Inefficient Incentives for Energy Saving in Tenancy Law and Policy Options to Remedy the Landlord-Tenant-Dilemma

The rental building sector is plagued by the so-called landlord-tenant dilemma, where landlords have no direct financial benefit from modernizations for energy efficiency if the tenant pays the energy bill, while tenants have no incentives to save energy if the landlord pays. The primary landlord-tenant dilemma occurs due to rent control, which limits rent levels in incumbent tenancies, and the secondary landlord-tenant dilemma stems from modernization costs being sunk and thus not reflected in the bargaining over rent levels when a new rental contract is negotiated after a modernization. Tenancy law, with an allocation system for energy and modernization costs, can help remedy these issues or exacerbate them. This paper develops an analytical model to study how efficiently different allocation systems set modernization and frugality incentives, and which systems compare favorably against each other in terms of landlords', tenants', and their combined welfare. The paper scrutinizes several systems, including a free market, the Swedish inclusive rent system, the German status quo, a slight variation to the German status quo, a consumption-based partially inclusive rent system, and a novel demand-based partially inclusive rent system. While the German status quo can theoretically set optimal incentives if ideally configured, it interacts peculiarly with the rest of German tenancy law, impeding optimal design. The demand-based partially inclusive rent system could more reliably set efficient incentives, but it requires a more radical reform of tenancy law.