In the Union Budget 2019-2020, the government had announced that it will come out with a Model Tenancy Law to safeguard the interests of both landlords and tenants and develop the rental housing market. Subsequently, the Draft Model Tenancy Act 2019 was issued and circulated among states for their comments. The government has maintained that the current rental laws are archaic and need to be reformed to expand the supply of quality rental housing and fulfil the goal of Housing For All by 2022. With the Union Cabinet giving its approval to the Model Tenancy Act, the process of reforming the country’s rental market has been firmly set in motion.
Rent controls have lowered rental yields
The relationship between landlords and tenants has historically been governed by the Rent Control Act, passed in 1948 by the central government and subsequently implemented by states. Over the past several decades, state governments have made modifications in their respective laws, in keeping with the principle that land is a state subject. However, these laws are widely considered as overly tenant-friendly with restrictions on eviction of tenants and revision of rents, among other things, even though rights of landlords are also defined.
While the initial objective of placing rent controls was to protect tenants from exploitation by landlords, these laws have, over the years, caused distortions in the land market and kept rents low even as house prices have risen. As a result, at 2-3%, gross rental yields in India are some of the lowest in Asia. Property developers have widely adopted the ‘Build-to-Sell’ model due to the prospects of low rental income and profitability. Inadequate supply of quality rental housing means that a significant proportion of the urban population continues to live in informal settlements. These are the larger issues that the new tenancy law seeks to address.
Model Tenancy Act ticks the right boxes
The new law has several progressive provisions that have the potential to transform the rental housing market. The key features of the law are:
- Tenant will give a maximum of 2 months’ rent for residential property and a maximum of six months’ rent for commercial property as security deposit
- Written agreement between the landlord and tenant is mandatory
- Landlord cannot revise rent in between the rental period and three months’ notice has to be given before revision of rent
- Landlord is responsible for fixing structural damages in the property and undertaking whitewashing, painting of walls, doors, etc.
- Tenant is responsible for repairs including kitchen fixtures, glass panels, maintenance of open spaces; must notify landlord of any damage to the premises on an urgent basis
- Landlords cannot evict tenants during the contract period and stop providing essential services such as power and water
- Landlord is entitled to double of monthly rent for 2 months and four times the monthly rent thereafter if tenant occupies the property even after termination of tenancy
- Tenant can sublet premises only with the prior consent of the landlord
- Appointment of a Rent Authority with previous approval from State or Union Territory
- Setting up of Rent Courts by states to settle disputes within 60 days of receiving the complaint
Step in the right direction; more incentives needed for ‘sunrise sectors’
The Model Tenancy Act is a step in the right direction and could gradually transform the rental housing market over the medium to long term. Greater formalization of the industry and investments in new business models could be witnessed over the next few years. The law will not affect existing tenancies but is likely to facilitate more efficient usage of vacant houses. However, the government needs to provide additional incentives, on the lines granted earlier to IT Export Units and SEZs, to drive growth of ‘sunrise sectors’ such as multifamily housing, co-living and student housing. Once such incentives are put in place, developers might gradually adopt the ‘Build-to-Rent’ model given the prospect of stable rental income over the long term. As the sector matures, institutional investors will also start funding multifamily projects aimed at millennial families. For instance, as more millennials get married, entire buildings or towers in a residential complex could be rented out to families. This would translate into a vibrant small neighbourhood including community spaces, shared utilities and amenities.
Global examples of multifamily housing show the potential impact the new law could have on the Indian rental housing market provided additional incentives are given. For instance, according to the National Association of REITs, the multifamily segment is valued at around US$2.9 trillion in the US, by far the most mature market globally. The segment attracted around 34% of institutional capital in 2020, the highest among all asset classes. In the APAC region, Australia is a fast-emerging multifamily market helped by structural changes that support growth of rental accommodation. The segment offers gross rental yields of around 6.5% and recent incentives such as 50% lower land tax and exemption from foreign investor surcharges until 2040 is driving investments.
The law will also increase private participation in the housing industry, including agencies specializing in asset management and maintenance. This would have favourable implications for greater employment generation and growth of the real estate services market supported by a well-defined legal framework.
Proper implementation of the law needs to be ensured
The Model Tenancy Act makes a genuine effort to address the thorny issues pertaining to landlords and tenants and address the imbalances that have crept in over the past several decades. Capping of security deposit at two months’ rent and non-eviction during the contract period will be a major relief for many tenants. The provision of higher rental payment in case tenant does not vacate the premises and the provision of time bound dispute settlement through dedicated rent courts will be welcomed by landlords. A large proportion of current tenancies do not have legal backing since there are no written agreements; this puts tenants, migrant workers in particular, at a severe disadvantage. Mandatory written agreements are a step in the right direction and will secure the rights of many tenants. Rents will be periodically revised and if there is a disagreement between the landlord and tenant, the Rent Authority can step in to fix the rent.
While the law does not fundamentally change the current economics of cost of financing and rental yields, yet it is a welcome initiative for institutionally owned rental housing. Over the next few years, as the segment gradually matures, institutionally managed properties could get a rental premium (50 to 100 bps) since it will be better managed and without the hassle of dealing with individual landlords. This premium could lower the gap between rental yield and cost of financing. Overtime, investment behaviour of individuals is likely to change as the economics of cost of financing vis-à-vis rental yields becomes more important and not simply capital appreciation, as is the case with real estate investments at present.
However, timely implementation of the Act in its true spirit will be the most important issue going ahead. Land is a state subject and the prerogative of implementation will be on the states. States will have to enact new legislations or amend existing rental laws. Timely appointment of Rent Authorities as well as adhering to strict timelines for settlement of disputes needs to be ensured.
In summary, the Model Tenancy Act is a reform that aims to alleviate India’s housing shortage through the provision of affordable, quality rental housing and attract long term institutional capital in this segment. The legal framework is a crucial step in ironing out the challenges faced currently both by landlords and tenants. Timely implementation of the law has the potential to set the housing market well on its way to a better and brighter future.