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Housing Policy Debate • Volume 2, Issue 4 1251

Selling Eastern Europe’s Social Housing Stock:Proceed with Caution

Harold M. Katsura and Raymond J. StruykThe Urban Institute

Abstract

As the countries of Eastern Europe begin to reorient their housing sectors towardthe private market, many quarters are advocating selling the units in the socialsector—typically about one-fourth of the housing stock—to the tenants. Whetherpurchasing their units is attractive to tenants depends on the sales price, currentand expected rent levels, availability and terms of financing, and the strength oftenant rights of occupancy. Drawing lessons from the experiences of three coun-tries—China, Hungary, and the United Kingdom—in selling social sector rentalunits, this paper concludes that too much emphasis has been placed on loweringthe sales price compared with changing other conditions. This practice results in asubstantial loss of revenue to government and a questionable distribution of thenation’s wealth.

Introduction

Fundamental to the transformation of centrally planned economiesto market-oriented ones is the privatization of the great majority ofeconomic activity that has been subject to central control.Unfortunately, as John Donahue points out in The PrivatizationDecision, privatization “is not only an inelegant term, it is alsolamentably imprecise.”1 In America, where little economic activityhas ever been in the public sector, privatization generally refers topublic agencies, especially local governments, contracting out withprivate firms for the provision of services the agencies themselveshave traditionally provided. In contrast, privatization in the con-text of Eastern Europe refers explicitly to changing the ownership ofenterprises from the public to the private sector.

In the planned economies of Eastern Europe, the state has ownedand managed a large share of the housing stock, particularly inurban areas. This stock has been rented to families, often for nomi-nal amounts, and units have been allocated according to complexrules. To date, privatization of the state rental stock has meant sell-ing the units to their occupants. Because the overwhelming major-ity of units are in multifamily structures, most countries have rulesregarding the share of unit occupants who must want to purchase a

1252 Harold M. Katsura and Raymond J. Struyk

unit before units in the building can be sold. Upon the sale of units,buildings shift from rental to condominium status.

Many of the issues that arise in determining the conditions underwhich to sell housing units are parallel to those that arise in sellingstate-owned enterprises (SOEs). Most obviously, the housing stock,like the stock of industrial assets, is extremely valuable and repre-sents a major resource under control of the state. These assets areso valuable that, if sold at or near full value, they could provide thestate with substantial funds to help during the economic transition.For example, Robert Buckley and colleagues2 have estimated thatthe market value of the state-owned housing stock in Hungaryexceeds the value of the assets contained in the country’s entirefinancial system. Other difficult issues involve who owns the staterental stock, what rights sitting tenants have, and how benefitsshould be distributed between the purchaser and the state—that is,the balance of taxpayers—if units are sold for less than theirmarket value.

Efforts to privatize should not overlook the need for a rental sector.Because private rental housing was generally not permitted inEastern European countries, state rental units constitute the rentalhousing stock. Success in selling all these units would mean theelimination of rental housing. Obviously, a rental sector is neededto provide housing for newly forming families, to permit geographicmobility, and for other reasons. Hence, the general privatizationobjective must be refined to be realistic.

This paper assesses the experience of several countries that havetried to sell state-owned housing to their citizens.3 Specifically, itidentifies impediments to the sale of state-owned dwellings. Theauthors stress at the outset that there may well be conditions underwhich the sale of units may not be economically rational. The realproblem is to define the “right” conditions. The experiences of thecountries under discussion shed light on the problems that EasternEuropean nations are facing and that other nations are likely toface in their housing sectors as their economies become moremarket oriented.

As the conditions of Eastern Europe’s centrally planned economieshave worsened, interest in privatizing the social housing sector hasbeen growing. One of the primary benefits of privatization is areduction in budgetary outlays for the operation and maintenance ofhousing. Receipts from the sale of units can be recycled back into

Selling Eastern Europe’s Social Housing Stock 1253

housing or, alternatively, be used to reduce budget deficits or toserve other purposes. Privatization of housing is also viewed as away to reduce inflationary pressures by soaking up excess demandand encouraging households to save more.

Importantly, the promises of privatization may not be realized. It ispossible, for example, to sell units at such low prices and with loansso heavily subsidized that the sale actually results in an additionaldrain on government finance.

By focusing on the sale of units, either to current tenants or toothers, this paper takes a narrow view of housing privatization.Although the construction, financing, and management of units arealso candidates for “privatization,” they are not the main concern ofthis report. These other kinds of privatization include reforms thatforce housing finance institutions to compete with commercialbanks for deposits; the breaking up and selling off of a state con-struction monopoly; and the contracting out of the management andmaintenance of state-owned housing.

This paper begins with a review of a conceptual framework for ana-lyzing measures to sell state-owned rental units and encouragehomeownership. This framework, developed by George Tolley in hiscomprehensive analysis of privatization in China,4 provides a usefulway to think about the central problem of how to sell rental unitswhen nobody wants to buy them. Tolley identifies the tools avail-able to policy makers to encourage sales and offers illustrativeexamples—based on China’s housing reform experiments—of thepotential impact of these mechanisms.

This analytical framework is then used to assess the experiencesthat Hungary and the United Kingdom have had in selling theirstate-owned rental housing stock.5 The United Kingdom has hadmodest success in selling units, but not without controversy. Mostof the units sold have been large, semi-detached dwellings and rowhouses. Hungary, on the other hand, has had problems sellingunits, problems likely to be encountered by other Eastern Europeancountries. Wherever units have been sold, purchasers have paid farless than the market price.

