An empirical comparison of Housing expenditures and user costs for the four Danish tenures Jens Lunde Department of Finance, Copenhagen Business School Marc Lund Andersen Knowledge Center for Housing Economics, Realdania ”Private Renting After the Crisis” ENHR Private Rented Markets Conference London School of Economics, Lincoln’s Inn Fields March 2015

Housing expenditures – liquidity – payments Rental properties: rents – The rental income must cover the landlords expenditures + capital return Owner-occupation: – Operation costs + maintenance + administration [value of own time] – Property and land taxes – Debt services (interest exp. + instalments) after tax

Housing expenditures – liquidity – payments Problems – Size of down payment / equity – Instalments – The influence from inflation – Depreciations – value of wear and tear – The influence from taxation

User costs – intuitively – private rental dwellings Expenditures to be covered through the rent income. The same items are included in the rules for the rent regulation, as a large part are under rent regulation. Operation, maintenance and administration expenditures + Land taxes + Rate of depreciation + Capital costs before tax (landlord’s required return) – Nominal property price increase

User costs – intuitively – private rental and owner-occupation Private rental dwelling: Operation, maintenance and administration expenditures + Land taxes + Rate of depreciation + Capital costs before tax (landlord’s required return) – Nominal property price increase Owner-occupied dwelling: Operation, maintenance and administration expenditures + Land taxes + Property value tax + Rate of depreciation + Capital costs after tax – Nominal property price increase

User costs – an analytical useful concept Wish an all-inclusive-concept, which - express the true housing costs - express the pure economic burden at housing consumption - doing the housing choice based on an economic calculation - render it possible to estimate the balance among the tenures at the housing market - render it possible to analyse the distributional effects of the housing policy ” …. that the best way to evaluate how the tax system, financial markets and housing markets have combined to generate incentives to owner-occupation is to evaluate the user costs of owner-occupied housing.” (Miles, 1994, p. 56).

User costs Ex ante or Ex post? Use the user cost formula for owner-occupation: UC OO t = E t · i E,t ·(1 – T E,t ) + F t ·i F,t ·(1 – T F,t ) + K t ·(d t + q t + e t + a· g T t – p ej,t ) Expected inflation will be paid through the nominal interest rate (Irving Fisher). Unexpected inflation will release a capital gain/ capital loss for the owner. Expected house price increases/decreases are paid through the purchase price Unexpected house price increases/decreases are not paid in advance and create gains/losses for the owner. Ex ante user costs can not be negative realistic seen, i.e. expected high price increases will be capitalized ”immediately” and release even stronger house price increase – for a while. Ex post user costs for owner-occupied houses have changed strongly over the last 35 years – and can be rather high as well as even negative.

Normalized required return of property investment - at a long term risky property investment Interest rate at an infinite investment horizon, i.e. inclusive a time premium: 4.5 % 5.5 % + Rate of depreciation1 % 1 % + Risk premium (illiquidity, risk on the property price, other risk at ownership)2 % 2 % minus expected long term price increase 2 % - 8 % Required annual operational yield of the property investment: 5.5 % 16.5 % The interest rate on a mortgage loan is much lower. While the interest rate on commercial bank loans is much higher. However, the weighted interest rate on the loans must be lower than the required return of the property investment. Never before seen negative short term interest rates – and never seen interest rates on 30 years FRM below 2½ %. Required nominal return: 7.5 % – if increasing property prices. More art than science Always THE problem: which rate of increase in the property prices can be expected?

Preliminary results of the calculation of housing expenditures and user costs for the four Danish housing tenures.

Assumed values of the economic variables VariablesActual values”normalized values” Market value of the property, primo 011 Part financed with equity (down payment)5% Part financed with bank loans15% Part financed with mortgage.80% Rate of return for an investment with the same risk.4.50%7.50% Debtor interest rate on the mortgage loan.2.15%5.15% Rate of fee on the mortgage loan0.90% Number of years at the mortgage loan.30 Debtor interest rate on the bank loan.7.00%10.00% Number of years at the bank loan.15 Rate of inflation (consumer price index).0.40%2.00% Rate of price increase for houses of unchanged quality.3.30%2.00%

The used parameters ParameterSize Operational, maintenance and administration expenditures in year t 2% Rate of depreciation in year t.1% The land’s value as part of the property value.25% Land tax rate.2.63% Property tax rate in t.0.60% The tax rate at the equity return at an alternative investment with similar risk % The tax rate for negative capital income.33.6% The starting capital cost percentage in social housing 2.80% Fee on mortgage loans, social housing0.30%

User costs - using normalized values Year Owner- occupation Private co- operative housing Private rental housing Social housing 10,07560,09090,09880, ,07730,09080,10200, ,07930,08980,10620, ,08100,08720,11040, ,08310,08590,11450, ,08500,08450,11870, ,08670,08170,12270,0829

User costs - using normalized values

Housing expenditures – using normalized values Year Owner- occupation Private co- operative housing Private rental housing Social housing 10,09110,10000,09880, ,09350,10040,10200, ,09720,10070,10620, ,10220,10090,11040, ,08610,08120,11450, ,08960,08090,11870, ,09380,08030,12270,0829

Housing expenditures – using normalized values

User costs – using actual values from the start of 2015 År Owner- occupation Private co- operative housing Private rental housing Social housing 10,04280,04850,05580, ,04480,04910, ,04760,04970,06510, ,05070,05010,07120, ,05450,05210,07800, ,05880,05490,08570, ,06360,05800,09420,0826

User costs – using actual values from the start of 2015

Housing expenditures – using actual values from the start of 2015 År Owner- occupation Private co- operative housing Private rental housing Social housing 10,08100,08030,05580, ,08420,08150, ,08890,08320,06510, ,09450,08500,07120, ,08290,07070,07800, ,08810,07310,08570, ,09380,07580,09420,0826

Housing expenditures – using actual values from the start of 2015