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

Introduction

In part one of this article, we explored a neoclassical analysis of the rent in advance phenomenon in Ghana. While that analysis is valid, it assumes perfect information between landlord and tenants. In the real work, there is unequal information between landlords and tenants. This leads to a confounding result, stemming from the difficulty in disentangling the contribution to the problem due to pure market equilibrium effects (from the interaction of demand and supply) on one hand and cultures that have evolve from the need to mitigate income risk and protect the private property (income) of landlords on the other hand. In other countries, where laws work better, tenants do not pay two or more years’ rent in advance despite market demand for housing exceeding supply. Moreover, an implication of the neoclassical view is that rent in advance must vanish from the market anything that market supply of housing exceeds demand. This has not been the case in all instances and indeed in many instances. Rather, rent in advance appears to have evolved into a form of culture that is embedded in landlord-tenant relationships in Ghana. Thus, in spite of its usefulness, a neoclassical explanation is insufficient in explaining the rent in advance phenomenon. Douglass North sums the argument above in the following:

“Why do people obey the rules of society…when an individualistic calculus would suggest cheating, shirking, stealing, assault and murder should be everywhere evident….Indeed, a neoclassical world would be a jungle and no society would be viable” (North 1981: 11).

Section 25(5) of the 1963 Rent Act (Act 220) makes it an offence for: 

“[a]ny person who as a condition of a grant, renewal or continuance of a tenancy [to] demand in the case of a monthly or shorter tenancy, the payment in advance of more than a month’s rent or in the case of a tenancy exceeding six months, the payment in advance of a more than six months rent…”. 

This provision notwithstanding, the norm in the private rental housing market is that landlord often requires two or more years’ rent in advance from tenants. This is a complete flout of the rent law. In this part, we shall argue that rent in advance phenomenon is a function of the quality of the institutional and regulatory framework of any country. An in the case of Ghana, weaknesses in information referencing and property rights and their enforcement, due to inefficiencies and corruption in the justice delivery system, have contributed in no small way to the emergence of the rent in advance phenomenon. Before we zoom into the analysis, we need to understand what ‘institutions’ are, what they are not and their role in economic exchange. 

What are Institutions?

North asked an important question: “why do people obey the rules of society…when an individualistic calculus would suggest cheating, shirking, stealing, assault and murder should be everywhere evident?” (North 1991: 11). In a historical context, reflections on the nature of institutions in development go back to Veblen’s (1919) reference to institutions as “settled habits of thought common to the generality of men”. In the literature motivated by Douglass North, political, legal and cultural institutions shape economic exchange. A widely accepted definition is the one provided by North (1991), who defines institutions as “the rules of the game in a society or, more formally, the humanly devised constraints that shape human interaction [and which] in consequence structure incentives in human exchange, whether political, social, or economic” (North 1990: 3). In North’s submission, institutions include “…any form of constraints that human beings devise to shape human interactions” (North, 1990: 4). Much recently, Kasper and Streit (1998: 30) defined institutions as “rules of human interaction that constrain possibly opportunistic and erratic individual behaviour, thereby making human behaviour more predictable and thus facilitating the division of labour and wealth creation”. Hodgson (2003) also refers to institutions as “..durable systems of established social rules that structure social interactions”. These social rules include formal, codified and enforceable rules as well as the informal norms of behaviour and social conventions. 

In the case of the private rented housing market in Ghana, the Rent Act (Act 220) and the Rent Control Law (P.N.D.L[1] 138) are major sources of institutions. In the subsequent sections, we shall argue that the ineffectiveness of these legal institutional frameworks have contributed in no small way to the rent in advance phenomenon in Ghana.

Rent Payment in Arrears and the Housing Market as a Credit Market

Unlike goods and services that require upfront payments, credit markets are based on deferred payments and receipts for credit (a form of finance) supplied today. In the real world with imperfect information, uncertain events between when credit is granted and when repayment is due, introduces two types of risk into the credit arrangement – adverse selection risk and moral hazard risk (collectively called agency risk) as explained in part I of this article. When lenders cannot distinguish among borrowers, they ration credit, often by increasing the interest rate to compensate for the risk posed (Stiglitz and Weiss, 1981). In the process, some potential borrowers would be completely rationed out of the market while others would receive just a portion of the amount requested for as a loan. Rationing is the mechanism to mitigate agency risk[1] such as adverse selection[2] and moral hazards[3] as well as the loss of revenue. 

In financial markets like the credit market where payment for goods and services are deferred, institutions complement contracts and laws in allocating value and risks across transacting parties, and thus structuring economic incentives to cooperate as well as to invest (Perotti, 2013). According to North (1991), institutions emerge based on transaction costs and are devised to create order and reduce uncertainty in exchange. The cost of transacting is determined by incomplete information and limited mental capacity by which to process information (North 1995: 18). Thus, when it is costly to transact and opportunism is inevitably or likely, institutions matter. 

