Sundown on the Rental Index? The Ministry of Justice is up to Something

Published on 2015/05/26

“So far, most lessors and lessees have accepted the rent table. But this is bound to change. After all, it has only been a year that the rent increase cap for current rents was lowered to just 15 percent over a three-year period. It prompted first law suits against the rent table, filed by landlords in Berlin. … I expect the courts to be positively flooded with law suits once the rent freeze is introduced, because the rent table will – unlike now – also be definitive for setting the rent level of new leases.” This is what I predicted as early as September 2014 in a commentary in the newsletter “Berlin Residential Investment Market.”

So the judgement by the District Court of Charlottenburg (file reference number: 235 C 133/13) comes as no surprise. More than that: It is just a beginning. The introduction of the rent freeze will hugely boost the significance of the rental index because existing flats may not be let for rents that exceed the local reference rent by more than 10%. That is why I anticipate a barrage of lawsuits that will unhinge rental indices across Germany.

Even without the rent freeze, rental indices have been compiled using dubious methodology. The fact that those who compile them call them “qualified” does not necessarily mean that they are. Article 558d of the German Civil Code requires that the compilation of a qualified rental index be based on scientific principles.

In truth, however, rental indices tend to be political compromises negotiated between tenant unions and landlords associations. The methods used to compile them do not stand up to scrutiny. Berlin’s Rental Index is but one of many examples. In methodological terms, it is by no means inferior to the rental indices of other cities.

The recent judgement by the District Court of Charlottenburg is devastating: The expert whose opinion the court drew on reached the conclusion “that Berlin’s rental index was not compiled in line with accepted scientific principles. He elaborates in this context that the sample underlying the rental index raises considerable doubts regarding its representativeness, that the definition of the rental index units and the allocation of the flats to these units is in some instances systemically incorrect, that the service charge discounts brought into play when calculating the net rents fail to match the rental market reality, and that the premiums and discounts determined via regression analysis are merely figments of the imagination. They were said to be essentially based on assumptions and speculations whose legitimacy was not demonstrated in any satisfactory way.”

The court did not say whether it shared the expert’s observations on all counts. Just two serious flaws sufficed to make the court conclude that the rental index was not compiled in line with scientific principles. It established as a given that

  1. the extreme-value adjustment undertaken by the creators of Berlin’s Rental Index for 2013 did not follow accepted scientific principles, and that therefore even the early data collection stage failed to take principally rental-index-relevant rents in field K1 of the rental index into account.”
  2. “on top of that… even the classification of the different residential locations into the categories ‘medium,’ ‘good’ and ‘fair’ [does not satisfy] accepted scientific principles,” because the apartments found in medium locations, for instance, are highly heterogeneous in nature.

Which way forward now? The rental index will be ripped to shreds in a flurry of lawsuits. It is actually downright impertinent of German lawmakers to pass a law in full awareness of the high number of legal disputes it will trigger. Even the official commentary for the rent freeze legislation states that there is reason to expect the rent freeze to trigger an increased number of civil lawsuits.

But perhaps this is playing into the hands of the Social Democrats, for they are currently preparing to deal property owners a real blow: Civil servants at the Federal Ministry of Justice have been busy for months trying to draft a new bill that will institute binding regulations for the compilation of rental indices. I have it from first-hand sources inside the Federal Ministry of Justice.

This would mean that judgements like the one just handed down by the District Court of Charlottenburg might actually suit the purposes of DMB German Tenant Union and Social Democrats, for they could argue that it highlights the importance of legally regulating the methodology used to compile rental indices. After all, the rent freeze will hardly function without an accepted rental index.

What is truly at stake for the Social Democrats in this context, however, is the creation of a legal basis for lowering rents. For according to the new draft bill currently in preparation, the rental index will no longer be based – the way it has been so far – on the rents of the past four years, but on the basis of the rents of the past ten years!

The Christian Democrats have let it be known they will refuse to back this. That’s all very well, except I don’t buy it. In the past, the Christian Democrats have always caved in. Whatever the Social Democrats seek today will be signed into law tomorrow or the day after tomorrow at the very latest – be it the rent freeze, the minimum wage, retirement at 63, the phase-out of nuclear energy, or now the new rental index law. It may well come to a “compromise” deal that will mandate calculation of the rental index on the basis of the past six or seven years’ rents. Which would be bad enough. So there is trouble brewing.

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