managing externalities in multi-unit housing: limited equity cooperatives as alternatives to public...

Managing Externalities in Multi-Unit Housing:Limited Equity Cooperatives as Alternatives toPublic Housing

Thomas J. Miceli and Gerald W. Sazama, Departmentof Economics, University of Connecticut

C. F. Sirmans, Department of Finance, School of BusinessAdministration, University of Connecticut

In this paper, we examine some of the ways that the market responds to housingexternalities, focusing especially on multi-unit, low income housing. We develop a theoreti-cal model of a household’s choice among private rental housing, public housing, andlimited equity cooperative housing. The results suggest that the ability of LECs to attracttenants depends, among other things, on the ability of self-management to internalizehousing externalities compared to hierarchical management. Case studies of LECs suggestthat the results are mixed. 1998 Society for Policy Modeling. Published by ElsevierScience Inc.

1. INTRODUCTION

Externalities arise in the housing market when the behaviorand characteristics of one’s neighbors enter one’s utility function.In this paper, we examine some of the ways that the marketresponds to housing market externalities. We focus specificallyon the market for multi-unit rental housing where these externali-ties are most severe.

In the analysis, we adopt the view of housing as a bundle ofcharacteristics (Rosen, 1974; Sweeney, 1974), including consump-tion services and management, or control, of externalities. For

Address correspondence to Prof. Thomas J. Miceli, Department of Economics, U-63,University of Connecticut, Storrs, CT 06269-1063.

We wish to acknowledge the comments and/or assistance of John Colburn, JamesHexter, Theodore Mallone, Robert Richards, Jonathan Wilson, Abdullah Yavas, andespecially Roger Willcox.

Received March 1996; final draft November 1996.

Journal of Policy Modeling 20(5):649–668 (1998) 1998 Society for Policy Modeling 0161-8938/98/$19.00Published by Elsevier Science Inc. PII S0161-8938(97)00071-9

650 T. J. Miceli, G. W. Sazama, and C. F. Sirmans

example, when a person rents an apartment in the private rentalmarket, part of the rent implicitly pays for management servicesaimed at minimizing negative inter-tenant externalities. Theseservices include screening of prospective tenants, monitoring oftenant behavior and eviction of undesirable tenants, maintenanceof the physical structure, including common areas, and the like.Tenants who value these services to a lesser degree can attemptto “unbundle” them by seeking apartment buildings where lessmanagement is provided and rents are correspondingly lower.These tenants thus trade the dollar cost of management for greaterexternal costs.

Low income households, however, may be forced to consumehousing with little or no management services, even if they valuethose services, because they cannot afford the dollar cost. Somepublic housing projects, for example, are notorious for the extentof negative inter-tenant externalities. A response to this problemis affordable housing that seeks to introduce a greater degree ofresident control. Housing cooperatives of this sort are referred toby various names; in this paper we will adopt the term limitedequity cooperative (LEC).1 LECs offer low income residents analternative to “unmanaged” public housing—namely, self-man-aged housing—wherein residents replicate many of the manage-ment functions that are “purchased” in private rental housing andare only partially present in public housing.

A primary objective of this paper is to model a household’schoice among these alternative responses to the problem of hous-ing externalities, given that the household has already chosen notto own in the traditional sense. A second objective is to evaluatethe likelihood that LECs will be successful in improving upontraditional low-income housing in mitigating the negative effectsof externalities through self-management. We shall argue that itdepends on the effectiveness of the mechanisms they have devel-oped for inducing residents to internalize the externalities.2

1 While there are no precise figures on the current number of low income housingcooperatives, we do know that all types of co-ops constitute 2.4% of the total stock ofmulti-unit housing in the United States, and 5.7% in the Northeast (U.S. Department ofHousing and Urban Development, and the U.S. Bureau of the Census, American HousingSurvey for the United States, 1989).