The final section of this paper presents some conclusions based onthe country analysis. In addition, it considers a number of relatedactions that should accompany the sale of units.


A policy framework

To date, China’s housing reforms have been concerned almost exclu-sively with selling units.6 Broader goals of achieving greater eco-nomic efficiency in the delivery of housing services and of improvingequity have taken a back seat to more immediate goals such asstimulating savings, dampening inflation, and generating resourcesfor more housing.

The main problem addressed by the Chinese is selling apartmentsto households that are not accustomed to paying much for housing.This is the typical situation in centrally planned economies, wherehouseholds are provided with housing by the state rather thanbeing given the additional income to select and purchase housing.In urban areas, work units and housing bureaus provide over80 percent of the housing. (Households in rural areas generallyprovide their own housing.)

Rent and wage adjustments have thus far been the key features ofChina’s plan to stimulate housing sales. Rents have been so lowthat housing has been a type of in-kind compensation for house-holds living and working in urban areas. By raising rents andincreasing wages to cover the higher rents, China hopes to reestab-lish a normal rental market. Although a household’s economic posi-tion remains unchanged by these adjustments, households havebeen given the new option of buying their units. The governmenthopes the desire to avoid paying the higher rent, combined with theavailability of special financing arrangements, will induce house-holds to buy their units.

The results from rent- and wage-adjustment experiments in11 small and medium-sized cities have been discouraging for severalreasons.

1. Not many households have been induced to buy dwellings.

2. Despite higher rents, households have not reduced their housingconsumption. No reallocation of housing appears to be takingplace.

3. Housing appears to be inadequately maintained; this is partlydue to the lack of sales but also may be due to uncertainty overwho is responsible for maintaining units.


4. The lack of demand for purchasing homes means that weak sig-nals are being sent to suppliers who, in any case, are subject tostate allocations. Thus, the supply response has been weak.

5. Financial instruments have not evolved in a direction thatencourages homeownership. The benefit of low-interest loans isbeing offset by short repayment periods that necessitate largedown payments.

The following analysis focuses on tenure choice, which involvesthe incentives and disincentives to purchase a unit, and on rentand wage adjustments, which can be thought of as prerequisitesfor selling units.

Tenure choice

The factors underlying households’ decisions to own or rent deter-mine how many apartments will be sold. Four main conditions canbe influenced by policies and can affect the number of householdsdesiring to own housing: (1) the price of renting relative to the priceof owning, (2) lending terms, (3) property rights, and (4) savings-portfolio decisions.

The relative price of owning. One of the first things a household willconsider in deciding whether to rent or buy is the differencebetween the price of renting and the price of owning. This compari-son is made difficult by the fact that cash outlays by homeowners donot present an accurate picture of expenditures. Although mainte-nance expenditures are observable outlays, depreciation and theforegone interest on the down payment and accumulated equity arenot. The user cost of ownership can be defined as the sum of theinterest component of the debt used to purchase the home, the for-gone earnings on equity, the maintenance expense, and the depreci-ation expense.7

In a free housing market, households compare their user costs ofownership with cost-based rental rates8 in deciding whether to buy.However, if markets are controlled—as they are under the Chinesehousing reforms—and if low preferential rents are used rather thancost-based rents, then a household will choose to buy only if the usercost of owning is reduced by lowering the price of the unit. Animportant point is that a reduction in rent causes a more-than-proportional decrease in the price a household is willing to pay tobuy a home.9


Lending terms. Another factor that figures prominently in a house-hold’s decision to buy or rent involves the terms for borrowingmoney. Simply put, lower down payment requirements, lower inter-est rates (possibly subsidized interest rates), and longer repaymentschedules increase willingness to pay. Conversely, high down pay-ment requirements, high interest rates, and short repayment peri-ods discourage households from buying homes.

In at least some Chinese housing experiments, finance termsinclude 30 percent down payments, repayment periods of 5 to15 years, and heavily subsidized interest rates (as low as 3 percentwhen a “market rate” would probably be at least 10 percent). Thenet effect of these terms is difficult to judge: the benefit of the lowinterest rate is offset by the high down payment and the short loanterm.

Property rights. Property rights constitute a third critical factorthat influences tenure decisions. The existence of rights held bytenants that resemble those commonly reserved for owners, as wellas the presence of constraints on an owner’s ability to sell, rent, orotherwise use his or her property, both serve to reduce the gainsfrom homeownership. For example, tenants in China have the rightto transfer their right of occupancy to relatives and are subject toeviction only if they leave the work unit providing their homes.This provides a quite secure living arrangement for tenants. InHungary, tenants can even sell their right to occupy a unit.

Factors that weaken ownership rights include restrictions on whoman owner can sell to and the resale price, restrictions on rentingunits (including rent control), unclear responsibilities for maintain-ing units, and uncertainty about property rights in the future.

Through a crude example, Tolley tried to estimate the value of prop-erty rights in China by comparing willingness to pay under a lim-ited-rights situation with willingness to pay under a full-rightssituation in a freely functioning market economy.10 He demon-strates that China’s property rights situation may decrease willing-ness to pay for the purchase of housing by over 40 percent. Thisnumber is not meant to be taken as a fact but rather serves to illus-trate the potential impact of property rights. In Hungary, it is esti-mated that the “rights of occupancy” sell in the gray market forabout 50 percent of the value of unrestricted rights of ownership.

