In brief: real estate acquisitions and leases in Germany

Acquisitions and leases

Describe the various categories of legal ownership, leasehold or other occupancy interests in real estate customarily used and recognised in your jurisdiction.

Ownership can be categorised in full ownership and co-ownership. Co-ownership is in practice important for the creation of condominium ownership, which legally consists of a share in the co-ownership of the entire property combined with exclusive ownership of an individual apartment.

Apart from the aforementioned forms of ownership, hereditary building rights, a form of in rem leasehold, exist and are widely used in Germany. Hereditary building rights grant the right to own a building located on or under a property owned by a third party for a certain period (often 99 years). At the end of the term of the hereditary building right, the building erected on the basis of the hereditary building right accrues to the owner of the property. Depending on the provisions of the hereditary building right agreement, the owner of the property has to compensate the property owner at market value of the building or an agreed price at the end of the term. Hereditary building rights can be separately sold, transferred and encumbered. However, transfer and encumbrance often require the consent of the landowner (depending on the provisions of the hereditary building right agreement).

Lease agreements are used for residential and commercial properties. While lease agreements for commercial properties can be concluded for a fixed term (eg, 10 years or even more) or an indefinite term, lease agreements for residential properties are (with some exceptions) generally concluded for an indefinite term. For tenant protection reasons, there are only limited termination rights for the landlord in case of residential properties.

Encumbrances such as rights of way or rights for installation of electric cables and water pipelines are commonly used in Germany. The creation of such rights requires a notarised deed and registration with the competent land register. Encumbrances registered in favour of the local building authorities for compliance with zoning and construction law (public building charges) are, in most German federal states, registered in separate public registers, which should therefore also be reviewed by an investor in case of real estate acquisitions.

What are the typical pre-contractual steps?

In larger real estate transactions in Germany, parties often conclude a letter of intent or term sheet before negotiating the details of the transaction. Both types of agreements are non-binding with respect to the obligation to purchase and sell the property. It is possible and customary to take the property off the market while the final agreement is negotiated. This is usually achieved by an exclusivity agreement or a binding exclusivity clause in the letter of intent.

In the acquisition, sale, leasing and financing of real estate, engaging a real estate broker is optional but very common both in commercial and residential property transactions. The broker can be involved on behalf of the seller or the purchaser or on behalf of both. Special education for brokers is not required. However, brokers have to register their business and need a licence issued by local public authorities. Nevertheless, the special licence does not certify any real estate experience.

In the case of real estate acquisitions, the amount of commission is not regulated by law and can therefore be determined by the parties.

Broker commissions for leasing residential properties are capped at a maximum amount equal to two net cold rents of the relevant property plus value added tax. It is regulated by law that the party engaging the broker pays the commission in such transactions.

What are typical provisions in a contract of sale?

Typical provisions in a real estate purchase agreement include:

• the description of the purchase object, including land register details and all encumbrances of the property;
• the purchase price and payment mechanism;
• closing conditions, in particular:
• the registration of a priority notice of conveyance in the land register;
• the waivers of any applicable pre-emption rights in favour of public authorities;
• the deletion of any encumbrance that will not be assumed by the purchaser (eg, land charges in favour of seller’s financing banks); and
• in larger transactions, merger control clearance;
• provisions regarding transfer of possession and proration of rights and benefits, including transfer of any lease agreements and other property-related agreements;
• covenants for the period between signing and closing (eg, the obligation to manage the purchase object with due care);
• representations, warranties and indemnities for pre-closing taxes;
• limitations of liability for representations and warranties (eg, caps, de minimis thresholds);
• conveyance of title and land register formalities;
• termination rights in case of default;
• a power of attorney granted by the seller to the purchaser to encumber the property prior to closing with land charges for financing the purchase price; and
• miscellaneous provisions, (eg, regarding governing law, jurisdiction, costs and taxes, etc).