2 We developed many of these ideas in an informal manner in Miceli, Sazama, andSirmans (1994).

LIMITED EQUITY COOPERATIVES 651

The paper is organized as follows. Section 2 provides a descrip-tive overview of the model. Section 3 then develops a more formalmodel of tenant behavior under the different institutional formsand derives the conditions under which LECs will be preferredover private rental housing or public housing. Finally, Section 4presents some evidence based on case studies of actual LECs.

2. OVERVIEW OF THE MODEL

2A. Housing Externalities

Externalities in the housing market arise for a variety of reasons.The social and behavioral characteristics of one’s neighbors andthe way they take care of their units (or fail to) all enter anindividual’s utility function (Henderson, 1985; Chapter 5). Al-though these externalities are present in differing degrees in allforms of housing tenure, they are especially severe in multi-unitrental dwellings. This is true for three reasons. First, becauseindividuals live in close proximity to one another in apartmentbuildings, the undesirable characteristcs of one’s neighbors, e.g.,how noisy or sloppy they are, are more noticeable. These inter-tenant externalities, therefore, do not depend on the fact that theunits are rented, but rather on their close proximity. Thus, theyare present in co-ops, apartment buildings, public housing projects,and densely populated residential neighborhoods. Second, be-cause the tenure of tenants in a rental apartment is less than theexpected life of the building, they will ignore the effect of theirbehavior on the value of the unit to future tenants. (This problemdoes not arise for owners because the sale price capitalizes thisvalue). As a result of this rental externality, tenants will tend tooveruse or undermaintain their units (Henderson and Ioannides,1983). The third reason housing externalities are especially strongin multi-unit rental dwellings is due to the presence of commonspace such as hallways, elevators, pools, and parking lots. Becausethese areas are essentially public goods from the perspective oftenants, a free-rider problem exists. Thus, common areas, likeindividual units, will generally be overused and undermaintained.

2B. Solutions to Housing Externalities

An ideal solution to the above externalities is to create incen-tives for residents of multi-unit dwellings to act collectively likea single owner–occupier. A step in this direction is for each resident


to own a share of the building, as in co-ops or condominiums.This is not a complete solution, however, because some costsremain external (Hansman, 1991; De Geest, 1992). In addition,some households do not wish to own their housing for reasonsother than externalities (e.g., mobility, liquidity constraints). Con-sequently, in what follows we focus on various responses to hous-ing externalities in multi-unit rental housing, with primary empha-sis on affordable housing.

One method for reducing negative externalities in multi-unithousing is to screen potential tenants in an effort to achieve afavorable population. For example, a landlord or tenants’ associa-tion can attempt to identify residents who, based on their pastbehavior, are likely to generate significant inter-tenant externalitiesor to abuse the facilities. The extent to which this can be done,however, is limited by fair housing laws, which restrict the charac-teristics of tenants that can be used as proxies for undesirablebehavior. As a result, some adverse selection is bound to occur.

Once tenants are in place, there remains an incentive for themto behave in an undesirable manner, regardless of how successfulthe screening process was. For example, tenants may abuse thefacilities or simply behave in an unruly manner. Thus, monitoringof tenant behavior is necessary, backed by the threat of evictionor other penalty (e.g., withholding of security deposit) if proscribedbehavior is detected. The rental lease or membership agreementtypically spells out what sorts of behavior will be penalized andwhat the penalties are. These contracts make the threats of thelandlord or members’ association enforceable by a court.

In what follows, we reckon the cost of these measures for reducingnegative housing externalities—screening, monitoring, and con-tracts—as part of the cost management of the multi-unit building.

2C. Public Housing

Much of public housing is notorious for the extent to whichnegative housing externalities are present. However, this is notnecessarily because low income households per se are more aptto generate these externalities. Instead, they may simply be unwill-ing or unable to pay the costs that tenants in private rental housingpay to eliminate or reduce them. Moreover, even if tenants desiresome form of screening to eliminate undesirable tenants, anti-discrimination laws often prevent it from being implemented. Forexample, Sleeper (1990; pp. 82–85) described how efforts to screen


tenants in New York City housing projects, while supported bytenants, were effectively blocked by civil rights advocates whoargued that it would disproportionately exclude minorities frompublic housing. As a result, unfavorable tenants are not screenedout, and undesirable conduct is not penalized in public housingprojects (unless it becomes criminal). Although the reduction ofsignificant management costs (along with subsidized rent) makeslow-income housing affordable in dollar terms, tenants ultimatelybear a utility cost as a result of undesirable neighbors and deterio-rating units.

