Radical new reform package heads for government ratification

Investors in German residential housing need to be aware of potentially very significant changes to the tenancy laws that are making their way through Berlin's Ministry of Justice and headed for ratification by Germany's Bundestag.

After succesfully passing legislation to cap permitted rents on housing (the 'Mietpreisbremse') and radically altering the traditional form of broker compensation (the 'Beststellerprinzip'), the German government is preparing a second wave of reforms designed to counter profiteering in the housing market and to make housing more affordable for more people.

The initial reaction from the housing industry in Germany has been, not surprisingly, outrage as the consequences of the proposed measures begins to sink in.

The two key clauses in the new package of tougher measures are a) the reduction from 11% to 8% of the amount of renovation costs that landlords will be allowed to pass on to their tenants, and b) the period of time used as a reference to determine the 'fair rent' for a neighbourhood is being increased from the past four years to the past TEN years.

Furthermore, a new secondary cap on rents is being introduced. No rent will be permitted to rise by more than 50% over an eight-year period, and under no circumstances by more than €4.00 per square metre.

Tenants should be able to defend themselves better against anything that could be deemed more than "necessary" improvements to their rented dwellings. A benchmark is being set which would define 'hardship' as when a rent rise as a result of improvements pushes the tenant beyond the barrier of 40% of his/her net income for the 'cold' rent of the apartment i.e without ancillary charges.

The planned reforms are effectively introducing the principle that only those upgrading investments made by landlords are permissible for cost purposes that a reasonable landlord would pay for, "even if he had to bear the costs of them himself" – a tricky concept.

The Justice Ministry is justifying the new package of measures on the grounds that previous measures had not been sufficient to prevent tenants losing their apartments after rent rises due to improvements. The new laws are designed to bring the interests of tenants and landlords closer together even after the desired effects of modernisation.

Axel Gedaschko, head of the housing owners association GdW, said the industry was appalled at the new proposals. "This totally endangers the whole modernising of our housing stock in Germany and the whole planned energy revolution ("Energiewende"), if the possibility of raising rents after refurbishment is so hugely limited by these new planned measures," he said. Necessary investment in modernisations would frequently make no economic sense, he said, while the complete refurbishment of older obsolete properties would be futile.

Critical also for investors is the length of time deemed relevant for the purpose of defining a local 'fair rent'. Increasing this period to the last TEN years, instead of the current FOUR years, means many more rental contracts from the past can be brought into the analysis of a weighted average rent for a locality. These serve to determine the so-called 'Mietspiegel' or 'rent index' for an area, which serves as a benchmark for other permissible rents in the area.

Gedaschko's organisation is highly critical of this extending of the relevant time period, as this would serve to freeze rents at a lower level, given that any improvements made to the property would be underweighted in the local rent index, and would actually hinder further improvements. "The rent index can't be used as a blunt instrument to dampen down rents," he says, "but instead it must be a tool to objectively reflect local market rent levels."

REFIRE: The ramifications of this new proposed legislation can scarcely be overstated, particularly in those German cities where rents have risen strongly over the past few years. In other words, in the popular urban centres where there are jobs and where people want to live. The net effect will be a freezing of rents, or, in some cases, an actual reduction of the rent the landlord is permitted to charge on a new lease.

Should the legislation go through, mortgage lending banks will immediately revise their lending policy, which heretofore has been based on steady but moderate rent increases. If this is no longer going to be the case, they will re-assess the value of the asset against which they are lending, and will revise the value downwards. They will inevitably adjust their loan-to-value lending downwards, and may even look for further equity from those to whom they have already lent money.

The critical step of extending the basis for determining average rents back to a period of ten years will likely kill off at one fell swoop any further rent increases. This is more radical than what the original Mietpreisbremse envisaged, namely a dampening-down effect on rising rents. It represents pretty much a full-on assault on the interests of residential landlords in Germany's most popular cities.

Landlords are likely to be rushing to their lawyers to determine the legitimacy of these planned measures before they're passed into law, but tenants' associations and the left-of-centre SPD party seem to have got the bit between their teeth in trying to push this one through.