To capitalise or not to capitalise? Public agencies versus urban residents

Introduction

Over the last several decades, public housing authorities in various countries have offered urban tenants – with cooperative, rental or leasehold contracts – economic incentives to increase their property rights in the housing units in which they reside. In return, the tenants would have to pay higher annual fees or a higher lump sum. Yet these seemingly attractive proposals have often met with indifference or only marginal acceptance. In general, the objectives of the public institutions have been economic and administrative efficiency. The primary economic objective has been to enrich the public coffers through the tenants’ payments. The administrative objective has been to reduce friction with the tenants and to streamline, simplify and expedite the managerial and regulatory work of the public institution (Hason, 2006).

Since the 1990s, as part of the waves of neoliberalism and privatisation, considerations of economic and administrative efficiency have become increasingly important factors in urban planning decision-making in many developed countries, such as Germany, the Netherlands, Great Britain, Sweden and Israel (Alterman, 2001: 23–35). The public authorities’ offers that would enable residents to increase their property rights and reduce leasehold payments are manifestations of these trends.

Urban residents have had to choose between maintaining their existing status and increasing their property rights by paying the required sums. This paper shows that many eligible residents have rejected the seemingly tempting offer of increased property rights primarily because such a move would involve a financial burden contrary to their individual economic interests.

In the USA, an example of the phenomenon is the Mitchell-Lama Housing Program in the state of New York, under which the owners of a housing cooperative had the option of ‘privatising’ their building. This would allow residents to sell their units at market rates, which would exceed the prices they had paid. Yet many residents chose not to privatise, for fear that this might increase their rent on the housing unit (because the building would lose its tax abatement) and might increase their payments on a non-subsidised mortgage. The policy of housing privatisation has become a major issue in the USA since the 1990s. ¹

In the UK, many social housing tenants have faced a similar dilemma since 1979, because of the massive privatisation of social housing. This process has encouraged many middle- and low-income households to fulfill their dream of owning their housing unit, but has forced them to take larger mortgages than they can afford (Whitehead, 1993, 2014: 105–120).

In Israel, since the early 1970s the Israel Lands Council (ILC) has tried various ways to encourage urban lessees to capitalise their residential leasing contracts by offering them a ‘bundle of attractive benefits’, mostly in the form of increased property rights. Despite these offers, which have increased over time, for many years the lessees have generally been unresponsive (Hananel, 2010, 2013, 2015; Hananel and Alterman, 2015: 156–161).

What is the explanation for this phenomenon? What accounts for the changes, over time, in the leasehold policies and the response of the target population? In this study, we focus on the relationship between the public housing institution and its clients, the lessees, with regard to leases and property rights. We focus on the Israeli case, for which we have detailed information, because it has affected a large sector of the urban population. ² The key questions in our study are: How have the lessees responded to the housing authority’s proposals over time? Why, over three decades, have the lessees refused to accept the housing authority’s proposals despite the major incentives offered? How has the authority responded to the lessees’ behaviour? And what explains the observed changes in the number of lessees who have complied with the proposed policy? More generally, we try to explain changes in policy concerning the relationships between clients and public institutions in the context of housing.

The relationship between the ILA and the urban lessees evolved over three decades in a multi-stage process. To analyse this relationship we use an extensive-form game theoretic approach, whose analytical properties fit well the ILA–lessees process and the relationship described above. ³ The ILA sets the game’s rules, including the terms of the payoff offer, to which the second player (the urban lessee) must respond by accepting or rejecting the offer. Information complete and each party reacts according to its expectation of benefit from the game. An equilibrium in terms of the lessee’s best response emerges. In the next stage, the first player (ILA) revises the offer, to which the other player reacts. Again a new equilibrium emerges. The game continues until the ILA offer is exhausted in the sense that a revised offer would not change the equilibrium result. The temporary equilibrium results embody the utility expectations of both sides and is expressed in terms of the number of lessees who have chosen to accept an ILA proposal compared with those who have declined to do so.

We chose this approach because it is useful in examining the strategic behaviour of the agents involved: the public institution and the urban lessees. Furthermore, it enabled us to track changes in each player’s behaviour over time, taking into account the other player’s strategic decision in the previous round as well as the equilibrium results, which evolved accordingly.