2D. Limited Equity Housing Cooperatives as an Alternative

Limited equity housing cooperatives are cooperatively ownedand controlled housing units where contractual limits are imposedon the equity value of members’ shares and the managementpowers of members. As noted in the Introduction, we will includeunder the heading of LECs all forms of housing that seek toinstitutionalize a greater degree of resident control. LECs maybe seen as an effort to resolve the apparent conflict betweenaffordability and the existence of negative housing externalities.According to this view, LECs seek ways of reducing externalitieswithout imposing the dollar cost of management on residents.Some methods by which they attempt to do this are as follows.

First, they frequently require prospective members to contribute“sweaty equity” toward the construction or rehabilitation of theirunits. Not only does this reduce the dollar cost of construction;it also induces self-selection of residents who are more likely toplace a high value on the unit and therefore maintain it over time.

Second, resident–members share among themselves tasks thatessentially replicate some of the management functions describedabove. These functions include screening of new members, re-porting unruly tenant behavior (and recommending eviction ifnecessary), supervising maintenance staff, and reporting structuralproblems.3 Because members do not pay themselves for thesetasks, the cost is the disutility of effort and the opportunity cost

3 LECs typically contract out some management functions such as maintenance of thefacilities. See, e.g., City of Burlington Economics Development Office (1990); Boston,Mass. Cooperative Housing Task Force (1987); and Madison Mutual Housing Association(1992). In addition, mutual housing associations (MHAs) offer various forms of organiza-tional support for co-ops, especially small ones which often cannot exploit scale economicsin these functions.


of their time. For low-income individuals, however, these costsare likely to be less than the cost of hiring a management companyto perform the same functions. In addition, it is argued by support-ers of LECs that members derive some utility from participatingin group activities aimed at improving one’s living conditions. Ofcourse, there is no guarantee that members will devote optimaleffort to these tasks, so a moral hazard problem remains.4 Toovercome this, new members are required to participate in trainingprograms designed both to increase their management skills, andto increase their awareness of the benefits of self-management.However, as we shall argue, the effectiveness of self-managementin replicating management by a landlord or management firm iscrucial in determining the success of LECs.

Third, to reinforce this sense of self-control, LECs also attemptto create a sense of ownership among their members. New mem-bers therefore receive an “equity share” upon payment of a mem-bership fee. Although this may at first appear to be a responseto the rental externality described above, ownership in the conven-tional sense is quite limited in LECs because, unlike full equityco-ops, neither the amount members contribute nor the amountthey get back when they leave are related to the full “marketvalue” of a share. For example, the initial fee is almost certainlybelow the true market value, and the rate at which the value ofthe member’s contribution can increase is typically limited to afixed amount (say, the annual increase in local wages).5 The reasonfor limiting equity shares in this way is to keep membership af-fordable; but, as a result, ownership rights are diluted, and themembership fee in effect becomes a refundable security deposit.6

Thus, we expect members to behave in some ways like tenantswho have posted a security deposit rather than, say, members ofa full equity co-op, who can sell their shares at market value.

Fourth, LECs also attempt to mitigate the rental externality bygiving members lifetime tenure (in accordance with the occupancyand membership agreements), and by seeking members who value

4 The problem is, who will monitor the monitors, given that members do not directlyreceive the full benefits of their management efforts.

5 Members are, however, at risk if the true market value of a share falls below theircontribution. Given the relatively low initial fee, however, this is unlikely to occur exceptin extreme circumstances.

6 Many LECs charge a fee that is comparable to 2 months rent, the standard depositin private rental housing.


this right. The idea is that the longer a tenant’s expected tenureis, the more he will behave like an owner. LECs also allow membersto assign the right to occupy their unit to an immediate familymember. This right is similarly designed to give members an interestin the quality of the unit beyond the end of their own tenancy.