Savings-portfolio decisions. The desire to own a home as a form ofwealth is the fourth and final factor influencing tenure choice.Reasons for accumulating assets include the desire to earn income,


to hold a hedge against inflation, to save for retirement, to haveresources available to protect against short-term job loss or illness,and to transfer wealth to heirs.

Households living in countries where high levels of social welfareservices are provided and private property is relatively scarce willgenerally have a lower incentive to hold wealth. The availabilityboth of financial instruments and assets that provide returns toinvestors and of funds to invest is a prerequisite for increasing thedemand to hold wealth, including wealth in the form of housing.

Higher income households tend to hold more assets and thus aremore likely to become homeowners. This is more than simply astatement that rich people can afford to buy homes; it means thathouseholds that hold assets will consider the possibility of addinghousing to their portfolios and that, among these households, thericher ones are more likely to buy housing. The lumpiness and rela-tive illiquidity of housing make it an unattractive asset to house-holds with relatively small asset holdings.

Rent and wage adjustments

If anything, China represents an extreme case of housing reform inthat most of its urban housing is provided essentially free of chargeby work units and housing bureaus; only about 17 percent of unitsare privately owned. This contrasts, for example, with Hungary,where rents typically account for 5 percent to 7 percent of occupantincomes and where, even in Budapest, half the stock is privatelyowned. Because cash outlays for rent in China are trivial and secu-rity of tenure is strong, there is little reason for a household to wantto purchase a unit. Thus, higher rents, which are made possible bycorresponding wage increases, are expected to provide householdswith an incentive to purchase apartments.

In adjusting rents and wages, China has encountered several prob-lems that are linked to the size of the adjustments and the distribu-tion of benefits and costs. Reformers have chosen to set rents atlevels that are insufficient to recover the cost of constructing units.The driving factor behind this may not be so much a reluctance toraise rents as it is a reluctance to raise incomes. That is, rentincreases appear to be determined not by construction costs ormarket forces but by the size of the wage increases the governmentis willing to allow.


Two points about the complexities of the Chinese situation deservefurther comment.

First, many of the distributional problems encountered in adjustingrents and wages would be eliminated if the housing stock weretransferred from the work units to some other body and ultimatelyput under private control (with the enterprises compensated).Distributional problems can occur because organizations that payhigher wages may not be the organizations that receive higherrents. For example, the work unit paying the wage increase maynot be the work unit that collects the rent increases. (This couldoccur if two or more family members work for different work units.One of the work units might have to pay higher wages but, becauseit is not the work unit which is providing the dwelling, it does notreceive any additional rent.) Another possibility is that a housingbureau may collect the rent increase while the work unit pays thewage increase. In Eastern Europe, distributional problems are lesssevere because it is common for the state to be both the employerand landlord.

Second, the idea that housing be provided as a form of noncash com-pensation is much stronger in China than it is in Eastern Europe.Moreover, Chinese workers derive comparatively little income fromprivate secondary jobs which collectively are known as the “secondeconomy.” In Eastern Europe, where conditions are less rigid, theincome distribution is less equal; it is possible for a substantialshare of households to pay much higher rents from their fullincome (not just the income from their “first economy,” of state job).Under these conditions, well-targeted state assistance is appropri-ate.

The preceding analysis offers a way to think systematically aboutefforts to sell state-owned housing. The section on tenure choiceidentifies four areas in which public policy intervention could influ-ence slow housing sales. To bolster sales, policy makers could:

1. Raise rents. Low rents discourage people from buying theirunits. Wage adjustments may have to accompany rent increasesif rents are too low. However, because rents are tied to units andwages are paid by employers, rent and wage adjustments haveredistributional consequences.


2. Rationalize borrowing terms. Down payment requirements,repayment periods, and interest rates should not be arbitrary.Lending should be at market rates. Competition for customersshould cause lenders to offer loan terms that are as attractive aspossible.

3. Clarify and strengthen property rights. Both strengtheningowner rights and weakening tenant rights will increase theincentive to own. However, changes in property rights, like rentincreases, are difficult to implement.

4. Stimulate the demand to hold wealth. It is hard to devise poli-cies that directly influence the demand to hold housing as anasset. Possible measures include increasing household incomes,improving the attractiveness of housing as an asset by clarifyingproperty rights, and improving the liquidity of housing by allow-ing units to be freely bought and sold.

Although most of the interventions appear conceptually simple,real-world attempts at privatization—including those in China—demonstrate that these reforms are difficult to implement.Sometimes the ability to introduce new ideas is constrained by poli-tics or the unwillingness of people to change. Other times, poor eco-nomic conditions limit reform possibilities. And additional issuesand problems can also arise, as evidenced by the privatizationefforts of Hungary and the United Kingdom.

Privatization of housing in Hungary

Hungary is trying to sell state-owned rental units as part of itsbroad housing privatization effort, which includes attempts toreform both the system of producing and allocating housing as wellas the system for managing and maintaining state-owned rentalunits.11 However, it is unclear to what extent selling units is viewedas the preferred way of dealing with the problems of the social hous-ing sector in Hungary.