The design of the paper is as follows: The next section briefly presents Israel’s land policy and reviews basic terms of urban leasing. The third section analyses the relationship between the urban lessees and the Israel Lands Authority as a series of extensive-form games. The concluding section summarises the findings and implications. We argue that these lessons, though emerging from the Israeli experience, are relevant to similar situations in which urban lessees must respond to proposals from agencies of public institutions.

Israel’s land and housing policy

Israel’s urban land policy regarding the relationship between the public authorities and their clients has evolved substantially. To understand this evolution, it is necessary first to briefly examine the main characteristics of the policy. First, most (93%) of Israel’s land is nationally owned. Consequently, Israel’s public land policy affects, directly and indirectly, the majority of the country’s population. Most Israeli citizens reside, work, and spend their leisure time on national land (Alterman, 2001, 2003).

Another important attribute of Israeli land ownership is that by law national land cannot be sold; instead, a public leasehold system is used (Hananel and Alterman, 2015: 71–86). Public land is administered by a governmental agency, the Israel Lands Authority (ILA), and its policy is regulated and enforced by a statutory body, the Israel Lands Council (ILC). ⁴

The ILC’s first decision, in May 1965, titled Land Policy in Israel, defined two different types of leases, one for urban areas and the other for rural-agricultural land. ⁵ In this paper we focus solely on land policy regarding the urban sector.

The leasing terms for urban land are based on market forces. This means that the price ‘is determined by its actual market value agreed upon by a willing seller and a willing buyer’ (first ILC decision, May 1965). Urban leasehold contracts involve two payments by the lessee: a partial single capital payment upon the signing of the lease (40%–80% of the land’s value) and an annual payment of 5% applied to the remaining value.

The ILC’s 1965 decision also refers to the duration of the lease: 49 years, with an option for the tenant to extend it for another 49 years. Only in the late 1970s did the ILC develop rules concerning the expiration of leasing contracts and renewal rights and set a renewal fee (Alterman, 2003: 17). ⁶

There are two more payments to the ILA that tenants make in order to expand their property rights. The first is a consent fee for the transfer of rights, when the property is transferred to a third party upon a sale or as a gift. Although the ILA almost always gives its permission for lease transfer, it uses this opportunity to tax part of the added land value (Alterman, 2003: 27–29). The second payment is a permit fee for development rights, which the ILA charges when the lessee seeks consent for additional development beyond the development rights that were in force at the time of the initial lease (Alterman, 2003: 30).

The capitalisation of urban residential leaseholds

In 1973, the ILC decided to change the payment method for urban residential leasehold contracts, from two payments to one advance payment. This method is known as ‘capitalisation’. Capitalisation is a simple technical operation in which the annual lease payments for the remainder of the lease are converted into a one-time payment of a capital sum (Vitkon, 2001: 425). The annual interest rate of the lease contract was 5%, for all regions of the country (Hananel and Alterman, 2015: 153).

The stated reason of this policy change was administrative efficiency, namely ‘to simplify and expedite leasing processes and supervision of leasing conditions’. ⁷ In practice, the increased number of urban lessees made it difficult for the ILA to administer the leases. The one-time advance payment method was intended to reduce the dependence of urban lessees on the ILA, thereby lessening the resulting friction. The secondary motivation for this policy was to collect more revenue from the lessees. Capitalisation of the lease contracts required reassessment of the land’s value, and in most cases this led to a substantial increase in the leasing fees (in some cases by hundreds of percentage points) (Hananel and Alterman, 2015: 153–156). At first, as shown in detail below, the capitalisation policy did not provide sufficient benefits to the urban lessees, for many of whom it involved a substantial financial burden. As a result, urban lessees were not eager to capitalise.

In response to the lack of interest in the capitalisation option, the ILA proposed a series of new policies containing both carrots and sticks. The carrots included a decrease in the capitalisation payments and an increase in the property rights. The sticks consisted of increased leasing fees for those who rejected capitalisation. The urban lessees’ main interest was financial, that is, paying the ILA as little as possible (Appendix. List of ILC decisions included in this study). They also wanted independence, that is, to reduce their friction with the ILA by gaining more property rights (Hananel and Alterman, 2015: 157–161).

