The Act Supplementing the Rules on Permitted Rent Levels at the Start of Tenancies and Amending the Rules on Modernisation of Rental Properties came into force on 1 January 2019.
In addition to tightening the rules which came into effect on 1 June 2015 and introduced a rent cap, the new act contains changes to the rules concerning rent increases following modernisation. The fundamental difference between the rent cap and the rules on rent increases following modernisation is that the latter apply to existing tenancies, whereas the rent cap is intended to keep new rental charges in check.
Tenants in Germany are generally well protected against rent increases in existing tenancies and high rent increases are uncommon; however, a major exception is when flats or houses are modernised.
Previously, if a flat was modernised in order to improve energy efficiency or if it was upgraded by (for example) renovating a bathroom or adding a balcony, landlords could allocate 11% of the modernisation costs minus the estimated costs that would have been necessary for maintenance work to the annual rent. Depending on the investment costs, rent hikes calculated in this way could be substantial; it was not unusual for the basic net rent excluding utility costs to be doubled. This allocation of modernisation costs to rent was introduced in the 1970s, when many flats in Germany had no central heating or bathrooms. This special form of rent increase was intended to serve as an incentive for landlords to modernise their rental properties.
However, in recent years, modernisations have come under increased political scrutiny. Further, in light of low interest rates, the 11% allocation of modernisation costs has been called into question. Added to this have been media reports concerning deliberate abuses of modernisation work in order to prompt less wealthy tenants to move out of their flats.
The new legislation aims to offer tenants improved protection against abusive practices when modernisation work is announced and carried out and prevent them from being disproportionately burdened by rent hikes due to modernisation.
The following rules came into force on 1 January 2019:
- The level of the allocation of modernisation costs to rent has been cut from 11% to 8%. In contrast to what was originally planned, this cap applies not only in regions where the housing market is overstretched, but nationwide. In addition, the monthly rent following the modernisation cannot be increased by more than €3 per m² in six years. For flats with rent of up to €7 per m², it may be increased by only €2 per m². Rent increases to reflect the customary rent levels in a particular location and increases in operating expenses are exempt from this. Under the provisional arrangements, landlords can still allocate 11% of the costs for tenancies established up to 31 December 2018 if the tenant received notice of the modernisation by 31 December 2018.
- For smaller modernisations with an investment value of up to €10,000, an optional, simplified rent increase procedure has been introduced in which (for example) the formal requirements for giving notice of modernisation work have been lowered and the costs of the fictitious maintenance work can be deducted at a flat rate of 30% of the modernisation costs.
- Landlords who only modernise flats in order to get tenants to give notice or to cooperate in cancelling the tenancy must pay a fine of up to €100,000. Besides this, tenants may bring claims for damages. Under the new rules, tenants benefit from an easing of the burden of proof.
Returns on investment depend on a wide range of factors, including:
- interest rates;
- duration of use;
- tax rates; and
- whether the modernisation expenses can be allocated to the rent.
Investors who are looking to invest in the German residential housing market will have to take the new rules into account in their business plans. The limited possibilities for allocating modernisation costs to a property's rent reduces the future potential cash flow from such property. This should be considered when setting selling prices.
The new rules aim to reduce only the allocation of a percentage of modernisation costs to a property's rent in regions where the housing market is overstretched and limit the reduction to a period of five years. However, if modernisations are to continue to be profitable for investors, lowering the level from 11% to 8% on a long-term basis appears problematic. Even if interest rates were to increase slightly, many modernisations could become unprofitable and therefore not take place. It would have made sense to link the percentage value of the modernisation that can be charged as rent to interest rate trends in order to avoid neverending discussions about correct allocation values.
Further, the government's ambitious climate protection goals require substantial investment in existing housing. The building sector plays a significant role in the transition to renewable energy sources. As modernised flats use far less energy than flats that have not been refurbished, this has great potential for the transition to renewable energy sources and the achievement of climate protection targets. However, the new rules are likely to have a counterproductive effect on the number of flats being modernised and modernisation to improve energy efficiency may be hindered.
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