Housing Standards 2003/2004:
Housing Policy in the Czech Republic - More Efficiently and More Effective

5. Simulation of an equilibrium market rent in the Czech Republic and of the financial and social impact resulting from an introduction of income-tested housing policy instruments

5.2 Simulation of "shock" rent deregulation

The model of "shock" rent deregulation flows from the assumption that rent deregulation would occur within a very short time span (practically "overnight"), i.e., the only changing parameter in this case was the rent level. The amount of the rent declared by households in the data set FBS 2002 living in rental dwellings with regulated rent was increased until the necessary number of rental dwellings was vacated that would satisfy the demand of "non-resident" households.

When simulating shock rent deregulation to the equilibrium market level in Prague, we considered four versions of the model: a version with an average interest rate on provided mortgage credits with expected zero price appreciation (version A1), a version with an average interest rate on provided mortgage credit with expected annual appreciation amounting to 1.5% (version A2), a version with a reduced interest rate determined according to the conditions offered by the largest provider of mortgage credits in the Czech Republic with expected zero appreciation (version B1) and a version with a reduced interest rate determined according to the conditions offered by the largest provider of mortgage credits in the Czech Republic with an expected annual appreciation amounting to 1.5% (version B2).

Table 1 shows a comparison of average simulated prices of equilibrium rent in Prague for alternative versions of the model. The table shows that depending on the input parameters in the model, the value of the equilibrium market rent in the short run fluctuates between CZK 39.5 per m² per month and CZK 82.8 per m² per month; in any case, it is significantly lower than the average supply rent which, according to the data of the Institute of Regional Information (Institut regionálních informací, IRI) was in Prague CZK 142 per m² in November 2002.

We can expect that in the event of shock rent deregulation the rent level in Prague would settle in the long run (if all other parameters, such as household income, remained the same as in 2002) between CZK 63.3 per m² per month (equilibrium rent corresponding to version A2 of the model provided that social housing and a housing allowance are introduced) and CZK 72.1 per m² per month (minimum rent required by investors in the rental housing sector).

Table 3 shows the actual basic housing cost burden measure (SMZ) for various groups of households before deregulation and after completing the deregulation process and achieving a short-term equilibrium rent level.

Table 3 makes it clear that a sharp rent increase to an equilibrium level would bring a significant growth of the housing cost burden level for some groups of households (especially single-member households of retired pensioners and households with a low and medium income). We can also expect that in the event of a shock rent deregulation, prices of owner-occupied housing would record significant gains in view of the poor price elasticity of the supply in the short run as a consequence of a portion of households moving from rental to owner-occupied housing, which would be reflected in a reduced affordability of owner-occupied housing. Due to these reasons we believe that rent deregulation must be spread over a longer time period during which negative social impact will be partially compensated by a growth of a household income; households will have time to optimise their housing consumption and thus the demands on public budgets will be mitigated.

Although spreading rent deregulation over a longer time period would probably bring less negative impact on Czech households, it will be necessary to adopt new and more efficient housing policy instruments in order to maintain the affordability of housing, namely social housing and a housing allowance.

In the simulation model, the age of the head of household and the total net household income were the criteria considered for dividing the Prague municipal rental housing stock into a social housing sector and stock rented for an equilibrium market rent (local adequate). The following types of households were entitled to social housing:

• with a head over 70 years of age regardless of the household income;
• with a head under 70 years of age provided that the total net household income did not exceed 1.5 factor of the living minimum of such a household.

After applying these criteria, slightly less than 35% of Prague households in the regulated municipal rental housing met the conditions for receiving social rent. Table 5 gives values of the basic housing cost burden levels for various groups of households before deregulation, after deregulation and after introducing the social housing in the model.

Table 5 makes it clear that the introduction of the social housing would lead especially to a reduction of the average burden level for households of pensioners, single-member and two-member households and households with the lowest income (households in the 1st income quintile). Nevertheless, despite the introduction of a social housing system in the municipal rental housing sector it is clear that the burden level of some groups of households still remains high. In order to maintain affordability of rental housing it is therefore necessary to provide additional support for such households in the form of a housing allowance.

The general equation for calculating the housing allowance considered in the simulation model was as follows:

APN = min (actual rent expenditures; MAXNAJ) - NMZ * household income

APN - income-tested housing allowance,
MAXNAJ - maximum tariff rent costs,
NMZ - normative burden rate (tariff).

MAXNAJ - maximum tariff rent amount per m² * maximum tariff dwelling size in m²

Maximum tariff rent amount per m² = fn (dwelling category)

Maximum tariff size of dwelling in m² = fn (number of people in a household)

The maximum rent was defined as an average market rent per m² paid by households in a given dwelling category (excluding households entitled to social rent at the level of cost rent), the maximum dwelling size for single member households was defined as 40 m², for two-member households as 55 m², for three and four member households as 70 m² and for households with five and more members as 85 m².

The equation for calculating the normative burden rate (NMZ) took the following form:

NMZ = 6 + 0.2060606 * (rank of the expenditure interval - 1)

Table 6 shows the values for the actual basic housing cost burden level of households in the rental sector after introducing a housing allowance.

In the simulation model we also attempted to take into account the fact that some households would probably try to optimise their housing consumption in reaction to the rent increase and the related increase of the housing cost burden measure even despite the introduced systems of social housing and the housing allowance (rent contribution), i.e., would seek less costly rental housing (involving moving within the rental housing sector and not the already simulated move to owner-occupied housing). Exchanges of dwellings were conducted using a specific algorithm and under certain conditions, which due to the limited scope of this excerpt cannot be presented here.

Using the simulation model, social and economic impact of rent deregulation spread over a longer time period were tested assuming that the supply would be non-elastic or partially elastic in terms of prices. Due to the limited scope of this excerpt, results of these simulations are not presented here.