As just noted, the true market value of dwelling exceeds thesum of the individual member’s shares. This raises the questionof who owns the difference. In effect, who is the residual claimant?In most instances, it is a local non-profit organization that overseesthe LEC. But this raises the further question of why such anorganization, presumably acting on behalf of the community, iswilling both to subsidize the provision of affordable housingthrough the LEC and to accept the risk of its failure (in effect,the loss of the surplus value). One answer, again based on housingmarket externalities, is that the community, acting in its owncollective interest, wishes to support low-income housing that doesnot generate the sort of negative externalities associated withtraditional housing projects.

This concludes the overview of the model. Several of the charac-teristics that we have discussed that distinguish private rental andpublic housing from LECs are summarized in Table 1. In the nextsection, we formalize the analysis in order to investigate the specificconditions under which households choose different institutionalforms of management, or control. Our interest is to see how differenttypes of households choose to bear the costs of housing externalities,and what some of the factors are that influence this choice.

3. A SIMPLE MODEL

In this section we develop a simple partial equilibrium modelof tenant behavior in multi-unit apartments under different man-agement structures. Specifically, we consider private rental hous-ing, public housing, and LECs. Initially, we consider a static modelthat focuses solely on inter-tenant externalities. Later, we considerthe rental externality in the context of a multi-period model.

3A. Inter-Tenant Externalities

Consider an apartment building consisting of n units plus somecommon area. Let hi represent the quality of the ith unit, and letg represent the quality of the common area. The quality of eachunit i is assumed to be a function of an input ti chosen by tenant


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i, and the quality of the common area is assumed to be a functionof the inputs of all tenants. Thus

hi 5 hi(ti), i 5 1, . . . , ng 5 g(t1, . . . , tn), (1)

where both functions are increasing in the tis.7 ti may be interpretedas tenant i’s choice of a level of effort directed toward maintaining,or not overutilizing, the facilities. The utility of tenant i is assumedto be separable in the numeraire good, x, housing, and effort:

Ui 5 xi 1 vi(hi, h2i, g) 2 ai(ti), (2)

where vi is concave in each of its arguments (2i indicates all j ?i), and ai is a convex function representing the disutility of effort.Note that (]vi/]hj)(]hj/]tj) and (]vi/]g)(]g/]tj), j ? i, represent theinter-tenant externalities. The budget constraint for tenant i isyi 5 xi 1 R, where yi is income and R is the rent or monthlycarrying charge. Substituting the budget constraint into Equation2 yields Ui 5 yi 2 R 1 vi(hi, h2i, g) 2 ai(ti).

3B. The Social Optimum

The social optimum consists of choices of ti that maximize

oi[vi(hi, h2i, g) 2 ai(ti)]. (3)

The first-order conditions for this problem are given by

(]vi/]hi)(]hi/]ti) 1 oj?i(]vj/]hi)(]hi/]ti) 1 oj(]vj/]g)(]g/]ti) 5 a9i ,i 5 1, . . . , n. (4)

Denote the solutions to Equation 4 t*i . Note that these choices ofti internalize the inter-tenant externalities, which are captured bythe last two terms on the left-hand size of Equation 4.

3C. Alternative Forms of Management

We now consider the extent to which management inputs canbe used to achieve the outcome implied by Equation 4. Above,we suggested that management takes the form of screening, moni-toring, and contractually imposed constraints, and that these func-tions can be undertaken by a landlord or management company(as in private rental housing), by tenants themselves (cooperative

7 Other inputs into hi and g are taken as fixed.


housing), or, in the extreme, not at all (public housing).8 In the caseof private rental housing, let M be the total cost of management,encompassing all of the various control functions. Assuming thatlandlord/managers are competitive and pass their costs on to ten-ants, each tenant in a managed apartment thus pays M/n in man-agement costs as part of his or her rent. In the case of LECs,suppose each member is required to contribute m units of manage-ment effort (in addition to his or her choice of ti), which result indisutility of bi(m) for tenant i (including the opportunity cost oftenant i’s time). We assume for simplicity that there are no addi-tional management costs in LECs, though LECs typically do con-tract out some functions.

