Why do Landlords in Ghana charge Two-Years’ Rent in Advance? Neoclassical and Institutional Perspectives (Part I)

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).

Source: Mankiw (2014). Principles of Macroeconomics

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. 

Kenneth A. Donkor-Hyiaman

Kenneth A. Donkor-Hyiaman

Dr Kenneth A. Donkor-Hyiaman is a Real Estate and Urban Economist and a Lecturer in Real Estate Finance and Real Estate Development at the Department of Land Economy, Kwame Nkrumah University of Science and Technology, Kumasi. kwakuhyiaman2@gmail.com +233(0)508043011

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