Price guidelines have been set according to when units were lastrenovated. Units that have not been renovated within 15 yearsreceive an 85 percent discount; units renovated between 5 and15 years ago receive a 70 percent discount; and units renovatedwithin 5 years receive a 60 percent discount. The financing termsoffered by local authorities have also been quite generous. Ninetypercent financing is available (i.e., a 10 percent down payment is


required) on an installment contract basis with a 20- to 30-yearterm and a 3 percent annual interest rate. (Inflation is about 20percent per year.) Outright cash purchasers receive an additional25 percent price discount. However, these sales and financingterms are only guidelines; it is not clear to what extent local author-ities have deviated from them.

Thus far, information about the success of Hungary’s effort to sellstate-owned housing has been limited. Sales appear to be confinedto units in the best locations and in the best condition, which couldbe an early warning sign of problems in marketing the units.Although the sale of units to tenants has been legal since 1969, pur-chase activity was essentially nonexistent until 1989, when regula-tions were relaxed and buying terms were made very attractive.In 1989, about 10 percent of the units were “claimed” by tenants.12

Since then, sales have been modest despite very deep pricediscounts from “market value.”

The development of the state rental sector

In 1954, the state first acquired control over vacant units and“excess” living space, and later over all dwellings with six or morerooms. Rents were set at very low levels and rent controls weremaintained. Strong tenant rights were also established early in thepostwar period. The 1948 housing code protected tenants from evic-tions without in-kind compensation in the form of another flat.Tenants also gained the right to transfer their right to occupancy totheir heirs. In addition, with the permission of the housing author-ity, tenants could sublet and exchange flats.13

So-called tenancy rights were further strengthened by the HousingAct of 1971, which introduced a type of user fee for acquiring theuse of a unit,14 and by regulations passed in 1981, which authorizedpayments to tenants who gave their units back to the authorities ortraded their units for smaller ones. The value of tenancy rightspaid by local councils was initially set at a multiple of the user fee.By 1987, the value was often seven to ten times the size of the userfees. Interestingly, although one of the goals of buying out a house-hold’s tenancy rights was to encourage the household to purchase orbuild a private unit,15 this approach also caused a problem in thatmany of the units the authorities got back were in poor condition.

Because of the development of tenancy rights, there are two mainways to acquire a state-owned unit in Hungary. The traditional and


most common way is through the state allocation process. Between1970 and 1982, about 62 percent of the households acquiring state-owned housing units received them from the state. Some studiesindicate that favoritism has played a role in the allocation of units,with a disproportionate number of units going to white-collar andmanagerial-type workers.16

The other principal method of acquiring a state-owned unit isthrough private transactions in the market for tenancy rights.17

About 31 percent of state-owned homes were obtained through thismethod between 1970 and 1982.18 The value of tenancy rights isfreely determined by the market. Basically, the development of atenancy rights market has resulted in a capitalization of the sub-sidy—the price of tenancy rights reflecting the right to pay a streamof low rents. Both the size of the rent subsidy and prices in thehomeownership market affect the price of tenancy rights.19

The basic rules for calculating rents for state-owned apartmentswere established in 1946. Rents were purposely set very low. Thenext major modifications in rents occurred in 1971, 1982, and 1990.Base monthly rents as of February 1990 ranged from 22.00 ($0.35)forints per square meter for fully equipped units to 4.50 forints($0.07) per square meter for low-quality units. Depending on fea-tures such as location, rents can vary up to 25 percent for a givenquality category. Despite large percentage increases in rents, theshare of income that a family devotes to rent is still only about5 percent to 7 percent.

A side effect of the low rents is their impact on renovation andmaintenance. Since 1949, responsibility for maintaining units hasrested with the Communal Management Companies (CMCs). Sincethe end of the 1950s, however, rental revenues have been insuffi-cient to cover outlays for renovation and maintenance. Thus, CMCshave required supplementary state budget allocations.

In December 1989, Parliament rejected a 50 percent rent increase infavor of a 35 percent rent increase. However, fees were institutedfor sewage and water service, and maintenance and renovationwithin a flat became the responsibility of the tenant. Rentincreases were not equal across-the-board; greater increases wereapplied to larger, higher-quality units whereas low-income house-holds were exempt from the increases.

Hungarians are hotly debating the sales of state rental units.Advocates of privatization complain that state-owned housingmakes up so much of the housing stock that units cannot be


efficiently maintained (at least by the current system). They arguethat selling units will reduce budget expenditures for maintenanceand increase occupants’ incentive to maintain their units. Someeven argue that obtaining ownership at concessionary prices is away of repaying the people for losses incurred during the national-ization process.

Arguments against privatization in Hungary largely center onequity issues. Some say it is simply a giveaway of state wealth,with the benefits mostly going to those who occupy their units as aresult of power and influence. In addition, privatization does littleto help those remaining in housing queues unless more housing getsbuilt. Some people fear that, under the guise of privatization, thegovernment will shed its responsibility to protect the poor.

Probable problems in selling units

Notwithstanding the political problems of privatization, Hungary islikely to encounter difficulties in selling units primarily because oflow rents and strong tenant property rights. In China, raising rentsand strengthening the property rights of owners relative to renterswere proposed as ways to encourage sales. These same ideas areappropriate for Hungary’s situation.

There are signs of weakness in Hungary’s sales program. Giventhat most purchases thus far have been largely confined to the mostattractive units, it seems plausible that, under present conditions,further price reductions will be necessary to sell the remainingstock. However, by raising rents, the government would increasethe incentive to own and reduce the need for price cuts.