In order to make the comparisons of housing under the variousforms of control meaningful, we assume that individual units andcommon areas are of comparable size and, initially, quality. Anyquality differences following occupancy will therefore be attribut-able to difference in the structure of control. Let r denote thecompetitive rent for a standard unit, representing the cost of thephysical structure. The overall rent, R, thus consists of r plus anydollar costs of management, less any subsidy, s. The overall rentfor private housing is therefore RR 5 r 1 (M/n), the rent or carryingcharge for an LEC is Rc 5 r 2 sc,9 and the rent for public housingis RP 5 r 2 si

P, where siP usually is specific to the individual tenant

(e.g., r 2 siP equals 30% of tenant’s i’s income). Note that, while

there are no dollar costs of management in the latter two cases,as we argued above, these costs will be incurred in other ways.

For simplicity, we assume that management by a landlord ormanagement company in private rental housing succeeds in induc-ing tenants to choose t*i according to Equation 4. This may comeabout, for example, as a result of competition among landlordsor management companies. This of course abstracts from agencyor other problems of imperfect enforcement, but we ignore them

8 It is, of course, extreme to assume that there is no management in public housing. Itis sufficient for our model, however, that management be limited. This will be true forpublic housing in part as a matter of policy, given that the government is in a sense the“landlord of last resort.” Thus, e.g., it is limited in the extent to which it can screen out“undesirable” tenants.

9 The periodic carrying charge in LECs is often below the market rent for comparableprivate units, reflecting an implicit rent subsidy. Much of this rent subsidy may be in a“hidden” form in that substantial parts of the development costs of these projects arefunded by private charities or, more frequently, by public monies.


here for simplicity as they are not pivotal to our argument.10 Whenresidents participate in some self-management functions in LECs,we assume that they induce tenant effort equal to ts

i, where tsi <

t*i depending on the effectiveness of self-management. Finally,when explicit management is absent, we assume tenants chooseti to maximize their own utility. That is, each tenant i chooses ti

to maximize.

vi(hi, h2i, g) 2 ai(ti) i 5 1, . . . , n. (5)

Denote the Nash equilibrium to this problem (ti, . . . , tn), whereit should be evident that ti , t*i as a result of the inter-tenantexternalities. We also assume that ts

i > ti.

3D. Tenants’ Choice of a Management Structure

This section considers the choice among the three forms of rentalhousing by those households who, for exogenous reasons, havechosen not to purchase their housing.11

Given the above model, the utility for a tenant choosing a privaterental apartment is

URi 5 yi 2 r 2 M/n 1 vi(h*i , h*2i, g*) 2 ai(t*i ), (6)

where h*i ; hi(t*1 ) and g* ; (t*1 , . . . , t*n ). Similarly, the utility fora tenant choosing an LEC is

Uci 5 yi 2 r 1 sc 1 vi(hs

i, hs2i, gs) 2 ai(ts

i) 2 bi(m), (7)

where hsi ; hi(ts

i) and gs ; g(ts1, . . . , ts

n). Finally, the utility frompublic housing is

UPi 5 yi 2 r 1 si

P 1 vi(hi, h2i, g) 2 ai(ti), (8)

where hi ; hi(ti) and g ; g(t1, . . . , tn).Because we are interested in the conditions under which LECs

will succeed in the market, we compare them pairwise with theother two alternatives. Consider first household i’s choice betweenprivate rental housing and an LEC, assuming initially that i’sincome is not a constraining factor (i.e., it is not too low to make

10 See, e.g., Fama (1980), Holmstrom (1982), and Barnea et al. (1985) for generaldiscussions of agency problems in management. Also, see Struyk, Mark, and Telgarsky(1991) for a discussion of the role of management in providing housing services.