The private rented housing market under conditions of rent payment in arrears effectively becomes a credit market and thus subject to rationing by landlords when they lack information to screen prospective tenants. Rent payment in arrears means that the tenant makes payment to the landlord for the use of the property at the end of the period. For a monthly tenancy, this will occur at the end of the month. In his work entitled ‘The Problem of Social Cost’, Institutional Economist Ronald Coarse postulated in what is popular known as the Coarse theorem that in a world characterised by perfect information, zero transaction costs, no wealth effects, the definition and allocation of property rights (a form of institution) is irrelevant to resource allocation (Coarse, 1960). However, institutions in the form of private property rights and their efficient enforcement matter in an imperfect world characterised by imperfect information, wealth effects and positive transaction costs. In other words, when landlords cannot effectively distinguish between prospective tenants in terms of their ability and willingness to pay for the use of their accommodation, as a result of not having full information about tenants, they face an adverse selection problem which could result in the selection of the wrong tenants who will eventually default on rent payments and obligations. In such a case, the landlord’s property rights would be comprised if there were no inefficient mechanisms such as efficient law and courts to enable him/her to enforce his rights. 

Property rights have been defined by Landes and Posner (1987 p.29) as an exclusive right to use, control and enjoyment of a resource, which does not entail further potential benefits of the transfer of property right to others. Rao (2003, p.115) highlighted the characteristics of property rights to include exclusivity, transferability, divisibility, duration and well-developed boundaries of rights and enforceability. The property right structure adopted by a society determines how much the owner’s decision actually affects the use of something, which eventually determines the strength of the rights (Alchian and Demsetz 1973, p.17; Jaffe and Louziotis Jr 1996, p.141). That is why the quality of the institutional framework of countries has been found to be strongly linked with economic development (Levine, 1995) and financial development (La Porta, Lopez-de-Silanes, Shleifer, and Vishny, 1997; 1998). 

Therefore, the quality of information sharing systems in a country influences how strong the legal system that protects property rights should be. In a private rented property market like ours where information about prospective tenants is hard to come by or difficult to verify because of the lack of centralised or national information systems like address systems and credit information systems, landlords are prone to agency risk- adverse selection and moral hazard. Given this risk, an efficient law in terms of both legal rules and their enforcement is required as a substitute to information asymmetry. By efficiency, I mean, it should be easy for landlords to procure binding and enforceable tenancy and lease agreements at lower costs and have access to the law courts with ease to enforce their property rights to rents when tenants default in rent payment. Unfortunately, most landlord and tenant relationships in Ghana are not backed by proper legal contracts that can be enforced in the courts in the first place. In fact, in many case, there are no contracts at all. The cost of legal services is so high that it deters landlords from procuring them. Where there are contracts, the inefficiency and potential corruption of the courts deter landlords from using them to recoup their rents from defaulting tenants. Institutions like the Rent Control Department are quasi-judicial institutions that should provide alternatives to the courts, but I dare say that they are perhaps even more inefficient than the courts. They are perceived as communist departments working in the interest of tenants to the detriment of landlords and investors.

Therefore, considering the high search cost involved in collecting and verifying information about prospective tenants, the high cost of legal services and the inefficiency of the courts and Rent Control Departments, landlords have devised an institution and a culture of taking rents in advance in order to remove any risk of rent loss or risk of incurring search costs as well as legal cost involved in enforcing their property rights in the courts or the Rent Control Departments. When a tenant pays all the rents for a tenancy in advance, the search and legal costs may not arise. The implication is that the weak institutional and governance frameworks are not only a problem at the macro government level but also at the micro household and individual level. It is this weaknesses in the information, institutional and regulatory framework combined with a shortage of affordable housing that have empowered landlords over tenants, who have the preferential and conditional power to set unfavourable rules of tenancy in Ghana. 

So, when Barack Obama spoke about weak institutions in Africa being the bane of development, I am sure he was recommending an institutional analysis of the whole fibre of interactions in our society including landlord and tenant relationship. Today, there are three credit-referencing bureaus in Ghana but how easy is it for landlords to access their services? Are landlords even aware of this information services and how useful they can be to them in screening prospective tenants? Until we begin to understand that the rental housing market characterised by rent payment in arrears in Ghana is a form of credit market and thus like other credit markets require information, regulation and an inefficient legal system to function, tenants will forever be the ‘slaves’ of landlords. 

Way Forward

Going forward, rental information systems must be established and the Rent Control law and Department strengthened and refocused and strengthened with the needed resources both human and financial to administer its mandate. Among other things, the refocusing of the Rent Control Department requires a change of the name of the institutions so as not be seen as antagonist to landlords and investors. I support Richmond’s call for the employment of the right people to the Rent Control Department; preferably, the Land Economists who have been educated at the Department of Land Economy of the Kwame Nkrumah University of Science and Technology. With the right remuneration and institutional reforms, our rental markets will improve to the benefit of both landlords and tenants.

[1] 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. 

[2] Adverse selection refers to a situation where sellers have information that buyers do not, or vice versa, about some aspect of product quality.

[3] 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.

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

More to explore

Leave a Comment

Your email address will not be published. Required fields are marked *

  • Sign up
Lost your password? Please enter your username or email address. You will receive a link to create a new password via email.
We do not share your personal details with anyone.
Scroll to Top