An odd feature of the Hungarian case that produces a strong disin-centive to buy a home is the ownerlike rights of tenants. The factthat a tenant has the right to buy and sell the right to occupancy ata market-determined price, as well as the right to occupy a unitindefinitely without fear of eviction, means that the property rightsgained from becoming a homeowner are small. With so little to dis-tinguish it from conventional homeownership, renting a state-owned unit does not really amount to renting—it is more likeowning.20 Recall that nearly a third of the occupants in state-ownedrental units acquired their units through the market for tenancyrights.


Households that obtain their units through the market for tenancyrights essentially are paying market rents; however, the rent theypay is the subsidized rent they pay to the government plus the lumpsum payment they make to the previous tenant. This lump sumpayment, which is known as “key money,” represents the capitalizedvalue of the subsidy and is equal to the discounted present value ofthe future stream of subsidy payments implied by the low rents.

Because the size of the lump sum payments is positively correlatedwith the size of the subsidy offered, a rent increase affects the valueof tenancy rights. A rent increase results in a kind of capital lossfor tenants because it lowers the willingness to pay for the right ofoccupancy (i.e., the right to pay a subsidized rent). This helpsexplain why there is extreme political resistance to raising rentsand why raising rents is an effective means of stimulating sales.For existing tenants, a combination of higher rent and lower valueof tenancy rights should increase their incentive to buy their units.For a household not occupying a state-owned unit, a rent increasecreates less of an incentive to buy because it immediately gets capi-talized in the form of a reduction in key money. Thus, the effectiverent the household compares with its user cost of owning remainsunchanged.

Clearly, if market rents were charged, one of the most perverseaspects of tenancy rights—the right to buy and sell the right tooccupy a unit—would no longer exist. There would be nothing tosell because the subsidy would be gone, and a more normal rentalmarket would develop.

With respect to financing the purchase of units, local housingauthorities need to raise the interest rate they charge borrowers;with the market rate approaching 25 percent, a 3 percent rateimplies a very deep subsidy. Higher interest rates work againstsales but reduce (implicit) budget outlays and inflationary pres-sures. By increasing willingness to pay, higher rents help makehigher interest rates palatable. Higher interest rates, in turn, pro-vide an argument in favor of raising rents on equity grounds, theidea being that if the cost of homeownership goes up, so should thecost of renting.

To determine how households will respond, Hungary needs to exper-iment with charging market rents. Increasing rents would simulta-neously increase the incentive to own, weaken the relative value oftenancy rights, and allow unit prices to increase. The higher rentswould help relieve the maintenance cost burden on the central bud-get, and higher prices would generate a bigger windfall for the


government. Increased willingness to pay can be used to reduce anyremaining financing subsidies, but at the expense of lower prices.

Privatization of housing in the United Kingdom

Having sold more than 1 million public housing units since 1979—1979-an amount equivalent to about a fifth of its present social housingstock—the United Kingdom is often cited as an example of a coun-try that has a successful public housing sales program.21 Althoughthis sales volume has been impressive, the sales campaign is anongoing effort, which makes it difficult to judge whether the efforthas been a success. Current conditions appear to favor more sales;however, it seems likely that sales soon will be harder to generatebecause of low rents, the socioeconomic characteristics of theremaining tenants, and the undesirable features of the remainingpublic housing stock. The United Kingdom’s experience with sellingpublic housing reinforces the point that rent levels, property rights,and financing arrangements are important determinants of privati-zation success, regardless of a country’s economic status.

The main features of the United Kingdom’s privatization effort havebeen the granting to tenants of the statutory right to buy theirdwellings, provided they have lived in their units at least two years,and price discounts based on length of tenure (1 percent per year)and type of unit (a 30 percent basic discount and an additional 20percent discount for flats and other unattractive units). The aver-age discount on units sold since 1979 is about 45 percent.22 There is a provision for recapturing discounts if units are sold within threeyears.23

The United Kingdom has many of the same rental housing prob-lems of other countries that want to privatize their social housingstock. It has a small private rental sector and a large, heavily sub-sidized public housing stock. The public housing allocation system,in which rents do not adequately reflect differences in quality andamenity levels, results in a misallocation of resources whereby somehouseholds live in excessively large homes while other householdsare overcrowded. Low rents contribute to poor maintenance andincrease the need for construction and income maintenance subsi-dies from central and local governments.

The sale of public housing in the United Kingdom was intended toreduce central government housing expenditures and improvemaintenance. In addition, it has been argued that the creation of a


“property-owning democracy” is desirable and that homeownershipdevelops a sense of pride and identity. The sale of public housing totenants is also seen as a means of spreading wealth and as a step tohelp revive the private rental sector.

Although some of the problems of the United Kingdom may be simi-lar to those of China or Hungary, privatization in the UnitedKingdom has taken place in a totally different context. First, theUnited Kingdom has a well-developed housing finance system thathas proven itself capable of providing funds to tenants exercisingtheir right to buy. Second, tenant rights are weaker there than theyare in China and Hungary, and tenants generally devote largershares of their income to rent. Third, the United Kingdom has apersonal income tax system through which homeowners can receivepotentially large tax benefits. Fourth, the quality of the country’ssocial housing stock is better and is composed of fewer large multi-family apartments. Finally, under the British political system, theprovision of housing is chiefly a local responsibility; as a result, thecentral government sometimes has difficulties influencing localhousing policies.