In the current market environment, typically only very limited sets of representations and warranties are given. Such representation and warranties differ depending on the size and nature of the transaction but typically include certain statements on:

• title and encumbrances;
• compliance with laws;
• encroachments;
• contaminations;
• lease agreements concluded with respect to the property;
• insurance;
• litigation; and
• payment of taxes and other public charges.

In terms of title, the purchaser usually reviews the land register excerpts and cadastral maps in its due diligence. Furthermore, the seller guarantees that the statements in the land register are true and correct as of closing of the transaction.

Down payments in the amount of 5 to 10 per cent of the purchase price are often requested by sellers in the current market. These amounts are usually paid to an escrow account held by the officiating notary.

Generally, risk of loss transfers upon closing. Most real estate purchase agreements for larger transactions contain detailed provisions regarding termination rights of the parties in case the building is partially or fully demolished prior to closing.

Who takes responsibility for a future environmental clean-up? Are clauses regarding long-term environmental liability and indemnity that survive the term of a contract common? What are typical general covenants? What remedies do the seller and buyer have for breach?

Under statutory law, the landowner faces liability for environmental contamination pursuant to the Federal Soil Protection Act and applicable soil protection acts of the federal states. The same applies to the polluter, its legal successors and the tenant.

In standard real estate purchase agreements, the purchaser usually indemnifies the seller from any remaining liability for contamination based on statutory law. More specific provisions with detailed indemnification obligations and covenants are used for the sale of properties with specifically known contamination.

What are typical representations made by sellers of property regarding existing leases? What are typical covenants made by sellers of property concerning leases between contract date and closing date? Do they cover brokerage agreements and do they survive after property sale is completed? Are estoppel certificates from tenants customarily required as a condition to the obligation of the buyer to close under a contract of sale?

The scope and exact wording of representations regarding leases very much depend on the individual transaction and the parties involved. Typical representations include:

• valid existence of lease agreements;
• no terminations or reasons to terminate lease agreements;
• no reductions of rent or defaults on rent payments or payments of ancillary charges;
• landlord’s compliance with payment obligations regarding tenant improvements;
• no disputes with tenants; and
• overall rent roll amount.

Covenants regarding lease agreements for the period between signing and closing typically include that the seller will not enter into new leases or amend or terminate existing leases without the consent of the buyer and that the seller will comply with its obligations under existing lease agreements.

Is a lease generally subordinate to a security instrument pursuant to the provisions of the lease? What are the legal consequences of a lease being superior in priority to a security instrument upon foreclosure? Do lenders typically require subordination and non-disturbance agreements from tenants? Are ground (or head) leases treated differently from other commercial leases?

As a general rule, all rights and obligations under a lease agreement transfer to the new owner by operation of law upon transfer of title. This mechanism does also apply in a sale in foreclosure proceedings initiated by the lender.

However, there are statutory break clauses regarding the lease agreement for the acquirer, if the property is sold either in foreclosure proceedings or in insolvency proceedings regarding the landlord’s assets. In these situations, the acquirer of the property is permitted to terminate the lease agreement subject to statutory notice periods.

As a result, tenants run a certain risk that the lease agreement may be terminated prematurely due to the landlord’s default or insolvency. Certain tenants therefore request the registration of a tenant easement in the land register with a rank prior to the land charge or mortgage of the lender. A tenant easement is an in rem right of the tenant to use the property for a specific purpose (ie, the purpose of the lease agreement). In the case of a termination of the lease agreement owing to an insolvency of the landlord or foreclosure proceedings, the easement remains in place and grants the tenant the right to continue to use the property against payment of a compensation. To mitigate a potential conflict with land charges of the lender, German mortgage banks developed certain criteria for such tenant easements. Investors should carefully review compliance with these criteria if they wish to finance the property with a German mortgage bank.

What steps are taken to ensure delivery of tenant security deposits to a buyer? How common are security deposits under a lease? Do leases customarily have periodic rent resets or reviews?