11 We include among purchasers those who choose to live in full equity co-ops andcondominiums.


private rental housing unaffordable, and it is not too high todisqualify him or her from an LEC). Subtracting Equation 6 fromEquation 7 shows that the LEC is preferred (i.e., Uc

i . URi ) if and

only if

M/n 1 sc 2 bi(m) . [vi(h*i , h*2i, g*) 2 ai(t*i )] 2 [vi(hsi, hs

2i, gs) 2 ai(tsi)]. (9)

The left-hand side of Equation 9 is the net cost of private rentalhousing, consisting of the dollar costs of management, plus therent subsidy (if any) in the LEC, minus the utility cost of self-management in the LEC. The right-hand side is the net benefitof rental housing, consisting of the difference in the overall utilityof housing in a rental apartment versus an LEC. Note that thisdifference is decreasing as the efficacy of self-management im-proves. Thus, according to Equation 9 individuals are more likelyto choose an LEC as the disutility of their effort decreases, asthe subsidy of the LEC increases, and as the efficacy of self-management increases.

Now let us compare LECs with public housing. A householdwill prefer an LEC over public housing if and only if

[vi(hsi, hs

2i, gs) 2 ai(tsi)] 2 [vi(hi, h2i, g) 2 ai(ti)] . si

P 2 sc 1 bi(m). (10)

The left-hand side is the difference in housing utilities (net ofeffort) between self-managed housing and public housing. Notethat this difference is increasing in the efficacy of self-management.This is weighed against the benefit of public housing, which consistsof the net rent subsidy si

P 2 sc, plus the avoidance of the disutilityof self-management effort. It follows from Equation 10 that ten-ants who place a relatively high value on externalities in housing,or who have a low disutility of effort (all else equal) will be morelikely to choose an LEC. Of course, in the extreme case whereself-management fails to improve the quality of housing at all(i.e., the left-hand side of Equation 10 is zero), public housing ispreferred unless the LEC is highly subsidized [i.e., unless sc 2si

P . bi(m)].Now let us relax the assumption that i’s income is such that all

three options are feasible. For instance, low income householdsmay not be able to afford the gross rent in the private rentalmarket. For these households, only the comparison in Equation10 is relevant. Similarly, some households may have income too


high to qualify for public or limited equity housing.12 In that case,private rental housing provides the only option outside of owning.

The implication of the preceding analysis is that the success ofLECs at finding a niche in the housing market turns on the efficacyof the self-management mechanisms they employ as a substitutefor external management, and the disutility to members of self-management. For example, how effective are LECs at screeningnew members, and how much screening is permitted by fair hous-ing laws? How effective are contractual methods in preventingundesirable behavior by residents (e.g., how easily can residentsbe evicted)? How much effort will members devote to self-manage-ment tasks? We present evidence on some of these issues below.

3E. Resident Associations in LECs

In all three types of control structures we have considered, resi-dents are free to, and historically have, organized resident associa-tions to enhance the tangible control functions modeled thus far.But these associations also can provide intangible benefits thatwere not incorporated above. These include living as part of agroup that you enjoy and trust, and participating in self-manage-ment. One can buy the management-control functions capturedby our variable M, but one presumably cannot buy the effectsdescribed here except to the extent that they are tied to the controlstructure of one’s housing unit. For example, management asembodied in M can be unbundled from housing and purchasedseparately in the market, e.g., by hiring a management company.However, one cannot unbundle the benefits of participating inself-management except by joining a housing cooperative.

This suggests that the self-management effort, m, that membersof resident associations supply may provide positive utility in addi-tion to the disutility of effort, b(m), and that this benefit is afunction of the degree of cooperation that other members show.13

As noted above, resident associations exist in private rentals andpublic housing projects, but in these cases, residents join thempurely on a voluntary basis. Thus, given the beneficial externalities

12 Examples of income limits in LECs can be found in Boston Mass. Cooperative HousingTask Force (1989); Colburn (1990); and Schreiber (1986).