Development of the United Kingdom’s public housing sector

Tenure. Large shifts in tenure have occurred since World War I.Before that war, more than 90 percent of households in England andWales rented from private landlords. Both individual homeownership and the social housing stock grew dramatically after WorldWar II. Growth of the social housing sector was spurred, first, bypolitical pressure in the early postwar years and, later, by the desireto replace private slum dwellings. By 1976, 30 percent of house-holds in England and Wales were in public housing; 55 percent werein owner-occupied units; and 15 percent were in private rentalunits.24 By 1987, less than 10 percent of the British housing inven-tory was privately rented. Today, about two-thirds of the stock isowner occupied and over 70 percent of the rental stock is publiclyowned.25

The right-to-buy (RTB) program contributed greatly to recent increases in homeownership, although it was by no means the onlyforce at work. Between 1975 and 1987 owner occupancy increasedby 11 percent (3.2 million units). Slightly less than a third of thisincrease (over a million units) was due to sales of public housing;


the vast majority of these sales were through the RTB program.26 Since 1984, new construction and transfers from the public housingstock have made roughly equal contributions to homeownership.27

Public housing sales peaked in 1982 at 240,000 units; annual salesdropped to 115,000 units by 1986 but rose again in 1987 and 1988.This increase came at a time when the housing market was rising(making housing more attractive as an investment). Tenant inter-est in purchasing their units remains high, according to a number ofstudies.28

Since 1961, homeowners in the United Kingdom have been entitledto mortgage interest tax relief and a capital gains tax exemption.The average mortgage interest tax relief was about £490 in 1988-89. Until 1989, no equivalent tax relief was granted to investors in pri-vate rental housing.

Rent levels. Rent increases—or the fear of rent increases—mayhave facilitated the high rate of public housing sales. The centralgovernment essentially forced local governments to raise rents byreducing subsidies to them and by restricting their ability to redi-rect other revenues to housing funds.

Even though rents have grown faster than the overall inflation rate,the increase relative to income growth has been quite modest. Forexample, in England and Wales, public housing rent (before rebate)as a share of income rose from 7.3 percent in 1979 to 10.7 percent in1982 and then fell to 9.7 percent in 1986.29 Given these smallchanges in the rent burden, it is hard to argue that higher rents have played a major role in sales thus far; indeed, failure to raiserents to cover more of total costs may be the most conspicuous defi-ciency of the overall privatization effort. A more plausible explana-tion for the high sales volume is that the heavy discounts combinedwith tax benefits have been more than adequate to compensatehouseholds for their loss of rental subsidies.

Tenant rights. Tenant rights vary quite a bit among municipalities.Public housing tenants are allowed to sublet parts of their units andto have relatives living with them in an extended family arrangement.30 Rents of private rental units have been controlled sinceWorld War I. However, newly constructed and vacated units arenow exempt from rent controls.

Murie notes that public housing tenants can be much less securethan tenants in privately owned units.31 For example, in some cases


local authorities have invoked extremely strict rules on public hous-ing tenants (e.g., tenants have been instructed to paint their doorscertain colors and to redecorate the interior of their homes a certainway). This type of intrusion on personal freedom has been used tosupport arguments in favor of selling public housing.

The 1988 Housing Act contains a number of measures that shouldeventually strengthen tenant rights. The Act turns rent setting intoa contractual relationship rather than a statutory one, with agree-ments being made between tenants and their landlords. It alsogives tenants the right to choose their landlord and to negotiate ten-ant rights with the landlord they choose.32

Housing finance. The RTB program promises seller financing tothose who cannot qualify for a loan from a lender (alternative pur-chase plans are also available). Building societies, however, havefinanced about 95 percent of public housing sales.33 The conven-tional loan instrument is a variable rate, 20 to 25 year mortgage.

In this context, it is important to note that financing need not becritical to selling units. The local council can simply arrange thesale and collect payments, in effect providing seller financing byforsaking use of assets equivalent to the value of the units sold untilthe loans are repaid. As noted, in Hungary units are being sold onthis type of installment basis.

An analysis of the units that have been sold supports the claim that“creaming” has occurred: The best units have been sold to thehouseholds in the best economic position. The flip side to this isthat the remaining housing inventory is of lower quality on average,and is occupied by households that are economically and socially theworst off. Nevertheless, Maffin34 notes that the number of tenantsstill living in the most desired unit types—semi-detached or rowhouses in suburban and rural areas—is large. This suggests thatthe housing stock retains considerable sales potential.

Conclusions

The examples of housing reform reviewed in the previous sectionsreveal remarkable consistencies (see table 1): The need to raiserents is universal, whereas rationalizing borrowing terms and clari-fying property rights are needed in China and Hungary. Most dis-turbing is that the cases provided more examples of what can gowrong with a privatization effort than of what can go right.


Table 1. Summary of Factors Affecting Sales Volume of State Rental Unitsin China, Hungary, and the United Kingdom

Sales price relativeto market price

Tenant protections/implicit property rights

Rent levels

Financing for unitpurchased:- available- cost

Sales volume

China Hungary

low very low

strong very strong

very low low

limited readilylow very low

very low low

United Kingdom

low

moderate

low

readilymarket rate

moderate

One gets the sense that some nations have been too eager to selltheir housing stock and have not thought out their objectives well.Of particular concern is that they resort so readily to big discounts,most likely because raising rents and tampering with propertyrights are politically uncomfortable. The value of the resourcesbeing transferred between the state and individuals via discounts isenormous. A country should not lose sight of the fact that when itoffers a household a discount on a home, it is offering a discount onwhat will be one of the most expensive assets the household willever buy. Each percentage point of a discount represents a lot ofmoney that society could use for other, more pressing needs.

