Making a Science out of Letting a Flat

Published on 2014/10/14
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A new science is born. It is the science of flat letting. The formative document of this science consists of 44 single-spaced pages. Its authors are the Federal Ministries of Justice and Consumer Protection. The title of the document – wait for it – reads: “Draft Bill for a Law to Slow the Rental Uplift on Strained Housing Markets and to Strengthen the Contracting-Party-Pays Principle in Housing Brokerage.”

But lets start with the good news. Here are the glad tidings for building principals: “Apartments occupied or let for the first time after 01 October 2014 are exempt from the rent control.” So project developers active in housing construction can stop reading right here, because the rest won’t concern them. They are, however, well advised to place this one sentence prominently in the sales kit of their new apartments for maximum advertising effectiveness. They will benefit from a precious privilege going forward.

Property asset holders, by contrast, are facing hard times. The explanatory notes on the draft bill authored by the civil servants of the two federal ministries state: “The options of owners and landlords to manage their rental flats as they see fit, and to derive economic benefit as they see fit, will be constrained to the extent necessary.” I find the phrasing absurd. The line just about suggests that this will be the first piece of legislation and regulation for governing the housing market, as if the rent increase cap was not already in place (and had not already been lowered several times, from 30 percent down to 15 percent), as if there was no Article 172, German Building Code (preservation statutes, historic district protection areas), and as if the protection against unwarranted eviction of tenants was not already prescribed in great detail, to say nothing of all the other rental housing constraints. The implied suggestion that the German housing market has been the governed by nothing but the laws of a free market economy is preposterous!

Be that as it may, flat owners will have to brace themselves for a new law that is highly complex and extremely susceptible to litigation. Even the civil servants who penned the draft bill conceded as much, stating explicitly:

“This [the rent freeze, R.Z.] could generate the added expense of having to retain legal counsel for lessors and lessees.” The paper also mentions a possible “increase in the number of civil lawsuits.” “The scope of such litigation and the prospectively generated costs are impossible to predict for want of adequate estimate bases.”

The civil servants of the federal ministries of justice and consumer protection discuss the draft bill’s “compatibility with constitutional law standards” at great length. They concede that provisions that “put the profitability of letting in serious jeopardy” might be problematic. The line is quoted from a resolution by the Constitutional Court of Justice. This, Germany’s supreme court of law, has made it quite clear that the limit for a permissible regulation is breached whenever rent control measures cause permanent losses for the lessor or a depletion of assets for the rental property.

Unperturbed, the ministerial draft bill includes the sweeping and unsubstantiated assumption that the law will not violate these thresholds. A survey recently published by the Wertgrund property management company, however, showed unambiguously that the profitability of letting, which marks the limit defined by the Constitutional Court of Justice, is already in serious jeopardy for the majority of landlords. The rate of return for more than half of all German property owners is less than 2 percent today! This means that even without the contemplated rent control legislation, existing constraints exceed the set tolerance level.

But that isn’t all: The situation for property owners is exacerbated by enormous costs the new scheme will entail:

The authors of the draft bill estimate that the time spent adjusting the rent level in accordance with the stipulations of the new law will be two hours. The extra effort will be required, or so the argument goes, to study the valuation criteria, e.g. on the basis of a rent table, and to gather the necessary data on a given flat, and to properly integrate them in the mandated price structure. For the 424,000 cases that the ministries estimate will have to do their math again to factor in the rent freeze provisions, this would imply an extra time effort of 848,000 man-hours.

If tenants were to request information about the definitive circumstances for fixing their rent rates (e.g. disclosing a copy of the previous tenant’s lease to verify the actual rent level), this is said to require “processing of the existing rate calculation in text format, for which a time frame of 45 minutes appears plausible.” The civil servants estimate that this added effort will be required in one of three cases. The civil servants own calculation thus translates into a total extra effort of 106,000 man-hours for landlords.

This means: The implementation of the senseless, purely ideologically motivated rent freeze will cost us, the property owners, an annual overtime of 954,000 man-hours from here on out! Just think of the sensible things you could do in close to a million man-hours! The rent freeze will not create a single new flat.

One of the provisions of the new rent control law, pursuant to which those apartments that have been thoroughly modernised will be exempt from the new regulation, created quite a stir. But it remains unclear what exactly constitutes a “thorough” modernisation, and what does not. The explanatory memorandum to the Act contains a few notes on the subject. The thing is: They are in no way legally binding. The explanatory memorandum of a law has no legal standing in court, as solely the wording of the actual law applies. And the draft bill at issue here says nothing about the nature of a “thorough” modernisation.

