The Rent Freeze and Inflation Hedging

Published on 2013/11/13
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If the whitepaper presented by the incoming coalition government is implemented as planned, it will practically wipe out any inflation-hedging option for property owners in the conurbations (with real or imagined housing shortages) where the regime is to apply.

1. Tent rates for newly constructed buildings will de facto be frozen. Even if a first-occupation lease in a new building is exempt from any cap, local headline rents need to come level with this rent over what is likely to be an extended period of time before it can be raised. This means that condominium owners will no longer be able to offset the inflation rate. Given such conditions, who would want to invest in rental housing development anymore? Those building principals who have been active mainly in the construction of condominiums for owner-occupiers in recent years because margins were much higher in this segment will gradually abandon rental housing construction, being increasingly unable to find investors interested in buying a product with frozen rents. (It will be interesting to see how investors will respond: Sign up for a major event hosted by the BERLINER IMMOBILIENRUNDE panel on 20 November where institutional investors and family offices will talk about their purchase criteria for residential project developments. This issue will figure prominently at the event. Please request your copy of the program at info@immobilienrunde.de)

2. Rent increases for existing units in conurbations (with real or imagined housing shortages) will be limited to 15 percent over a four-year period. This may sound harmless, because 3.75 percent p.a. is quite a bit. The thing is: rents do not rise in a linear curve. Rather, lengthy phases of stagnation are followed (once the vacancies have been eliminated) by brief spurts of rental uplift in a sort of catch-up effect. The catch-up effect will be checked by the lowered rent increase cap for existing leases, as soon as permissible rent reviews will be limited to one third of the rent increase cap that was originally introduced.

3. So what will happen if the inflation rate exceeds the level of 3.75% p.a. over an extended period of time? In recent years, we have gotten quite used to minimal increases in the cost of living – to the tune of two percent or less. But let’s not forget: The German inflation rate exceeded seven percent in the early 1970s, six percent in the early 1980s, and five percent in the early 1990s.

Inflation rates between 1960 and 2007
YearInflation rate
19601,6 percent
19653,1 percent
19703,6 percent
19737,1 percent
19756,0 percent
19805,3 percent
19816,3 percent
19852,0 percent
19902,6 percent
19913,7 percent
1992*5,1 percent
19934,4 percent
19942,7 percent
19951,7 percent
19961,5 percent
19971,9 percent
19980,9 percent
20001,4 percent
20012,0 percent
20021,4 percent
20031,1 percent
20041,6 percent
20052,0 percent
20061,7 percent
20072,4 percent (September)
*representing West Germany through 1991, and the reunified Germany after 1992

Does anyone seriously believe that policymakers will rescind or raise their rent increase cap in face of an elevated inflation rate – which is by no means unlikely given the reckless monetary policy of the central banks? For it is precisely in such situations that key priority is given to “tenant protection.”

4. The rent table, which is the basis for rent increases, will be subjected to yet more political manipulation than it is anyway. The agreements published by the incoming coalition government states the intention to put the rent table on a broader basis and to present it in a more realistic form. This is nothing but a euphemism. The GdW Federal Association of German Housing and Real Estate Companies is quite right to criticise: “Under the historic methodology, the local reference rent has represented a market-oriented average rent. Expanding the time period for determining it beyond four years would needlessly jettison the existing methodology of monitoring actual market practice, and cast serious doubt on the profitability of letting. Because rent rates that used to be standard ten years ago, for instance, are neither market-standard nor profitable today when taking construction costs and other costs of living into account.” What is more, the rent freeze on re-lettings alone will put the rent table under increasing downward pressure in the coming years, generating a self-reinforcing negative dynamic.

About the Author

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