Is the industry overreacting again? Are the rent-capping suggestions made by the Social Democrats in truth only half as bad?
My feeling is that the industry should show a much stronger reaction. If the Social Democrats’ suggestions were to be implemented, they would produce the gravest and most incisive cut for property owners yet seen in the annals of the Federal Republic of Germany. Anything we have witnessed in recent decades would pale by comparison; and we have witnessed quite a bit.
Just as a reminder:
- Between 1989 and the end of 2005, the degressive deduction-for-depreciation (AfA) was successively scaled back, from 7% p.a. to eventually 4% p.a., before it was scrapped altogether. It resulted in a massive dip in rental housing construction; and the current rise in rents is one of the ramifications.
- The speculation period was extended from two to ten years at 01 January 1999.
- The inheritance and gift tax on real estate was raised several times, adding up to a tax hike of several hundred percent.
- The real estate transfer tax was initially raised from 2% to 3.5%, and has since gone up to 4.5% or higher in most German states.
- As early as 2001, the cap for rent increases was lowered from 30% over a three-year period to 20% over the same period. At the moment, it is about to be reduced to 15% within three years, or indeed to 15% within four years if the Social Democrats get their way.
But all this is harmless compared to the suggestions lately tabled by the Social Democrats. They will force property owners to drastically reduce the rents on unexpired leases. This is what I call a rent reduction law.
Most of the critical responses do not seem to have grasped the full meaning of the initiative: the Social Democratic suggestion to raise the rent rates on new leases by 10% compared to local reference rents is deceptive, for this is not about any cap on rent hikes, but about a government-ordained rent reduction on a massive scale. Rents on new leases have tended to exceed the local reference rents substantially in recent years, at least in the major cities. Now, if the re-letting rent exceeded the local reference rent by 20% before the cap demanded by the Social Democrats enters into force, it will force the owner, once the tenant moves out, to lower the rent by 10% from the rent rate most recently paid, because new leases must not exceed the local reference rent by more than 10%. This is what is actually at stake! It means that rents on new leases in all major German cities will have to be lowered, which in turn would lower the local reference rents, and thus initiate a down-spiral of rent rates.
Thus, for the sake of clarity, my recommendation is to keep referring to this draft bill solely as “the rent reduction act” whenever the demands by German Tenant Union and Social Democrats come up for discussion.
Similarly, neither the idea to lower the rent-increase cap from 20% to 15% (an idea backed by the Christian Democrats and the Liberals), nor the proposal by the Social Democrats to extend the reference period from three to four years, is quite as innocuous as it may seem at first glance. The argument that 3.75% p.a. is a rental growth average that has not been realised at any times during the past decades in Germany and that it is therefore insignificant (see the point made above) does not bear scrutiny. Rent rates simply do not show a linear annual growth curve that could be quantified in an even percentage.
One look at the actual development during the past decade suggests: rent rates have stagnated – or indeed declined – for many years, before rallying for a few years, as if to catch up, in a manner of speaking. At the moment, we are midway through the boom cycle. Here is an example: let us assume that the existing rent rate stagnates for a period of five years, only to decline during the next three years at a rate of 2% p.a. and to recover in the three years thereafter by rising at 5% p.a. It is precisely this latter rent hike that would cease to be an option in the future. But this is what a normal long-term rental growth curve looks like.
And what about the inflation-hedging quality of real estate? If the inflation rate was to climb to 4-5% p.a. or more at some point – there are people who worry that it might -, and if rent increases were limited to 3.75%, this would be tantamount to a massive impairment for property owners. Or do you seriously think that the political leaders would rescind the capping limit for the benefit of landlords? Think twice!
21 January 2013
The New Carelessness – or: Words and Paper are No Permanent Solution
Are the financial crisis and the Euro crisis a thing of the past? Well, it may seem so at first glance. Investors increasingly have the impression that the crisis has essentially been overcome. This sense of security manifests itself in a variety of ways:
- The Swiss franc in its role as “safe currency shelter” has lost considerably against the Euro.
- The gold price suffered substantial, if temporary, dips. Even though it has rebounded lately, the gold price trend shows that the panic on the markets has subsided for the time being.
- During the first week of January, equity funds that invest exclusively in rallying share prices collected nearly nine billion US dollars worldwide, the largest cash inflow since March 2000 at the peak of the dot-com rally.
- Bond and equity prices in the crisis-ridden countries in Europe’s southern periphery are rallying.
- Prices for luxury properties in London, among other places, are rising slower than in recent years.
- CDS prices for most Eurozone member states have plummeted.
- The warnings of cautious and critical voices are losing their audience.
All these are signs of a new carelessness and of a hazardous optimism that is backed by no fundamentals.
- But have any of the issues that triggered the Euro crisis actually been resolved?
- Has the sovereign debt dropped?
- Is the unemployment in the crisis countries declining?
- Has anything changed about the 50% unemployment rate among Spain’s young?
- Has Italy tackled the urgently needed reform of its labour market?
- Has the economy of France, the second-largest in the Eurozone, stabilised?
- Has the policymakers’ mania to regulate banks and the financial system had even the slightest positive effect?
- Has anything changed for the better in the former crisis countries (except in Ireland)?
Each of these questions must be answered with a resounding No. What appears to have helped things were WORDS uttered by Mario Draghi who said he would do anything to save the Euro. These words were backed by massive bond purchases, that means by the production of fiat money in vast quantities. The ECB has lost its independence in the process and this will cost it dearly.
However, words and paper are no long-term solutions. The problems were glossed over and ignored, rather than solved. Ignored problems will, however, resurface at some point and unfold an unsuspected destructive energy.
But what would it mean, if circumstances proved me wrong while proving those right who spread optimism and declare that both the Euro crisis and the financial crisis over? In this case, interest rates would start rising again in the medium term (bad for project developments and real estate investors) and the run on real estate would come to a swift conclusion. Institutional investors would soon be relieved of the pressure to invest in real estate and other alternatives to bonds. Moreover, the immense demand for real estate generated by family offices and high-net-worth individuals would decline. Rising interest and regressive demand for real estate would exert considerably pressure on the real estate market prices. But to say it again: all of the above explained could (and will) happen at some point, but it will not happen in the coming years unless I am completely off the mark with everything I wrote in this commentary.