Neither does it say anything about the way the “local reference rent” should be determined, even though it represents the key concept of the law! Here is an example: I myself own flats in Bremen and Berlin. Bremen does not even have a rent table. So how am I supposed to calculate the “local reference rent” when trying to re-let a flat? If I get it wrong, I might get fined, and face pay-back claims by tenants. But how am I supposed to know how to get it right?

The civil servants have this to say on the subject: “If no local rent table is available, the landlord will have difficulties determining the permissible rent rate. Inversely, the prospective tenant will have problems verifying the propriety of the asking rent. Assistance in such cases could be provided by comparables databases maintained by the interest groups of lessors and lessees, as well as by statistical surveys on the local reference rent.” Which means that a landlord in Bremen – or any of the many towns in Germany that compile no qualified rent table – would be expected to conduct extensive research before letting a flat. Thus, the landlord turns into a property researcher, and letting a flat becomes a science in its own right.

The situation in Berlin differs from the one in Bremen. Berlin does have a rent table. But how accurate is it? Serious doubt is called for. In proceedings before the District Court of Charlottenburg over a rent increase, Professor Walter Krämer of the Institute for Economic and Social Statistics of the Dortmund University of Technology was appointed as expert witness. His expert opinion demonstrated that Berlin’s rent table is by no means compiled in line with accepted scientific principles. But this is precisely what Article 558 d, Section 1, German Civil Code, mandates for a qualified rent table.

The expert demonstrated that the random sample on which the Berlin Rent Table is based is not representative. For the Berlin Rent Table of 2013, around 12,000 data records covering more than one million flats were analysed. While this would have been a sufficient number in and of itself, fact is that only 4000 tenants actually responded. The expert also showed that the response rate varies from one segment of the population to the next. The expert, a tenured professor for statistics, argued that this results in serious statistical distortions.

It was not the only statistics error the professor revealed: Gross rents were incorrectly converted into net rents, extreme-value adjustments were incorrectly applied, threshold limits were hazy, while special characteristics were not properly factored in. These things represent “not the standard in modern mathematical statistics,” reads the opinion by the statistics professor, a slap in the face of the authors of the Berlin Rent Table. He also called the breakdown of Berlin’s urban area into just three types of residential locations arbitrary. Things that are subject to considerable differences are treated as identical, as the statistics professor observed. From a statistics point of view, he argued, it is indispensable to divide the residential locations into inner and outer districts.

As you can see: Conflict between tenants and landlords over the agreed rent rate is practically built into this piece of legislation. For no one knows for sure how to define “local reference rent,” the key term of the law, and how to determine the going rate.

Indeed, I find it hard to detect anything in these 44 pages that is both clear and reassuring. In addition to the above-quoted line about the provision exempting new residential units, certain passages discussing the modernisation issue are worth mentioning. To make it quite clear: This is not about the thorough modernisation that – like new schemes – will cause the application of the entire rent control legislation to be waived, but about modernisations that fail to qualify as “thorough” modernisations.

The draft bill includes provisions for the scenario that a landlord undertook modernisations prior to signing the lease with a new tenant that are not reflected in any rent increase. Under the currently effective legislation, the landlord cannot recover the costs of capital improvements undertaken during vacancy periods by raising the rent to be paid by the next tenant. And following the introduction of the rent freeze, the landlord would be entitled only to a rent rate equal to the rent paid by the previous tenant of the (unrefurbished) flat or else a rent not exceeding the local reference rent by more than 10 percent.

However, the draft bill provides that tenant and landlord may consensually agree on a higher rent in cases where the landlord refurbished the flat prior to the occupation by the new tenant, provided the agreed rent matches the rent level the landlord would have been able to charge to a tenant with an unexpired lease pursuant to the currently effective provisions.

Except for this encouraging exemption clause, however, I found precious few reassuring aspects in the draft bill. Many aspects remain unclear, and it will take us all day to figure out how to apply the law in practice when we sit down together with landlord-tenant law experts on 03 November. You are certainly invited to join us for this session of the BERLINER IMMOBILIENRUNDE panel on 03 November. You will see that the devil is in the details, and that letting a flat will be something akin to science in the future. (“Getting serious now – the New German Rent Control Legislation” – this will be the subject of a panel event hosted by BERLINER IMMOBILIENRUNDE on 03 November. Request your copy of the program e-mailing us at: info@immobilienrunde.de.)

About the Author

Dr. Rainer Zitelmann is one of the leading experts for the strategic positioning and communications of companies.