The adoption of the capitalisation system has dramatically changed the lessees’ relationship with the ILA by blurring the differences between leasing and ownership. This process, which has been called ‘creeping privatisation’ (Alterman, 2003) or ‘concealed privatisation’ (Barak-Erez, 2008, 2012: 85–86; Weisman, 1991, 1999), was conducted in a creeping manner, and was a significant step toward full privatisation of urban land (Hananel, 2013, 2015; Hananel and Alterman, 2015: 153–191). The interests of each party are illustrated in Figure 1.

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Figure 1.

An illustration of the ILA’s set-of-offers curves and the lessees’ willingness-to-accept curve.

The figure shows the original offer curve made by the ILA (marked as period 1). It slopes from left to right to indicate the tradeoff between the property rights the ILA was willing to grant lessees and the ILA’s expected revenues. The lessees’ willingness-to-accept curve indicates that they favoured more rights for lower cost. The figure shows that initially (period 1) the offer curve hardly intersects the lessees’ willingness-to-accept curve, that is, most lessees did not capitalise their leasehold contracts. Consequently, the ILA successively lowered its offer curve, agreeing to accept lower payment and to grant more property rights. The results were equilibrium points (marked by E1–E4), that show, in each period, the number of urban lessees who accepted the ILA offers and those who declined. As the figure shows, these equilibrium points reflect reduced payments for expanded property rights.

What explains the evolution of the relationship between the ILA and the urban lessees? We use a multi-stage game (extensive sequential game) to model the behaviour of these two agents – the ILA and the urban lessees. Both parties must make choices based on the available information and their respective interests and expectations.

In each of the four periods, the ILA offered urban lessees property rights in exchange for capitalisation. The urban lessees had to decide whether to accept the ILA’s offer. In this game there is complete information, and the payoff matrix is calculated at the end of each period by backward induction. In each period we observe a different equilibrium, which reflects the division between those who agreed to accept the ILA offer and those who declined. These points – E1, E2, E3, and E4 – are shown in Figure 1. Next we characterise the game and its results.

The ILA versus urban residential lessees: An extensive sequential form game

In game theory parlance, the relationship between the authorities (ILA) and the urban lessees can be described by a matrix in which the rows and columns denote strategies and the matrix’s entries specify agents’ utilities. The ‘payoff matrix’ contains the information regarding the relative benefits and costs to agents that emerge from each possible strategy vector of choices (Gilboa, 2010: 114–117; Riker and Ordeshook, 1973: 119–120). Yet, this game form allows no reference to the element of time, whereas the situation of interest to us has a chronological timeline. Therefore, we use an extensive sequential form game, as explained above, that allows us to model the chronological order of moves by the players. The game is described by a decision tree: at each node one agent is expected to make a move. Edges coming out of the node represent the various moves that the players can chose from (Doron and Sened, 2001: 150–151; Gilboa, 2010: 114–117).

The game includes two players: the ILA, which is a public body that determines the rules of the game by its policy decisions, and the urban leaseholders, who must choose whether to accept or reject the ILA’s capitalisation offers. Following the lessees’ response, the ILA may changes its capitalisation/property-rights policy in the next setup of the game. The ILA and the leaseholders engaged in this kind of game over several periods. In each period, a player considers the impact of his or her actions on future actions by the other player. The number of lessees who capitalise in each period represents the equilibrium of each of the series of games played over time (E1–E4, in Figure 1). ⁸

We chose to model the process through this game because we believe that it fits well the ILA’s evolving relationship with the lessees and also explains well the temporary equilibrium results, given their respective payoffs, past experience, and future expectations.

On the basis of the trajectory of the ILC policies concerning property rights that were linked to capitalisation, we regard the 46 years since the initiation of the process (1973–present) as one extensive sequential form game, which consists of four distinct periods, described below. In each period, the ILA changed its policy in response to the urban lessees’ behaviour in the previous period. Thus, each period is represented by a different payoff setup that players face. The four periods are: (1) 1973–1974: the first decision regarding capitalisation; (2) 1975–1989: exemption from consent fees and renewal fees; (3) 1990–2007: discount offers and exemption from permit fees; (4) 2008–present: ‘conceptual capitalisation’ and ownership (explained below).

