face two options if their lessors exercise the right to reclaim the apartment they lease. They can select Option A, that is take $300,000 and vacate the premises; or, if they have access to financing (the Housing Bank has been recapitalized and is again giving housing loans), they can select Option B, that is, pay $300,000 to the owner and buy the unit. In the case of Option B, if they have to take a loan, they will incur higher annual payments than they were used to, but they will end up owning their homes. If they select Option A, they would be able to relocate outside of Beirut and use their indemnity to purchase a large apartment there, or buy a smaller one in Beirut itself. In all cases, the tenants will suffer higher financial costs, or disadvantages of harsher winters and longer hours driving on congested roads, or smaller accommodations. They will, however, gain greater mobility, and the security and tranquility of owning their own homes.
2. The point of view of owners.
Whether the tenants select Option A or B, the owners will gain $300,000 over and above the rent in 2014. This may be inferior to having $600,000 in 9 years, as they would have under the new law, unless they can manage a rate of return of 8% or more on their investment of the $300,000. So they may be expected to resist this proposal especially that their expectations have been raised by the new law. The proposal, however, guarantees them a very high rate of return of 10.16%, as shown in Table 2. It would have allowed them to gain an accumulated value $1,714,773 or more than 85 times their initial investment of $20,000. This represents almost 3 times what they would have gained had they left their property vacant to benefit from the large increases in real estate prices.
Adjustments in the proposal for special categories of owners who were unfairly treated
The proposal presented above is generally a fair solution to the owner-tenant problem. There are categories of tenants who have, however, suffered unduly from inconsistent legislation in the past or because of the fixation on rent differentials. This, as I mentioned above, was the case of owners who initially contracted with tenants in the late 1980's. The proposal above can be adjusted to reduce the inequities that are uncovered in these special cases. The adjustments can take the form of increases in rent levels, or in changes on how the split between tenants and owners is calculated, should the latter decide to exercise their right to reclaim their property. Instead of a 50-50 split, a 60-40 split could be envisaged. It is, however, up to the owners who fall in these categories to present their case and establish they have suffered inequitable treatment. The adjustments to their situation will, then, have to be determined on the basis of the merits of their case.
The proposed solution is fair to both tenants and owners. Its application is simple and straightforward, does not leave room for estimation biases and avoids bureaucratic abuses. By giving the tenants protection under the law, it removes their pretext for refusing to participate in the improvement and rehabilitation of the buildings they reside in. It will go a long way to help achieve the desired goal of making most residents of the capital owners of their own homes. It will achieve all this without creating an additional heavy bureaucracy, without putting an additional burden on the finances of the state, or, through higher taxes, on its citizens. It avoids a very painful social crisis that can only result in conflicts and upheavals as the lower and middle classes are brutally marginalized and forced out of the city. It does all this while giving the property owners an excellent rate of return on their investment.
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