Model Tenancy Act is a step in right direction, but no magic wand

Every big city in India has its share of locked homes. These are homes that people, including many non-residents, have bought as an investment to sell for a higher price someday. They are not interested in renting out these homes because it is simply not worth the risk of tenants deciding to overstay beyond their contracted period.

On the flip side, with so many homes lying vacant and landlords unwilling to rent them out, even people who aren’t financially in a stable position are forced to buy homes. This desperation allows builders to build homes that are at best ticky-tacky.

A fully built home lying vacant is a massive waste of money and resources at the macro level. These are resources that could easily be used somewhere else.

To tackle these issues, the Union Cabinet approved the Model Tenancy Act (MTA) on Wednesday. It will now be circulated to states and Union territories for adaptation by enacting fresh legislation or amending existing rental laws suitably.

The model tenancy law starts with the clause that all rental agreements need to be in writing and registered with the Rent Authority of the district. The idea here is to tackle the enormous black economy that prevails in the rental market, with many landlords failing to declare their rental income to the taxman. While asking landlords and tenants to register rental agreements is one thing, it doesn’t mean that they will start complying.

The tenant and the landlord can decide the terms of the agreement. At the same time, the model law clearly marks out the responsibilities of the tenant and the landlord when it comes to the maintenance and upkeep of the property.

In short, it is the landlords’ responsibility to make structural repairs, whitewash the property, carry out adequate plumbing and electrical maintenance as and when required. When it comes to the tenants, they need to get taps, switches and sockets, geysers, kitchen fixtures, etc., repaired as and when required.

Having said that, there are two clauses in the MTA that address the landlords' major insecurities For the landlords, the most significant risk is the tenant overstaying beyond the period contract period or on its termination. To take care of this, the MTA proposes that if a tenant overstays, he or she will have to pay twice the rent for the first two months and four times the monthly rent after that, until the tenant continues to occupy the said accommodation.

The tenant’s biggest risk is landlords demanding substantial security deposits and then dillydallying about returning the money once the contract gets over, with the tenant needing to move on. This creates enormous problems for people starting out in their careers and financially in a vulnerable situation.

It also creates problems when the rental lease runs out and the next prospective landlord demands a security deposit. If the deposit with the previous landlord hasn’t been returned, it becomes tough for the tenant to raise a similar amount of money for a new deposit.

Also, large deposits add to the rent, given that the tenant loses out on the interest/return he would have otherwise earned on the money he hands over to the landlord.

The MTA proposes that the security deposit in residential property will not exceed two months of rent. This is something that addresses the problems that many tenants face while renting a house.

The government expects the impact of the MTA to be revolutionary. As the press release accompanying the announcement of MTA pointed out: “The Model Tenancy Act will facilitate the unlocking of vacant houses for rental housing purposes." This is the key aim of MTA.

For this to happen, state governments should adopt the MTA in its true letter and spirit and not go around diluting it as they had done with the model RERA Act to help the builders who are key financiers of state-level politicians.

Also, how well the Rent Courts, which are to be set up by district magistrates/district collectors with the approval of the state governments, function, will decide whether vacant houses are opened up or not.

In case of a dispute, the landlord or the tenant may file a case with the district rent court. How fast Rent Courts hear cases and come to a decision will be very important if the government objective of MTA leading to more vacant houses being unlocked is to be achieved. Nevertheless, the only way to find this out is by setting up rent courts.

The press release further points out: “It will enable the creation of adequate rental housing stock for all the income groups thereby addressing the issue of homelessness."

This is kite flying at its very best. Most of the locked homes are spread across India’s largest cities, where a flat on average costs around ₹50 lakh. Even assuming a 2% rental yield, the annual rent comes to around ₹1 lakh (2% of ₹50 lakh). Rental yield is the annual rent divided by the market value of the home. The homeless in India don’t have this kind of money.

The press release continues: “Model Tenancy Act will enable institutionalization of rental housing by gradually shifting it towards the formal market." This is also far-fetched given that the rental yield of 1.5-2.5% prevails across most Indian cities when it comes to residential property.

Why would any institution invest in creating an asset that gives a return of 1.5-2.5% per year before tax is a question well worth asking.

Also, the low rental yield will continue to discourage the high net worth individuals and corporate honchos, who typically tend to own multiple properties, to rent them out. The MTA can’t do anything about this. The thing is that the rental yield will only go up if property prices come down substantially.

One way to encourage landlords to rent their homes is to tax rental income to a certain extent, at a lower rate than the marginal tax rate.

To conclude, MTA is a step in the right direction but not a magic wand that it is being made out to be by the government and vested interests in the real estate sector. Expecting it to start delivering immediately is a false hope at best. Many other things need to fall in place for the MTA to be effective.

Like any other economic reform, to be effective, the central government needs to communicate clearly with the state governments, which has rarely happened in recent years.

Vivek Kaul is the author of Bad Money.