The ILA’s data show that in 1988, about 275,012⁹ urban lessees were encouraged to capitalise their leasehold contracts. Because the ILA has data starting only in 1988, we do not know exactly how many urban leasehold contracts existed in 1973, when the capitalisation system began, and exactly how many leasehold contracts were capitalised during the first two periods. We estimated, however, that an insignificant number of leases (a few hundred annually) were capitalised during the first and second periods, most of them in the context of a transfer of property rights between lessees. ¹⁰ Accordingly, in the first period (1973–1974) only 774 contracts were capitalised. In the second period (1975–1989) 1935 contracts were capitalised. In the third period (1990–2008), for which pertinent data are available, 238,824 contracts were capitalised, and 7100 were capitalised in the fourth period (since 2008). Currently, 26,379 contracts are still not capitalised.

Key variables that covariate with a lessee’s decision to capitalise include payoff benefits and the lessee’s expectations regarding future policy changes. The expectations are based on the value that the lessee attaches to the probability that the ILA will improve its policy in the future. The payoff benefits are based on the utility that can be attributed to these expectations. These benefits are shown in the literature to reflect mainly the lessee’s disposable income and utility function. The disposable income, in turn, is shown to be influenced by socioeconomic variables and demographic factors, such as a household’s gross income, a lessee’s vocation and education level, marital status, work experience, number of children, and the children’s age. These variables are embedded in the household’s disposable income per household member, which affects the decision to accept or reject the ILA policy offer (Ganong and Shoag, 2015; Hyra, 2015; Rossi, 1980; South and Crowder, 1997).

Support for this conclusion can be found in the fact that when we consider the number of lessees who capitalised their contracts over the years by cause, we find that most of them (90%) chose to do so using the discount offers, which were substantial, during the third period. In previous periods, lessees were required to capitalise their residential leasing contracts in order to carry out actions that require the consent of the ILA, such as in the case of the sale of the property or in order to gain development rights. These data are presented in Table 1 below.

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Table 1.

Total urban residential leaseholds that were capitalised, by cause.

Cause for capitalisation	Total number	Percentage
Discount sales	222,954	90
Transfer of rights 11	6643	2.5
Lease renewal	7307	3
Conceptual capitalisation	6268	2.5
Other 12	5461	2
Total	248,633	100%

As already mentioned, to explain these results we use the extensive sequential form game, showing how the game and the corresponding equilibrium changed in each period. As we shall see, in the first period the ILA introduced the capitalisation option to the urban lessees without giving them any tangible benefit. Consequently, the lessees did not cooperate. Over the years, the ILA significantly increased the benefit it offered the urban lessees to encourage them to capitalise their residential leasing contracts.

In light of the data presented above, it can be argued that a rational lessee would have two options: first, choose to wait, assuming the probability of a better offer from the ILA in terms of additional rights for less payment; second, comply with the offer, assuming the probability that the offer will be retracted in the future and that a worse option will be offered. The revealed behaviour of lessees in each period indicates that the lessees assumed there was a very high probability that a better offer would be made in the future. Only during the third period, when the offer essentially eliminated all costs to the lessees, did the majority accept the offer, indicating their assumption of a low probability of receiving a better offer in the future. In the absence of data on individual lessees’ decisions, and to simplify the presentation, we chose not to incorporate the probability elements into the game, though such elements are implied. Generally, the urban lessees are assumed to be rational players in two ways. First, they make their decisions, whether or not to capitalise their residential leasehold contracts, by maximising their utility, expressed by the payoffs at each stage. Second, their decisions in each period implied their expectations that the ILA would improve its offer in the future.

Today, the ILA’s assumption is that those who have not yet capitalised are lessees who are unable to bear the burden of payment (having a too low disposable income). Therefore, the ILA is considering exempting these lessees from any additional charge for their leasehold capitalisation.

The ILA’s benefits and the lessees’ benefits

As indicated above, the ILA derived benefits from revenue (denoted by R) and from the reduction of friction with the leaseholders (denoted by F). Over the years, the weights of these factors, denoted respectively by w₁ and w₂, (w₁+w₂ = 1), have changed in favour of reducing friction (increased w₂). For the sake of simplicity, we assume a quasi-linear function, for example, U_ILA = w₁ (R) −w₂ ( F ). As friction is reduced, the ILA’s profits increase at a decreasing rate. ¹³

The lessees’ benefits are derived from a reduction in their payments (denoted by P) and the gain in property rights (denoted by G). We assume an indirect utility function expressed as: U_L = r₁ (G) −r₂ ( P ); (r₁+r₂ = 1), implying an increasing and marginally decreasing function of P, and an increase in the monetary equivalence of G. The figures below are based on these profits of the ILA and the lessees’ utility. In sum, the ILA’s policy variables are the lessees’ payments (P) and property rights (G), while revenue (R) and friction reduction (F) are the consequential objectives.