13 Iannacone (1992) models participation in religious groups in a similar way, whereexternalities from group worship is an important source of benefit for members.


associated with participation, we would expect under-participa-tion. In contrast, LECs institutionally and contractually mandatethe collective participation of members, for example, by requiringa minimum level of m. As a result, they can internalize this exter-nality in the same way that governments coerce optimal contribu-tions to public goods. The ability of LECs to internalize thisexternality more effectively than the alternative forms will thusattract those households who value this benefit, but who are other-wise at the margin based on conditions Equations 9 and 10 above.This mandate of collective effort seems to be a key factor distin-guishing LECs from alternative housing forms.

3F. The Rental Externality

To this point, the model has been static, focusing solely on inter-tenant externalities. The rental externality, in contrast, arises ina multi-period model where a resident’s tenancy period is shorterthan the life of the building. Thus, the resident fails to internalizethe benefits of the building to future users. To capture this, assumethat all n tenants will vacate the building at a known date,14 anddefine P(hi, h2i, g) as the present value of the building to futureusers starting from that date, where P is increasing in all of itsarguments (Miceli, 1992). The optimal choices of ti must now takeaccount of P, which captures the rental externality, in addition tothe inter-tenant externalities captured in Equation 4.

In principle, this externality presents no new management prob-lems; it simply requires an adjustment in the optimal ti. We intro-duce it here, however, to evaluate limited equity shares in LECsas an alternative means for internalizing it. The idea behind equitysharing, of course, is to replicate, to the extent possible, the incen-tives of ownership. A sole owner, for example, fully internalizesthe rental externality because P represents the sale price whenhe vacates. A partial owner (e.g., a member of a full equity co-op) partially internalizes the externality because he receives ashare of P upon vacating. The key is that there is some incentivefor an owner to consider the impact of his effort on P. BecauseLEC shares are not allowed to appreciate according to changes inthe true market value, however, there is at best a weak relationshipbetween the value of a member’s share and P. Hence, the LECresident does not have an increased financial incentive to consider

14 This assumption is more restrictive than necessary to establish the points that follow.


P in choosing ti, unless t can be monitored (and verified in court)and the damages beyond normal wear and tear deducted fromthe value of the share.

As noted above, in addition to equity shares, LECs typicallypromise residents lifetime tenure, subject to the terms of the occu-pancy agreement. This represents another effort at inducing resi-dents to behave like owners without giving them the full rights ofownership. This device will not be effective, however, to the extentthat residents anticipate moving at some future date, given thatthey will not be able to sell their equity share at the market price.

Possibly counter-balancing the absence of financial incentivesto behave like an owner is the sense of resident “control” thatLECs attempt to foster. This control ranges from giving residentsthe right to redecorate their unit, to responding promptly to theirrequests to have repairs made or unruly residents disciplined.There appears to be no guarantee, however, that this sense ofcontrol will develop among co-op residents.

4. EVIDENCE FROM CASE STUDIES

Unfortunately, there are no rigorous empirical studies of resi-dent behavior under the alternative forms of resident controlwhich we can use to evaluate the success of LECs. However, wecan draw on some specific case studies, surveys, field experience,and interviews, to analyze some of the conclusions from the previ-ous sections.

The principal conclusions of the model in Section 3 are foundin Equations 9 and 10, which suggest that the key factors influenc-ing an individual’s choice between LECs and public or privaterental housing are (1) the efficacy of self-management comparedto hierarchical management, (2) the disutility of self-management,and (3) the affordability of LECs. We briefly discuss these issueshere in light of available evidence on LECs.

Typically, self-management in LECs includes tenant review ofnew applicants (screening) and tenant participation in setting andenforcing house rules and regulations (monitoring). These mea-sures for controlling behavioral externalities are best left to resi-dents themselves because of their reciprocal nature. However, thespecialized skills required for most maintenance tasks, and thepresence of scale economies in these tasks, generally make it costineffective for members to undertake them, although tenants often


contribute to physical maintenance on a voluntary basis.15 In addi-tion, tenants with specialized skills, e.g., in bookkeeping, oftencontribute their time.

