Heritable building rights: the answer to the shortage of development plots?

Building a property on land that is just leased is gaining traction

By Sara Seddon Kilbinger, Senior Reporter, REFIRE

As building plots become more expensive and scarcer, heritable building rights – where property owners do not have to buy the land but can lease it – are becoming increasingly popular.

‘Erbbaurecht’ offers both advantages and disadvantages but essentially means that a property is built on a plot of land leased over several decades. The specific structure of heritable building rights is regulated by the Erbbaurechtsgesetz, the German Heritable Building Rights Act. The basic premise is that a landowner leases the land he owns to the builder, the so-called ‘heritable building right holder’, who pays ground rent for the use of the land and in return is allowed to build a property on the owner's land.

As such, land and real estate ownership are separated from each other, so the prospective owner buys the property without the land. This is rented for a long period of time in return for an annual lease. As a rule, this amounts to about 3% to 5% of the standard land value per year. According to the German Association of Leasehold Builders, the national average stands at around 3.7%.

For people looking to acquire their own home, the ground lease has a decisive advantage: they need less equity to be able to afford their own property. The counterparty also benefits from such deals, according to Frank Lösche, a construction financing specialist at Dr. Klein in Hamburg: ‘If a municipality, a city or a church grants its land as a ground lease, it can make land usable for people without giving away its property,’ he said.

In addition, heritable building rights can offer would-be buyers around prohibitively expensive land prices. Since 2010, the price of building land has risen on average from €130 per square metre to €190 per square metre, according to the Construction Price Index of the Federal Statistical Office.

Heritable building rights offer “entry-level” opportunity

Subsequently, paying ground lease is viewed by many as an “entry-level” opportunity for would-be buyers with little equity. For people looking to buy homes with regular mortgages, you typically need a down payment of around 20% of the property’s value, as well as an additional extra 10% to cover other charges. For a home costing around €400,000, this would amount to €120,000, an amount that is beyond many young buyers, making heritable building rights seem even more attractive.

Another key advantage is that developers aren’t required to buy their own plots of land on which to develop, nor do they have to finance such purchases, something that seems especially attractive given that interest rates are rising. The law on hereditary building rights protects hereditary builders for the entire lease period, provided the agreed interest is paid on time. Even if the property is sold at auction, the heritable building right and the built property remain unaffected. Subsequently, leaseholders can freely dispose of the property, provided they do not let it fall into disrepair.

Nonetheless, those who can afford it are often better off in the long term buying a plot of land, especially given current favourable construction interest rates: ‘For people with a lot of liquidity, full ownership is basically also an option,’ said Matthias Nagel,managing director of the German Association of Leasehold Builders.

How long the heritable building right is valid is regulated by the contract concluded between the owner and the heritable building right holder, although it is often for 99 years. At the end of this agreed lease period, the building constructed on the plot becomes the property of the landowner. If leaseholders do not fulfil the stipulated contractual obligations, the land owner can also make use of the so-called reversionary claim before the expiry of the agreed period. The landowner can then demand the transfer of the heritable building right to him or herself. This may be the case, for example, in the event of default in payment of at least two annual payments of the ground rent.

Institutional investors also joining the fray

It is also a set up that could appeal to institutional investors such as pension funds and provident societies, who are looking for long-term and inflation-proof capital investments, for which leasehold properties are perfectly suited, according to Michael Jung, managing partner of Continuum Capital Investment Management GmbH. Both portfolio holders and developers benefit from the separation of land by way of leasehold through reduced purchase prices and higher returns, according to Jung. Many well-known projects have been developed on a leasehold basis, including the Messeturm in Frankfurt and the Allianz Arena in Munich.

Continuum also works in partnership with developers who approach them, acquiring the land on their behalf and incorporating it into their portfolio. The developer then receives a long-term heritable building right on which the buildings can be constructed as planned.

Nonetheless, there are also some significant disadvantages. For example, the right expires after the agreed period, at which point the land and the property built on it pass into the control and possession of the owner. The owner is obliged to compensate the previous leaseholder for taking over the property, yet does not have to pay more than two thirds of the market value of the property.

Another issue that prospective buyers must consider is that with a typical home purchase, the loan is usually paid off in full after 20 to 30 years. However, the costs of a leasehold contract continue for the entire term and you never own the underlying land. With a leasehold, in some cases, the ground rent can be as much as 6% a year, depending on how the contract with the lessor is structured. That's several hundred euros a month that a normal homeowner doesn't have to pay.

In big regions, this can lead to sizeable losses compared to a conventional sale of real estate, according to the Bavarian Consumer Advice Centre. As a result, lenders tend to offer poorer financing conditions for leaseholds. In addition, the shorter the remaining term of the lease, the less willing lenders are to finance it and the higher the interest rate is likely to be.

As the owner of the property, leaseholders generally have sole control over the building but if they decide to sell, the heritable building right encumbering the property often reduces the sale value considerably. Leaseholds are valued according to the specifications of the Valuation Act with fixed discount factors over the remaining term. In addition, the ground rent can also be increased during the term, which can make it difficult to know what the true costs will be. The ground rent is based on the land value, which rises with inflation. However, the interest rate does not rise automatically. The ground lease provider may only adjust it every three to ten years, depending on what is stipulated in the contract.

Government championing heritable building rights

Still, given the shortage of building plots available to buy, heritable building rights are gaining traction and even the government is getting involved. In Hamburg, the SPDand the Green parties have come up with the initiatives "New construction rents on urban land - always affordable" and "Land and housing - keep Hamburg social" in protracted talks that have been going on since February 2021.

‘We guarantee a 100-year social commitment for at least 1,000 new flats per year, in combination with a rent development linked to inflation and wage levels,’ said Dominik Lorenzen, chairman of the Green Party parliamentary group in Hamburg.

Starting in September 2024, 5,000 flats with a 100-year social commitment will be built in the first subsidy scheme over a five-year period. These apartments will be built on 33% of the urban land designated for housing construction with 20% of these 1,000 flats per year to be reserved for priority housing seekers. The plots of land for this scheme will be granted under a heritable building right with a 100-year term, and the apartments will be subsidised for 50 years. After expiry of the subsidy, rents will be fixed in accordance with the increases stipulated in the leasehold contract.

‘We need more leeway for urban development in individual cases, which we were able to preserve in the difficult talks with the final agreement,’ said Finance Senator Andreas Dressel (SPD) at the presentation of the agreement. ‘At the same time, we as a city are obliged to keep leaseholds attractive even in difficult times for housing policy.’

However, not everyone is in agreement: ‘The compromise with the popular initiatives will not lead to the creation of more affordable housing,’ said housing industry associations BFW Nord, Grundeigentümer-Verband, IVD Nord and VNW in a joint statement. ‘Instead, it significantly jeopardises the construction of subsidised and privately financed housing on city land. In this respect, we consider it a dramatically wrong decision.’ In addition, the associations have warned that financing over 100 years without public funds is not calculable: ‘Subsidies in social housing currently run for a period of 30 years. From today's perspective, it is difficult to impossible to find a financing institution that will finance the period after these 30 years with low rental income. It will be difficult to find serious developers for such concepts.’