Given the players’ respective benefits, we specify the payoff to each player from each variable, resulting from different policies, to be in the range of (0, +10) or (−10, 0). Since each player’s benefit is derived from two different weighted variables (P, G) and (R, F), in theory, each player’s total value can range from (−20) to (+20).

The payoff from each weighted variable changed over time. The values of each of the policy variables and their respective weights are as follows: Revenue was initially very high, yielding a payoff of (+10), but over the years it decreased gradually to (0). For the lessees, the payment for capitalisation was initially high, but over the years it decreased gradually to (0). The property rights that the ILA offered the lessees increased over time. Thus the payoff ranges from no ownership (0) to full ownership (+10). The utility from reducing friction is the only one that remained consistently high over time (+10).

Using the extensive sequential form game we next examine these changes over the four periods indicated above. The figures above are arbitrary and aimed at reflecting the relationships between the ILA and the urban lessees, and are based on the underlying utility function of each of the players in each period.

Period 1. 1973–1974: The first decision regarding capitalisation

During the first period, the ILC introduced the policy of capitalisation, with the objectives of reducing friction between the ILA and the lessees and increasing revenue. During this period, the transition to capitalisation was very slow. Since under the ‘old’ rules the annual payment was much lower, capitalisation offered the lessees no significant benefit and therefore they were not eager to accept the ILA’s offer. During this period, the ILA placed much greater weight on revenue than on friction reduction. The payoffs resulting from different strategic moves by the agents are illustrated in Figure 2.

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Figure 2.

Period 1: 1973–1974. ¹⁴

Over the years, the lessees placed little weight on property rights but great weight on payments. Given the lessees’ utility function, choosing to capitalise during this period meant that one paid much more (−10) and gained no rights (0); thus the utility would be (−10). Assuming equal weight for revenue and friction reduction, in this period the ILA would receive more revenue (+10) and reduce friction (+10), for a total utility of (+20). Lessees who chose not to capitalise would not pay more and would not gain more property rights (value 0), while the ILA would not receive additional revenue and would not reduce friction, for a total utility of (−20).

The information the ILA received at the end of the first period was the urban lessees’ clear preference for not capitalising (E1 in Figure 1: Capitalised, 774; Not capitalised 274,238). This led the ILA to revise its policy terms and to offer, in the next period, a new ‘carrot and stick’ policy.

The few lessees (774) that capitalised their residential leasehold contracts during this period did it mainly for lack of choice. The rest decided rationally not to capitalise, because capitalisation was mandatory only if the property was sold or if the lessee sought to gain development rights. ¹⁵

Period 2. 1975–1989: Exemption from consent fees and renewal fees

The first ‘carrot’ came from a policy change in 1975 – exemption from the ‘consent fee’. ¹⁶ It applied when lessees who capitalised their contracts transferred the rights to other residents. ¹⁷ The ILA also linked the capitalisation with ‘renewal fees’ following the initial 49-year period. ¹⁸ From that point on, urban lessees who capitalised could extend the lease for another 49-year period at a considerable discount. The ‘stick’: Starting in the mid-1970s, the ILA updated the annual leasing fee for lessees who did not capitalise their residential contracts and gradually increased the fee. However, the increases were too gradual to motivate many urban lessees to capitalise.

Finally, in 1988, the ILC expanded the capitalisation policy, which had initially affected only apartment dwellers, to include all urban residential leaseholders, including those in single-family housing (Hananel and Alterman, 2015: 153–161). The payoffs of this period are shown in Figure 3.

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Figure 3.

Period 2: 1975–1989.

In this period, lessees who chose to capitalise still had to pay a considerable amount of money, but a little less than in the previous period (−8). The lessees also gained some rights (+3), so the total utility was (−5). The ILA received less revenue (+8), but reduced the friction with the lessees (+10), for a total utility value of (+18). Lessees who chose not to capitalise paid a bit more (−2) and did not gain more rights, yielding a total utility value of (−2). The ILA did not receive more revenue (−8) and did not reduce friction with the lessees (−10), for a total utility value of (−18). Thus, although the ILA offered improved terms, they were not improved enough to induce the lessees to capitalise. During this period, only 1935 leasehold contracts were capitalised, while 272,303 were not (E2, Figure 1).

