A new institutional economic perspective on the emergence of institutional landlords in Beijing's housing rental market

Abstract

Recent development in the commonly called "long-term apartment rental market" in media has attracted a lot of attention in China. Much attention has been on the never-ending crisis in this market and how it might affect the daily lives of renters and the sustainability of the business model. The term "long-term apartment rental market" is somewhat misleading as it refers to an arrangement where a middle agent rents an apartment from a property owner under a long-term contract (3-5 years) and sublets it to tenants with a shorter lease after making some modifications to the properties. The purpose of this study is not to investigate the reasons that have led to the current crisis in this market but to analyze why such contractual arrangement exists in the first place from a new institutional economics perspective. The obvious research question is why the property owners do not contract directly with the tenants. Many modifications made by the middle agent are very simple and can be done easily by the owners. What is the role of the middle agent? In this study, I shall refer to the middle agent as “Institutional Landlord” and the ultimate owner of a property as “Individual Landlord”. Prospective tenants can choose to rent a property from the Institutional Landlord (in “Institutional Rental Market”) or the Individual Landlord (in “Individual Rental Market”). The Institutional Rental Market emerged in China only in recent years and both markets co-exist. My theoretical framework is based on information asymmetry. Information asymmetry in the housing rental market arises from two main sources. First, the property owners know the quality of their properties more than the prospective tenants. Second, the tenants know their creditability more than the property owners. The information asymmetry problem suppresses many transactions that are beneficial to both property owners and prospective tenants and causes rent dissipation. I conjecture that Institutional Landlords can reduce the information asymmetry problem and facilitate transactions that were not possible in the past using the information they possess and the brand names they have established in related businesses. These Institutional Landlords are originally large real estate agency companies. These companies can guarantee the quality of the rental housing units with their brand names and commitment to the subsequent remedial works had there been any defects in the housing units. They further reduce information asymmetry by making the housing units they rented from the Individual Landlord more homogeneous with standardized decoration, fitting and fixtures. Their agency business in the housing rental market has accumulated data that allows them to predict the behaviors of the prospective tenants far better than the Individual Landlord can do and thus reduces the information asymmetry problem about the credibility of the prospective tenants. I developed hypotheses based on the above theoretical framework and tested them with empirical data I collected from a major real estate agent who is also acted as Institutional Landlord in Beijing. Specifically, the empirical results suggest that (1) housing units with more difficult-to-measure attributes are more likely to be rented to Institutional Landlords; (2) the observed rents received by housing owner in the Institutional Rental Market is lower compared with those in the Individual Rental Market since the housing units in the former have more serious information asymmetry problem; (3) repeat tenants are likely to pay a premium to rent a housing unit in the Individual Rental Market since they are more informed and can price the higher quality housing units more accurately than the new tenant; (4) the premium paid by the repeat tenant is higher for housing units with more difficult to measure items and higher decoration costs in the Individual Rental Market but not in the Institutional Rental Market. Both the theoretical analysis and empirical tests confirm that Institutional Landlord originally emerged to reduce rent dissipation in the housing rental market. However, for reasons beyond the scope of this study, subsequently, there were an influx of new entrants to the Institutional Rental Market. Most newcomers do not have the informational advantage and experience to solve the information asymmetry problem. The results of this study suggest that these new entrants are doomed to fail.