Beyond the more obvious benefits to be derived from charging mar-ket rents and market prices, such as the better allocation and main-tenance of units, lie more subtle, but still important, benefits. Forexample, it is evident that market rents would weaken the overlystrong rights tenants hold in Hungary. In addition, in any country,equity concerns—with respect to who benefits from subsidies—willdiminish if market prices are charged, even when sitting tenantsare given the first right of unit purchase. This is not to say that themarketplace does not have its victims. Subsidies for disadvantagedhouseholds are an important part of any progressive society, and itis the duty of public officials to devise means that effectively targetthese funds.


Policy makers can influence rents, lending terms, and propertyrights—key variables influencing sales success. The directions inwhich policy makers should manipulate these variables are clear; ifthey would raise rents, facilitate lending at market rates, andstrengthen the property rights of owners relative to those of renters,sales would increase. The big question is whether policy makershave the political will to make the necessary changes.

To facilitate the privatization of the state rental stock, governmentswill have to protect the poorest families when raising rents. Thesocial safety net must be extended to the housing sector, probably inthe form of a well-designed housing allowance program whose bene-fits can be carefully focused on the poor. Such a plan is being imple-mented in east Germany and is under active consideration inHungary. In both cases, pensioners and families with low earningsmake up the target group.

Also, the management of the properties must be changed andimproved. Currently, the state rental stock is typically managed bySOEs, each of which manages tens of thousands of units. Becauseof the combination of few resources and general laxity in manage-ment, maintenance and other services have been at very low levels.Both tenants who pay higher rents and owners who pay mainte-nance fees will demand better services, which will be forthcomingonly if the property management system is transformed.

Only through competition among companies will a true market inrental housing emerge. The big SOEs should be broken up and pri-vate for-profit and non-profit entities should be permitted to com-pete for management contracts on individual buildings. Forbuildings that are owner occupied, the residents can select the com-pany; for buildings that continue to be rentals, local governmentand residents can make the decision together. The critical point,however, is to improve the management services so that occupantssee they are receiving additional services in exchange for the higheramounts they pay.

Appendix

Simple analytics of homeowner user cost versus rent

This appendix presents a few simple equations that highlight the relation-ship between rent levels and the prices households are willing to pay topurchase homes.35 We begin by defining the relationship that must hold ifa household is to be indifferent about renting or purchasing a unit:


R=iV+dV+E, (1)

where R is the annual rent, V is the value of the unit, i is the annual inter-est rate, d is the annual depreciation rate, and E is the annual cost of oper-ating and maintaining the unit.

The right-hand side of the equation is the user cost of ownership and con-sists of the annual interest charge (iV), the annual depreciation (dV), andannual operating and maintenance costs (E). The interest rate (i) is a com-posite rate that reflects both the interest charged on the outstanding loanbalance and the foregone interest on equity in the home.

Equation (1) states that a household will be indifferent about owning orrenting when rent is equal to the user cost of ownership. If the rent weregreater than the user cost of ownership, the household would prefer to buythe unit; conversely, if the user cost of ownership were greater than therent charged, the household would prefer to rent.

To demonstrate how the price a household is willing to pay to buy a unitvaries with rent levels, we can solve equation (1) for V, which yields

V=(R-E)l(i +d). (2)

Equation (2) shows how R is positively related to V. We can substitutesome numbers into this equation to illustrate how a proportional change inrent (R) requires a more-than-proportional change in unit value (V) ifequation (2) is still to hold. For example, if R equals $1,000, E equals$100, i equals .10, and d equals .02 (reflecting a 50-year depreciationperiod), then V must equal $7,500 for equation (2) to hold. However, if wenow raise R by 50 percent to $1,500 and hold the remaining variables onthe right-hand side of equation (2) constant, then V must equal $11,667 forequation (2) to hold. Thus, if rent (R) increases by 50 percent, unit value(V) must increase by 55.6 percent—a disproportionate amount. Thisdemonstrates that willingness to pay to purchase a unit can be particu-larly sensitive to rent changes.

We can expand equation (1) to include other factors that influence tenurechoice:

R-T=iV+dV+E-Q(Y,Z). (3)

Equation (3) contains two new terms: T is the annual value of the prop-erty rights held by a tenant and Q is the annual value of a variety of bene-fits received by homeowners. Q is a function of Y, a set of familycharacteristic variables (which includes things like income, wealth, andlife-cycle stage), and of Z, a set of nonshelter variables (which includesitems such as property rights, appreciation, and tax consequences). Theright-hand side of the equation is still the user cost of ownership; the left-hand side is the cost of renting.


We can again solve for unit value (V), which gives us

V=(R-T-E+Q(Y,Z))/(i+d). (4)

Equation (4) summarizes how a household’s willingness to pay to buy aunit varies with the rent level (R), the value of tenancy rights (T ), the ben-efits of homeownership ( Q ), and the interest rate ( i ). As before, R is posi-tively correlated with V. Higher rents make it possible to charge higherprices for units. If T increases—that is, if tenancy rights becomestronger—V must decrease for equation (4) to hold (all other factors heldconstant). In other words, strong tenancy rights will suppress the amountthat a household is willing to pay to buy a unit. On the other hand, if Qgoes up, so must V (all other factors held constant). Thus, for example, ifthe capital gains or tax benefits that a household with characteristics Yexpects to receive increases, the household’s willingness to pay to purchasethe unit will also increase. Note that although we have assumed Q to bepositive, it could be negative. In both equations (2) and (4), the interestrate (i) appears in the denominator of the user cost of ownership formula;thereforae, if the interest rate increases, V must decrease if either of theequations is still to hold (all other factors held constant). This is simplyanother way of showing how raising interest rates can lower the effectivedemand to buy a home.

