Hamburg drives initiative to impose cap on index-linked leases

With residential rents continuing to rise steadily in Germany's big cities, the left-of-centre SPD party in Germany's ruling coalition is making moves to introduce a cap on the maximum permissible annual rent increase, even when lease contracts are index-linked to the benchmark of the consumer price index.

In a new initiative spearheaded by the government of Hamburg in Germany's Bundesrat (Upper House), the Housing Minister, Klara Geywitz, has indicated her strong support for capping the annual permissible rent increase at 3.5%. In her view, and in that of opponents of index-linked contracts, adapting rents to the current inflation rate of 10% or more only adds fuel to the fire by raising the overall level of local comparable rent indices (Mietspiegel), now widespread in nearly all German cities.

The German Tenants’ Association (DMB) has also voiced its criticism of indexed rents, saying that they pose a risk to tenants who may become saddled with ongoing rental hikes if inflation remains high.

Landlord association Haus und Grund is against any interference in existing index-linked contract. Its members have to absorb the full cost of inflation in their ongoing upkeep and maintenance expenses, it argues. Besides, for most landlords the lease agreement offers clarity, whereby even the issue of what is a fair and comparable rent in a local vicinity is often the subject of dispute.

Haus und Grund in Munich says it represents about 420,000 housing units, equating to around 70% of the city’s residential stock. Index-linked rents used to account for around 40% of stock, a figure that has now risen to 60%, according to Haus und Grund. Comprehensive figures on index-linked rental agreements across the country are not available because landlords are not obliged to disclose such information. But typically, many landlords do not exercise their right to raise the level of rent every year to match inflation, although they can do so retrospectively to the last upward adjustment.

The new move to cap index-linked agreements is still just up for debate, and did not form part of the coalition's governing agreement. The responsible department for pushing such a deal through would be the Department of Justice, which is headed by Marco Buschmann, a member of the liberal FDP party, which is generally viewed as landlord-friendly. Hence no immediate enthusiasm to push through any changes to the law at a nationwide level is seen as likely.

Back in Hamburg, the red-green governing coalition IS mustering support for a change to its law, and may have better chances there, where data supports the evidence that many more landlords have indeed been demanding the full extent of their permissible rent increases. Hamburg's Senate has also been active in compelling public authorities to reserve a right of first refusal to the city authorities on any property being sold off, rather than offering them on the open market. The concept of "100-year lease contracts" to keep property under city control was widely reported in the Hamburg media.

A recent report by property advisor JLL suggested that for commercial property, the current inflationary environment is likely to lead to a big rise in indexing office rents. Tenants may agree to the inclusion of such clauses on the grounds that the increasing supply of office space will put them, in any event, in a better negotiating position.

Many office leases contain so-called adjustment clauses, which are indexed to the cost of living and in almost all cases, the consumer price index of the Federal Statistical Office is used as a basis. ‘Some of these are graduated rents, but more than 80% are agreements that provide for the adjustment of the rent to the development of the general cost of living,’ said [[Helge Scheunemann]], head of research at JLL Germany. For the contractual partners, this means that if the Consumer Price Index rises, the “cold” rent also rises.

JLL has evaluated indexed leases totalling more than 6.3 million square metres, which are located in almost 900 office buildings nationwide. In total, 82% of the leased space is accounted for by leases signed in 2010 or later, 45% in 2018 or later and 21% were signed after 2020. The wide variety of indexing clauses is striking, with nearly 100 different agreements registered in the sample. ‘With a share of 40%, the rule is that the inflation rate is added in full to the rent every year,’ Scheunemann added.

However, certain criteria often have to be met before indexation comes into effect. For example, in almost 20% of the cases analyzed by JLL, the underlying price index must have risen by 5% before there is a rent adjustment. In 10% of cases, that rises to 10%. As office markets developed in favour of landlords, the more frequently full indexing was found in leases, due to the landlords' increased negotiating power: ‘This was particularly evident in Germany's office strongholds in 2019 and 2020, when fully indexed leases accounted for 47%, compared to 36% previously,’ Scheunemann said. It remains to be seen how sustainable this is in a decidedly weaker environment.