Lease agreements in Germany typically stipulate the obligation of the tenant to provide a security deposit. Regarding residential lease agreements, the deposit must not exceed an amount three times the monthly rent. Payment of the first part of the security deposit is typically due upon handover of the premises.

In commercial lease agreements, however, the parties are free to agree the amount of security deposits, which may exceed the threshold of three monthly rents. Depending on the tenant and the asset, bank guarantees or parent guarantees are common in commercial lease agreement.

Rent reviews are restricted in residential lease agreements by statutory law. Increases are subject to the fulfilment of certain requirements (eg, rent increases in case of modernisation measures or rent increases up to the level of the market rent). Furthermore, a staggered rent or an indexation of the rent in accordance with the German consumer price index is possible but must comply with certain prerequisites pursuant to the German Civil Code.

In long-term commercial lease agreements, indexation clauses, which link the rent to the development of the German consumer price index, are widely used.

What due diligence should be conducted before executing a contract? Is any due diligence customarily permitted or conducted after contract but before closing? What is the typical method of title searches and are they customary? How and to what extent may acquirers protect themselves against bad title? Discuss the priority among the various interests in the estate. Is it customary to obtain government confirmation, a zoning report or legal opinion regarding legal use and occupancy?

Buyers usually seek to protect themselves against bad title by way of due diligence and representations and warranties given by the seller. The scope of due diligence very much depends on the individual transaction target and transaction structure. Usually at least a legal, tax and technical or environmental due diligence is conducted by the buyer. In transactions that include the acquisition of the property holding company, buyers would also conduct a financial due diligence. Conducting due diligence after signing but before closing is rather unusual.

In large auction sale processes, the seller would typically also conduct a seller due diligence and provide the results in the form of a vendor due diligence report or - more often - a ‘fact book’ to the interested bidders.

Regarding title due diligence, each acquirer needs to review the land register. Unless an objection to the accuracy is registered with the land register or the inaccuracy is known to the acquirer, the acquirer of property may assume that the content of the land register is correct. Therefore, there is usually no additional title search done in Germany for real estate acquisitions.

All registered encumbrances of the property are ranked. The general concept of the land register is ‘first in time, first in rank’. However, it is possible to deviate from this concept and agree on (and register) changes of the rank with the consent of all affected parties.

As regards legal use and occupancy, the parties usually review the zoning law situation, any applicable zoning plan and the building permit of the property as part of their due diligence.

Is it customary to arrange an engineering or environmental review? What are the typical requirements of such reviews? Is it customary to get representations or an indemnity? Is environmental insurance available?

Engineering and environmental issues are usually covered by a technical due diligence conducted by civil engineers. As part of the legal due diligence, registers of contaminated sites are checked.

In most transactions, representations and warranties regarding structural and environmental issues are limited. In transactions involving real estate with known contamination, the parties usually extensively negotiate the exact liability regime for the contamination. Specific insurance solutions covering risks resulting from environmental issues are also available on the market in individual cases.

Do lawyers usually review leases or are they reviewed on the business side? What are the lease issues you point out to your clients?

Leases are typically reviewed both from the legal and the business side. The review on the business side usually focuses on key commercial terms. The lawyer’s review also comprises, among other things, compliance of the lease agreement with statutory law (eg, regarding indexation clauses or recoverability of operating expenses), identification of break clauses and change-of-control clauses, sublease and assignment provisions as well as a general review regarding all kinds of unusual (payments) obligations.

Furthermore, lease agreements for commercial properties must be concluded in written form in order to provide for a fixed term of more than one year. The German Federal Court of Justice has developed a specific interpretation regarding this written form requirement. If the parties violate this requirement, the agreement can be terminated by either party with the statutory notice period (ie, for commercial lease agreements with a notice period of six months). Lawyers therefore typically also check compliance with the written form requirement as part of the legal due diligence exercise.

What other agreements does a lawyer customarily review?