Author

Harold M. Katsura is a research associate in the Urban Institute’s Center forPublic Finance and Housing. Raymond J. Struyk is director of international activi-ties at the Urban Institute.

Endnotes

1. John D. Donahue, The Privatization Decision: Public Ends, Private Means(New York: Basic Books, 1989), 5.

2. Robert Buckley, et al., “Housing Sector Reform in Hungary” (Paper preparedafter a World Bank mission to Hungary in May 1990).

3. State-owned housing is also known as state housing, public housing, socialhousing, and council housing. We freely interchange these names throughout.

4. George S. Tolley, “Economic Analysis of Chinese Housing Reform” (Paper pre-sented at the Housing Reforms in Socialist Economies Policy and ResearchSeminar, Washington, DC, June 12-13, 1990).


5. We examined other privatization cases before settling on these countries. Ofthose not included, the best documented case is that of Algeria, which has hadexperiences similar to those of the countries included in this report. For moredetails, see, for example, S. Strauss et al., “Housing Finance in Algeria”(Report prepared by Abt Associates, Inc., for the Office of Housing and UrbanPrograms, U.S. Agency for International Development, 1990).

6. This section draws heavily from Tolley, “Economic Analysis of ChineseHousing Reform.”

7. This term could be extended to include capital gains and tax consequences,

8. In a free market, suppliers will not build new rental units if the rents they cancharge will not cover costs.

9. See appendix A for more details.

10. Tolley, “Economic Analysis of Chinese Housing Reform.”

11. The information on Hungary’s housing system contained in this section isdrawn primarily from Jozsef Hegedus and Ivan Tosics, “The Hungarian State-Rental Sector: Its Development and Present Problems,” in Background Papersfor the Mission of the World Bank “Housing Group” to Hungary: 3-18 May1990 (Budapest: Metropolitan Research, 1990); Jozsef Hegedus and IvanTosics, “Privatization in East-European Housing Systems: (Past Tendenciesand Recent Collapse of the Socialist Housing Model)” (Paper prepared for theSeventh International Conference of Europeans, Washington, DC, March23-25, 1990); and I. Tosics, “Privatization in Housing Policy: The Case ofWestern Countries and That of Hungary,” International Journal of Urban andRegional Research 11, no. 1 (1987): 61-70.

12. A “claim” is a tenant’s expression of intention to buy; the actual sale must beapproved by the local council. Of the units claimed by tenants in 1989, only1.3 percent of the stock was actually sold.

13. Rental rates for sublets are determined by mutual agreement of the partiesinvolved; that is, the rates are market rates.

14. This fee was set at 10 percent of the cost of the unit.

15. Further on, we show that a more effective approach is to reduce the value oftenancy rights.

16. See, for example, Hegedus and Tosics, “The Hungarian State-Rental Sector.”

17. Over time, local authorities lost their ability to control the exchange of flats.Two factors contributed to this. First, the administrative burden of managingall exchanges was too high; in addition, strict enforcement would sharplyreduce tenant mobility. Second, the shaky political and economic climate inHungarian cities contributed to a relaxed attitude toward these exchanges.

18. The remaining 7 percent of units during this period were acquired throughinheritance or in the form of a gift from close relatives.


19. The value of tenancy rights has been estimated to be about one-half the mar-ket price of privately owned flats. This relatively low value reflects uncer-tainty about the future status of tenancy rights and rent levels.

20. Buckley et al., “Housing Sector Reform in Hungary.”

21. This section draws heavily from Duncan Maclennan, “Privatization,Deregulation and Competition in the British Housing System, 1979 to 1989”(Paper prepared for the World Bank, 1989).

22. Ibid.

23. Under the right-to-buy program, a household can also “lock in” a price anddefer the actual purchase for up to three years, or it can purchase a unit gradu-ally through a “shared ownership” arrangement (in which at least 50 percentmust be purchased initially, after which additional ownership shares may bepurchased periodically). See Robert Maffin, “A Review of the Right-to-Buy,Tenant Management and Enterprise Zones Activity in Great Britain” (Papersubmitted to the National Association of Housing and Redevelopment Officials,1989).

24. Alan Murie, “Privatization in Housing in the U.K.: The Sale of CouncilHouses” (Bristol, England: School for Advanced Urban Studies, University ofBristol, n.d.).

25. Maffin, “A Review.”

26. Ibid.

27. Maclennan, “Privatization, Deregulation and Competition.”

28. Ibid.

29. Ibid.


31. Murie, “Privatization.”

32. By giving tenants the “right to choose” a different landlord (which couldinclude, for example, a housing association or a private firm) the governmenthopes to introduce competition among housing managers. If tenants select aprivate landlord, the landlord purchases the unit from the local authority.

33. Building societies are similar to savings and loan associations in the UnitedStates.


35. For a more extensive treatment, see Tolley, “Economic Analysis of ChineseHousing Reform.”

Selling Eastern Europe’s Social Housing Stock: …...Selling Eastern Europe’s Social Housing Stock 1255 4. The lack of demand for purchasing homes means that weak sig-nals are

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