Period 3. 1990–2007: Discount offers and exemption from permit fees

In the mid-1990s, as part of the ‘carrot’ policy and after realising the failure of previous policies to induce capitalisation, the ILA began a series of capitalisation discount offers, which gave exceptional discounts and preferential terms for a limited period to lessees who chose to capitalise. The discount offers were not connected to the actuarial value of the lease, and in some offers the capitalisation calculation was based on 3% per annum instead of 5% (as was the ongoing rate). ¹⁹

As additional carrots, during the 1990s the ILA gradually offered exemptions from ‘consent fees’ and ‘renewal fees’ for those who chose to capitalise. As part of the ‘stick’ policy, the ILA substantially increased the annual lease fee for contracts that were not capitalised.

In 2007, the ILA introduced another capitalisation discount offer, accompanied by an extensive media campaign. The offer included cancellation of up to 30% of the debt, cancellation of debt-restructuring payments, and various payment options (including online, bank, and debit). The offer was valid for only six months. The policy’s effects on the agents’ utilities are displayed in Figure 4.

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Figure 4.

Period 3: 1989–2007.

Given the lessees’ utility function, which put greater weight on fees, those who chose not to capitalise in this period would pay more than in the two preceding periods (−4) and would not gain more rights (0), thus attaining a total value of (−4). In this situation, the ILA would not get more revenue (−5) and would not reduce the friction with the lessees, which had greater weight in its utility function (−10), yielding a total value of (−15). However, lessees who chose to capitalise, given the discount offers, would pay less than in the two preceding periods (−5), though still a substantial amount, but would gain extensive property rights (+6). Given the weights in the lessees’ utility function, the total utility of a lessee would be (+1).

As for expectations, it seems that in light of past experience, urban lessees believed that the ILA’s offers in this period were the best, in utility terms that they could get. Consequently, as the data show, during this period (1990–2007) most of the urban lessees (88%) agreed to capitalise their residential leasehold contracts.

As for the ILA, in this period the ILA would gain some revenue (+5) and would substantially reduce friction with the lessees (+10), thus yielding a total utility of (+15).

At this equilibrium point, a total of 238,824 lease contracts had been capitalised; 33,479 had not (E3, see Figure 1, and E3*Figure 4). Therefore, the fourth ILA proposal, which is presented below, focused solely on the 33,479 urban lessees who had not yet capitalised their residential leasing contracts (the distance between X₃ and X₄ in Figure 1).

Period 4: 2008–present: Conceptual capitalisation and ownership

At the beginning of this period, the ILA increased the benefit of the lessees in relation to property rights and payments. In 2008, the ILA introduced a new policy titled ‘conceptual capitalisation’: Instead of encouraging urban lessees to voluntarily capitalise their residential leaseholds, the ILA considered a contract capitalised once the lessee had paid seven years’ annual leasing fees. A one-time payment in advance was no longer required.

In 2009, the Israeli parliament enacted a land reform ²⁰ to allow transfer of full private ownership to urban lessees on condition that the leasing contract be capitalised (Hananel, 2010, 2013, 2015). ²¹ Figure 5 describes the new payoffs associated with the revised version of the game.

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Figure 5.

Period 4: 2008–present.

The strategic choices of the lessees and the ILA yielded an additional 7100 capitalised leasehold contracts; 26,379 are still not capitalised (E4, Figure 1). The ILA is clearly better off offering this policy change, as it reduces friction and discontent significantly.

In this period, the lessees did not have to pay more (0) and gained ownership (+10), yielding a total value of (+10). The ILA did not receive more revenue (0), but it reduced friction with the lessees considerably. Thus each strategy gains (+10), yielding a total value of (+10).

The explanation for the lukewarm response by urban lessees in this period is their indifference, in terms of utility, between capitalising and not capitalising. Both strategic choices yield the same payoffs to the lessees and the ILA. Even the offer of full ownership of the land did not constitute a significant incentive for urban lessees. This is because – thanks to Israel’s land policy and its lease method – most of the lessees are unaware of the difference between ownership and permanent lease. In fact, according to the literature, they consider themselves owners of the land and not renters or tenants. Even the Israeli courts, in many rulings, have referred to the urban lessees as owners of the land (Goldberg, 1987; Hananel and Alterman, 2015: 153–161; Tzur, 1987; Weisman, 1987).

