Effects of rental legislation on the office market: a game theoretic analysis

When the rental market in Sweden is described in general terms it is said that in 1972 the commercial rental market was deregulated while the residential rental market continued to be regulated. This is however not the whole truth, because even though the landlord is free to set the rent in an empty office, there are rules concerning the rent that the landlord can demand when a lease is to be renewed and also rather detailed procedural rules. As the rental contract in Sweden is rather short, typically 3 years for office buildings, the rules concerning renewal of contracts are important for the working of the market. The hypothesis to be developed in the article is that the rental legislation increases the risk for the landlord and makes it rational for the landlord to accept a rent below the rent that would prevail if the parties had contractual freedom regarding renewal of leases. This hypothesis is visualized in a game theoretical model. The hypothesis is confirmed by preliminary studies from the rental markets in the Nordic countries. Differences between rent levels in renewed leases and newly signed leases are significantly lower in the other Nordic countries (Norway, Finland and Denmark) compared to Sweden. This may be explained by the relative contractual freedom between the landlord and tenant in the other Nordic countries compared to Sweden. In the end of the article the authors discus alternative procedural rules in Sweden, and what the authors consider to be a reasonable balance between the interest of landlords and tenants in renewal of leases.