By Andrei Khalip

LISBON (Reuters) - Portugal is close to imposing a "do or die" rental reform after a quarter of a century of argument, aiming to give the construction and property industries a last chance to avoid collapse.

From the rundown, centuries-old edifices in downtown Lisbon or Porto, with clothes drying outside often masking cracks in the walls, to swanky new condos whose windows are mostly adorned with "for sale" signs, the property market badly needs change.

The law reform, demanded by the European Union and IMF as a condition of Portugal's bailout, will end the anomaly of well-to-do families occupying comfortable apartments on low rents set three decades ago, and effectively slash taxes for landlords.

But the draft law, expected to win parliamentary approval this month, will also mean big rent increases for hard-up ordinary tenants in western Europe's poorest country who are already suffering under austerity and recession.

"There have been attempts to reform this sector for 25 years and none succeeded. But now you can say it's do or die," said lawmaker Antonio Leitao Amaro, the bill's sponsor from the ruling Social Democratic Party.

Portugal missed out on the property boom which its euro zone peers Spain and Ireland experienced in the years until 2008, but is now sharing in the bust that has followed.

New construction is unlikely to recover for years. Therefore the reform aims to stimulate the tiny rental market, allowing builders to pick up work renovating properties which landlords have long neglected due to low rents or simply left empty.

A study by the Portuguese Industry Confederation showed that rented property accounts for only about 20 percent of housing in use, while 80 percent is occupied by the owner. Portugal has about 740,000 empty homes, roughly the same number as those being rented.

The reform bill cannot come soon enough for the industry.

"In the past couple of months we have entered the collapse phase," said Manuel Reis Campos, head of the Construction and Real Estate Confederation CPCI. "The rent and urban rehabilitation bills are extremely important to save the sector, but it will be months before everything is in place."

"Basically there is no rental market. It's probably the worst market in Europe," he said, estimating that the market for urban reconstruction would be worth 28 billion euros as 1.8 million homes need repairs and refurbishing.

DIRE STRAITS

With Portuguese unemployment at an all-time high and incomes falling due to the austerity drive imposed under last year's EU/IMF bailout, construction of new housing has all but halted and thousands are losing their homes due to foreclosures.

Housing loans and financing for construction have dried up. Banks, under EU pressure to improve their capital reserves due to the euro zone debt crisis, are getting rid of foreclosed properties in fire sales with 40 percent discounts, leaving builders and real estate firms in dire straits.

Renting could be a solution in many cases, but not without a radical overhaul of the market.

With 720,000 workers, the sector is the largest employer in Portugal, but it is shedding jobs at a rate of more than 10,000 a month. The number of property and construction firms going bust has soared by 50 percent so far this year from a year earlier.

Reis Campos said Portugal's unemployment could hit 20 percent from about 15 percent now if the situation is not tackled soon.

Leitao Amaro expects his reform to be approved by parliament by the end of May and in force in June after long deliberations he says were needed to make sure the bill provides the necessary stimulus without hurting ordinary people too much.

But Luis Lima, head of the Real Estate Mediators' Association, blamed the delays to the reform for helping to bring his industry to its knees.

"We had the advantage of having no property bubble like in Spain or Ireland. But now we have basically created the effect of a burst bubble by our own fault, with banks' discount prices contaminating the whole market in a vicious circle," he said.

Portugal's centre-right government acknowledges "a very serious problem" which it believes the reform will address, saying it will make it easier for workers to move, helping the labor market to become more flexible and competitive.

Lawmaker Leitao Amaro said there are currently no incentives for owners to let. "Among other problems, that causes problems with workforce mobility as people who have their own apartment or house are less likely to take a job in another city."

SWIFT EVICTIONS, TAX INCENTIVES

The reform bill aims to phase out "old rents" kept frozen for decades, which have allowed some well-to-do families to pay 50 euros ($65) a month for a five-bedroom flat in some cases.

It now takes over 18 months to evict a non-paying tenant, while the bill would shorten this to three months, allowing private bailiffs to act with a simple court order.

Rent guarantee insurance, practically non-existent now as insurers don't have access to tenants' rent and banking history, should also give owners additional incentives to let properties.

Red tape surrounding rehabilitation projects will be cut and they will enjoy tax incentives and EU funding. A special tax rate on rental income will be set by next year.

"The tax is planned to be at 25 percent and it will be a major incentive for owners to rent out as real estate investors are now subject to the maximum tax rate of 42 to 47.5 percent," Leitao Amaro said.

Real estate experts believe the reform will succeed but could hurt the poor. "Portugal has long needed a functioning rental market, where it is cheaper to rent than to own. It's going to get it now, finally. But it's a pity it has to get there via misery," said Eric van Leuven, managing partner at global real estate services firm Cushman & Wakefield in Lisbon.

GILBERTO THE COBBLER

But resistance is growing among tenants who fear unbearable rent increases. The Association of Lisbon Tenants argues that about 250,000 Portuguese households on "old rent" contracts, mostly sealed over 30 years ago at average market prices of the time, have long amortized owners' investment.

"We are talking about families with an average age of 60, mostly low-income families. And this bill solves only one thing - it throws them out into the street," said Romao Lavadihno, the leader of the association that has a team of 18 lawyers working to stop the "old rent" adjustment.

On Thursday, the group held a rally in downtown Lisbon with over a hundred mostly elderly tenants protesting against "the law of evictions" and defending "our right to housing".

The government says the poorest families will have only limited increases, but this offers little relief to most.

Gilberto Luis, a 52-year-old Lisbon cobbler, pays 40 euros a month for a tiny apartment in a dilapidated three-storey building with moldy walls that he shares with three family members. He rarely brings home more than 450 euros a month.

"We don't know yet by how much, but rent will go up. We're already paying more for electricity, for bread, the bills take every cent. I'm desperate, I have nothing more. The folks in the government forget that not everyone has their wages."

($1 = 0.7716 euros)

(Additional reporting by Daniel Alvarenga, Editing by David Stamp)