Inefficient incentives for energy saving in tenancy law and policy options to remedy the landlord-tenant dilemma

The rental building sector faces challenges due to the so-called landlord-tenant dilemma. This issue arises because landlords have no direct financial benefits from energy efficiency retrofits if the tenant pays the energy bill. On the other hand, tenants have little motivation to save energy if the landlord covers this cost. The primary landlord-tenant dilemma results from rent control limiting rent levels in existing tenancies. The secondary dilemma is due to the undervaluation of energy cost savings in the new rental market. Tenancy law, through the allocation system for energy and retrofit costs, can either address or worsen these issues. This paper develops an analytical model to examine how efficiently various allocation systems incentivize retrofits and energy conservation and how they compare in terms of improving the welfare of both landlords and tenants. I analyze several systems: a free market model without and with rent control, the current German system, a slight variation of the German system, the Swedish inclusive rent system, a consumption-based partially inclusive rent system, and a novel demand-based partially inclusive rent system. The German status quo could theoretically offer optimal incentives if it were ideally set up; however, it interacts in a complex way with other aspects of German tenancy law, hindering optimal design. In contrast, the demand-based partially inclusive rent system is more likely to set efficient incentives consistently but would require substantial reforms in tenancy law.