MAGAZINE The new Berlin rent price cap

It is Valentine’s Day, and high up on the 34^th storey of the London Shard – the UK’s tallest building – people start to arrive at the plush Shangri-La Hotel that offers stunning panoramic views of London. But there is no romantic element to this gathering. Instead, property industry representatives are here to gain insight into the residential rent cap and freeze in Berlin that is passing into law.

At the breakfast event organised by law firm Greenberg Traurig is a mixture of pan-European real estate investors. They include household names such as Cheyne Capital and Meyer Bergman. The latter has sent its in-house legal team; their interest is heightened by recently investing in a German residential property portfolio (though without an asset in Berlin).

Before the briefing, some delegates discuss potential exemptions, and wonder about loopholes, but generally they just want to know what others think of the new law.

All their questions are answered during a two-hour presentation and Q&A session by Christian Schede of Greenberg Traurig Germany and Marcus Cieleback of Patrizia.

With every third euro of German residential transactions being in Berlin last year, it is easy to see why the detail of the city’s attempt to deal with ‘unfair’ rents or undersupply of living accommodation via regulatory landlord control is of massive interest.

Legislative details
It was only recently – 30 January – that the Berlin State Parliament passed the law called the Berliner Mietendeckel.

The rent cap applies to 75% of the rental residential market in Berlin including single-family/semi-detached houses, furnished apartments, as well as short-term letting models. A last-minute change did soften things a little bit as it was decided it would not now apply to newly constructed buildings that were ready for occupation on or after 1 January 2014.

Nor does it apply to publicly subsidised apartments, or places that were modernised or refurbished with funds from public sources. Dormitories and apartments operated by recognised welfare organisations are also exempt.

Taking the above into account, the rent freeze element applies to all existing leases in operation up to 18 June 2019. Even if an index-linked or stepped rent was agreed, a lease will still be covered by the new law. The only respite is for space re-let after 18 June 2019. The law was relaxed here, provided that the lease remains in place when the law is officially published.

The rent cap spectrum is very precise: the absolute limit for a property will sit  somewhere between €3.92 and €9.80 per m2 per month based on the 2013 rent index. The applicable cap can be adjusted for real wage increases and depends on the age and standard of fit-out.

If it is a building with no more than two apartments (that is, detached or semi-detached houses) a rent increase of 10% is allowed. If it is an apartment with ‘modern equipment’ the rate can be lifted by €1 per square metre. Modern equipment denotes five things, from an elevator to built-in kitchen, and low energy performance.

Some owners were wondering if rents might need to be reduced. However, only the rent freeze element applies from Day One of the new law, not the cap, provided the rent has not been increased in the period between 18 June 2019 and passing of the law.

However, if the rent is 20% or more above the relevant cap it must be reduced after nine months of the law coming into effect. This must be done automatically by the property owner – it is not dependent upon the tenant applying, which was required in an earlier draft.

Penalties and exemptions
Greenberg Traurig’s Schede explained this means that landlords should check their entire Berlin portfolio. If they do not, and fail to make a reduction where necessary, they might be subject to a fine. There are exceptions though. If the apartment is deemed to be in a ‘good location’ the rent could be exceeded by 74% per square metre. What if the flat is in an average or simple location? There, only 9 cents per square metre or up to 28 cents will be allowed. The State Administration is supposed to be appointing a legal ordinance to determine what is a good, average and simple location.

There are other criteria to consider for first-time lettings, re-lets and modernisations. Also to ponder is the chance a landlord argues it should be allowed to charge a higher rent if it can show ‘economic hardship’. What this constitutes is a debate in itself with its own definitions and procedures. An application will be reviewed by the Investment Bank Berlin (IBB). Originally, the law said the IBB would deal with applications within three months, but this was scrapped after the IBB said it did not have the manpower.

What else should owners of Berlin residential property know? The list includes an information duty towards tenants and penalty fines.

Schede said that overall, the rent cap law is expected to stall investment and modernisation measures. Over breakfast, delegates had already been warning of ghettos being created where there was little incentive for property owners to invest. The detail of the law as explained later did not seem to alter that view.

Challenges ahead
Inevitably, attention also turned to whether the law itself might be overturned. Various groups allege that the Berlin State law breaches the Federal Constitution. The CDU and FDP parliamentary groups in the Berlin State Parliament announced on 31 January they would challenge the law before the State of Berlin constitutional court. Also, members of the CDU and FDP parliamentary groups in the Bundestag have sufficient signatures from MPs to file a constitutional complaint with the Federal Supreme Court.

Schede said he saw strong arguments that the Berlin rent price cap violated fundamental rights and principles of the German Constitution. 'In particular, the concept of citywide, automatic, and mandatory rent reductions sanctioned with penalty fines is likely to be in breach of the constitutional property guarantee and the freedom of contract. Also, the new law still does not provide for certain required differentiations. Most importantly, it does not provide for an appropriate treatment of substantially refurbished apartments. Similarly, it does not appropriately consider the location of the leased space when it comes to determining permitted rent levels.'

Property owners are already counting the cost. Covivio has a Berlin residential portfolio making up 9% of its total revenues. It estimates it will lose revenues this year and is selling more assets in the German capital.

How to manage
But speaking to delegates at the Valentine’s Day event in London, Patrizia’s Cieleback struck a conciliatory tone.

The move that Berlin is making is being seen in other European cities too, going back 10 years or more. Stockholm is said to be the most highly regulated market and yet the Nordics is an active market, he pointed out.

‘What is currently ongoing in Berlin from an economist’s point of view is simply a real-world life experience. The State of Berlin is experimenting with a legal approach to deal with the affordability issues you have in many areas.’

He continued: ‘Berlin is by far the most liquid German market, and legal uncertainty will definitely have an impact. Most likely volumes will go down, but possibly they might even go up as there might be some sellers. Some will say that they believe in the fundamentals of Berlin, so why not take the opportunity a bit like immediately after the Brexit vote.’   

He echoed many people’s view that rent caps and freezes were a ‘strange way’ to deal with affordability as they did not promote the building of any new residential units. He added that a lot of German regions were very closely monitoring Berlin’s approach. ‘Will it be constitutional? What will be the change and what will be the effects on the city?’

He added: ‘Understanding the rules of the game is one of the very important things you can do. Regulation has always been a part of the European residential investment market. The problem currently is that you don’t know if the Berlin State law is constitutional. But if you are a long-term investor and understand the rules of the game, it should not be so much of an issue. For some large owners, it will be an asset-by-asset calculation. As an investor, you should be able to deal with it.’