As we have argued, LECs do not duplicate the financial incen-tives of ownership. A recent survey of members of two co-ops inDenver, one limited equity and one market equity, indicated thatlimitations on the resale price of shares were a significant concern(Ellenbecker and White, 1987). For example, only 34.6% of re-spondents in the full equity co-op, and 15.6% of respondents inthe limited equity co-op, agreed that co-ops should limit the returnon investment. In addition, zero and 7.8% of respondents, respec-tively, believed that “feelings of homeownership” were an advan-tage of co-op living. Several case studies reinforce our conclusionthat LECs must therefore use alternative mechanisms to induceresidents to behave like owners. These include screening of mem-bers, training programs, monitoring, contractual methods (leasesand occupant agreements), and organization by-laws.16 The ques-tion, as we have suggested, is how well these mechanisms willwork, and in some cases, whether they are legal.

For example, the pre-screening of members in LECs seems tobe an important mechanism whereby residents exercise controlover their living environment, but there is some question aboutwhether it is consistent with civil rights and/or fair housing laws.The importance of careful monitoring in LECs was learned bythe Madison Wisconsin Mutual Housing Association when itfound that some of the buildings were using their autonomousmaintenance funds to buy lawn chairs instead of making necessarylong-term repairs. The available case studies also suggest that adamage penalty is necessary to induce residents of LECs to treatthe property as an owner would. In addition, the studies point tothe importance of lifetime tenancy rights, the right to remodelone’s unit, and the general sense that residents have some “con-trol” over their housing.17 Whether a sense of control develops

15 See Freed (1985); Boston Area Cooperative Housing Task Force (1987); Parliamentet al. (1988); and Van Ryzin (1992).

16 A good example of contracts and by-laws is Sample Documents for Limited EquityCooperative Housing, which can be obtained from Regional Housing Legal Services,Glenside, PA. On monitoring, see Freed (1985); and Cooperative Housing Task Force(1986). On screening, see Co-op Resident Selection Criteria, Stop Wasting AbandonedProperty (SWAP), Providence, RI. On training programs, see the 1986 training programmanual of the Madison, Wisc. MHA.

17 Neighborhood Reinvestment Organization (1989; pp. 3–9); and Bratt (1989; Chapter 8).


among residents, however, seems to vary from co-op to co-op. Forexample, LECs with a lot of members receiving Section 8 federalrent subsidies often become de facto public housing in terms of thedegree of collective action by residents, though some of these co-ops have seen improved member responsibility as a result of trainingprograms and intervention by full-time organizers.18

As noted above, LECs typically impose income limits for mem-bers and receive some form of subsidy. And in fact, the surveyby Ellenbecker and White (1987) indicated that a significant at-traction of LECs is their affordability. Subsidization of LECsgenerally covers the development cost of the project and the costsof initial resident screening and training programs. These costsare paid for mostly by a patchwork of public funds and privatedonations that are collected by a sponsoring nonprofit organiza-tion. One study estimates that a LEC would need a minimum of500 units to be able to fund these costs internally,19 though anothersource suggests that an LEC can cover its maintenance and admin-istrative costs with a much small number of units.20 Most LECsalso have subsidized capital through grants, public guarantees,and low interest loans.21 Indeed, the limits on the availability ofthis subsidized capital may be the most important restraint to thefurther growth of LECs.

In conclusion, we believe that the finding that residents of LECsoften choose them because of their affordability, but at the sametime have concerns about resale value, highlights the fundamentalchallenge facing LECs: how to provide housing that mimics thefeelings and incentives of homeownership but at an affordableprice. In this paper, we have tried to examine some of the issuesthat are critical to this challenge.

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18 Case studies of the Rose City LEC in Norwich, CT, and the Albany, NY, LEC indicatea substantial degree of resident control. The organizing experience of Ken Glaston andinterviews with Baltimore MHA residents indicate personal growth and satisfaction fromthe group experience in LECs (Bratt, 1989; p. 25 and Chapter 8). For an interesting debate,occasionally polemical, about the general issue of resident autonomy in Liverpool, England,see Marin and Parkinson (1986).

19 Bratt (1989; p. ix).20 Personal communication from Roger Willcox.21 See Colburn (1990), and Boston Cooperative Housing Task Force (1989).


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