At present (2016), about 10% (26,379) of the peak number of urban residential leasehold contracts (275,012 in 1973) have not been capitalised, mainly because the lessees lack the means to pay the seven-year fees. The ILA is examining various options for handling these cases, but is leaning toward freezing the lessees’ capitalisation fees until the lessees ask to increase their development rights or sell their housing unit. ²²

Discussion and conclusions

We analysed the relationship between a public institution and its clients – the housing authority and its urban clients (the lessees). Such relationships are typical of many urban areas. We focused on the Israeli case, given the availability of data and the importance of such policies for the majority (91.5%) of the population in Israel. ²³

The authority changed its policy over time to encourage urban lessees to capitalise their residential leasehold contracts. The ILA’s main motivation was administrative efficiency, namely reducing friction with the lessees, and increasing revenue (at least initially). Over the years, the ILA gradually reduced the payments it required of the lessees in exchange for property rights. With each policy change, some lessees decided to capitalise and receive increased property rights, while others decided not to. How can we explain these changes in behaviour by the two sides, the ILA and the urban lessees, and what general conclusions can we draw?

To answer these questions we reviewed policy changes and lessees’ responses using an extensive sequential form game played between the parties, where the equilibrium is assessed based on the number of lessees who did or did not accept the ILA’s policy offers.

The game is prompted by the strategic choices of the two parties. These choices are made based on the expected payoffs from each anticipated strategic vector of choices. The ILA’s objectives were to reduce friction with the lessees and collect revenues. The lessees’ objectives were to reduce payments and increase property rights. The process was characterised by policy changes, which offered various mixes of payment and property-rights incentives. Table 2 summarises the payoff matrix of both players (the ILA and the urban lessees) and the equilibrium result in each period.

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Table 2.

Summary of payoff matrix and the equilibrium point of each player at each period* (p. 20).

	Non-capitalised lease contract	Urban lessee		ILA
		LesseeAgrees	Lessee declines	Lesseeagrees	Lesseedeclines
Period 1	275,012	−10 (774 0.3%)	+20	+20	−20
Period 2	274,238	−5 (1935 0.7%)	+18	+18	−2
Period 3	272,303	+15 (238,824 87%)	+1	+1	−4
Period 4	33,479	+10 (7100 3%)	+10	+10	+10
Present	26,379

Note: Areas marked in grey indicate the equilibrium point for each player in each period.

We conclude that the urban lessees’ interest – reduced financial obligation – was the dominant factor; increasing the lessees’ property rights was of secondary importance. This is reflected in the respective weights placed by the lessees on these variables in their utility functions, as tangibly presented in Table 2. Over the years, the ILA changed the mix of payments (revenue) in exchange for property rights by reducing the fees and increasing the rights, thus reducing friction with the lessees.

Evidence of the lessees’ preferences is found in the fact that ultimately 90% of the urban lessees who chose to capitalise their residential leasehold contracts were responding to ‘discount sales’ (period 3), as shown in Table 1.

The policy change of 2009 allowed the lessees to gain ownership almost automatically, with the only remaining condition that their urban residential leasehold be capitalised. However, in this period only 7100 urban lessees decided to capitalise their urban residential leasehold contracts, while 26,379 urban lessees did not. Was it because they chose not to, or because they could not afford to?

A key policy conclusion that can be drawn from this analysis is that a public agency does not always correctly identify its clients’ interests and needs. The ILA’s lack of sensitivity to, and understanding of, the urban lessees’ needs was a key factor in the relationship between the parties. In our case, it took more than four decades for the ILA to give up the revenue objective and succeed in reducing friction with the lessees by realising that the typical urban lessee’s basic motivation was to pay less, rather than to increase his or her tangible property rights.

As in the cases of public housing tenants in England and the Mitchell-Lama Program in New York, we find that the residents’ main aim is to lower costs, rather than to gain additional property rights.

It is important to examine the implications of public institutions’ imposition of restrictions, such as capitalisation in the Israeli case, on clients’ behaviour in the housing market as individuals and on the collective level. If capitalisation were not mandatory, individuals might have been able to change residential units more frequently and thus improve their housing situation. Perhaps the accelerated release of secondhand apartments for the housing market might have reduced costs and possibly averted the current crisis in the Israeli housing market. However, these important issues require and deserve a separate study.