How the legal system explains homeownership rates

There is a favoritism towards renting in the economics blogosphere, perhaps reflecting some partial irrationality of homeowners, or maybe it’s just a collective cosmopolitan ethos of econ bloggers. In either case I find it interesting to consider rational economic reasons for the strong preference for homeowners that Americans display. A recent paper by Pablo Casas-Arce and Albert Saiz explores an angle I haven’t heard before. Their argument is basically that an inefficient legal system creates a cost of renting versus owning:

In this paper we argue that, lacking alternative means of enforcement such as reputations, market participants will tend to avoid the use of contracts when operating in an environment with very inefficient courts. As a result, the legal system may alter the allocation of ownership rights.

To examine this claim we consider the housing market, where these effects are most financial intermediaries emerged in India in response to Financial regulation. transparent: essentially, a user of housing services can either buy a house or rent it from another owner or landlord. Hence, studying the prevalence of rental properties will tell us about the use of rental contracts and, hence, the allocation of ownership rights in such a market. To the extent that contracts can be enforced, they will allocate these rights in an efficient manner to maximize welfare. This will involve some individuals purchasing the houses they use, while others will buy access to them from a separate owner on an occasional basis, using a rental contract. But when these temporary transfers of control are costly to enforce, we will see departures from that optimal allocation. In particular, market participants may decide to avoid contractual disputes by relying less on rental agreements and, instead choosing a market structure that displays more direct ownership by the final user.

The part of enforcing a rental contract that can be costly in an inefficient legal system is kicking out a renter, either to evict them or simply because the landlord doesn’t want to renew the lease to them for some reason. Megan McArdle’s recent problems trying to purchase a home with a current renter is a perfect example of this. As they discovered, in D.C. it can be very difficult to remove a renter:

District of Columbia Law and Superior Court Rules prohibit the execution of evictions when a 50% or greater chance of precipitation is forecasted for the next 24 hours. Additionally, if the weather forecast calls for temperatures below 32 degrees Fahrenheit over the next 24 hours, evictions other than those designated as Commercial Property will be canceled.

Official weather determinations are made daily at 8:00am., and are based on the National Weather Service Forecast for the Ronald Reagan National Airport, formerly National Airport, the official weather location for the District of Columbia.

When evictions are canceled due to weather and the Writ expires due to no fault of the U.S. Marshals Service, the Landlord will be required to re-file for an Alias Writ and a new filing fee will be required. All Writs identified as Alias Writs and those that are about to expire, will be considered for priority scheduling.

This tells us that the recent problem involving the unclear legal status of a bunch of foreclosures, if not resolved clearly and carefully, could lead to a higher rental rate. After all, this decreases the efficiency of the ownership contract relative to the renter contract.

The lesson in the long run is that if you want more renters, for reasons of labor mobility or whatever, you should make sure the legal system related to rental contracts operates efficiently. This doesn’t necessarily mean favoring landlords over renters, but rather making contract enforcement clear and easy.