Apart from the lease agreements, the legal due diligence usually includes the review of service agreements pertaining to the property (eg, asset management or property management agreements), finance agreements and insurance agreements if the transaction is either structured as a share deal or if these agreements are explicitly transferred to the purchaser in an asset deal. In share deal structures, the scope of review also comprises all corporate documents (articles of association, shareholders’ agreements, etc) of the relevant property holding company.

Brokerage agreements are typically not within the scope of the review.

How does a lawyer customarily prepare for a closing of an acquisition, leasing or financing?

Lawyers typically prepare the fulfilment of all closing conditions and any documents that have to be signed at closing. The exact set of preparations depend on the specific structure of the transaction (eg, for share deals or forward deals often more complex closing preparations are required compared to asset deals regarding existing buildings). For asset deals, the public notary is usually responsible for the fulfilment of certain closing conditions (eg, waiver of statutory pre-emption rights and registration of priority notices in the land register).

The usual timing between signing and closing also depends on the specific project. Simple transaction for which no merger clearance is required can often be closed four weeks after signing or even simultaneously with signing. In forward deals (ie, projects in which a building is sold that is still under construction), the period between signing and closing can be several years.

For closing of a financing, lenders require that the loan documentation is duly signed and all conditions precedent are fulfilled, including, for example, all security documents and legal opinions by lawyers.

Is the closing of the transfer, leasing or financing done in person with all parties present? Is it necessary for any agency or representative of the government or specially licensed agent to be in attendance to approve or verify and confirm the transaction?

Signing of a real estate purchase agreement must occur in front of a public notary with all parties present (either in person or represented by a proxy). Upon fulfilment of all closing conditions, the public notary issues a payment notification to all parties and the purchaser pays the purchase price on this basis. Closing is effected by payment of the purchase price to the seller’s account. Afterwards, the notary will procure registration of the change of ownership with the land register.

In more complex transactions and usually in share deal transactions, all parties meet in person to verify the completion of all closing conditions, the existence of all closing deliverables and the due execution of the agreements that have to be signed at closing. Depending on the deal structure and closing deliverables, a public notary may also be required for notarisation at closing.

Closing of financing agreements usually occurs upon fulfilment of all conditions precedent and, in particular, the signing of security documents. Usually, no in person meeting is required.

For lease agreements, the parties usually agree on a formal handover of the property upon the start of the lease term. Lawyers are only in exceptional cases involved in this handover process.

What are the remedies for breach of a contract to sell or finance real estate?

In the event of default of either party to consummate a real estate purchase agreement, seller and purchaser have the possibility to sue the other party for specific performance and request damage compensation.

Purchasers further typically have to agree on a submission to immediate enforcement in real estate purchase agreements. Therefore, if the purchaser fails to close, the seller can also directly enforce its purchase price claim. Furthermore, in case of non-payment of the purchaser at closing, the seller typically has the right to terminate the agreement and retain a potential down payment of the purchaser.

In the event of breaches of a loan agreement, each party can also sue the respective other party for specific performance and request damage compensation.

What remedies are available to tenants and landlords for breach of the terms of the lease? Is there a customary procedure to evict a defaulting tenant and can a tenant claim damages from a landlord? Do general contract or special real estate rules apply? Are the remedies available to landlords different for commercial and residential leases?

The consequences of a breach of the lease terms are governed in the specific lease agreement and the lease related provisions of the German Civil Code.

In case of severe breaches, either party may terminate the agreement for cause. Lease agreements for commercial premises customarily specify under which circumstances the parties may terminate for cause. For residential lease agreements, the landlord’s termination rights are restricted to the circumstances listed in the German Civil Code. These circumstances include, in particular:

• default with rent payment or a substantial portion of rent on two successive payment dates;
• default of payment for a time period of more than two payment dates of the rent in an amount equal to the amount of rent for two months; and
• substantial violation of the lease agreement.

After a termination, the property owner may file an action for eviction with the competent court.

In the event of a breach of lease terms by the landlord (eg, defects of the property), the tenant may sue for specific performance and request damage compensation, rent reduction or both.