The Rent Reduction Law Proposed by the Social Democrats

According to a recent survey done by the IVD Federal Investment and Asset Management Association and the CRES Centre for Real Estate Studies of Steinbeis University in Berlin, residential rents in Germany rose by 9.4% during the past 20 years, climbing from 5.04 euros per square metre to 5.51 euros per square metre. It went on to say that the rents in Germany’s leading ten cities saw a nominal increase from 7.01 euros/sqm in 1992 to 7.96 euros/sqm today, which equals a rise by 13.6%. Yet with inflation having climbed by more than 40% during that same time, the rent rates of 2012 in real terms clearly undercut the level of two decades ago.
When adjusted for inflation, the 2012 rents actually reflect a drop by an average of 22.8% nationwide since 1992, and by 19.8% in the top ten cities. The report added that residential rents in West Berlin remain substantially below the level of twenty years ago. Following two decades of losses for landlords, rents finally rebounded two years ago and are rising still. The Social Democrats would like to put a stop to that. Their election manifesto defines two approaches:

  1. Rents on new leases are no longer to exceed the local reference rent by more than ten percent.
  2. The rent increase cap on unexpired leases is to be lowered to 15% over a four-year period.

Let me use an example to illustrate what the first of these proposals means: A 4-bedroom flat close to Hackescher Markt in Berlin and built in 2009 will currently rent out at a square-metre rate of 16.74 euros. The local reference rent (upper limit), however, is only 9.45 euros per square metre. Assuming the lessor manages to let the flat at 16.74 euros today, but the tenant moves out a year later, then the flat cannot be re-let at a square metre rent of more than 10.40 euros. This is tantamount to a rent reduction by 38% in the event the flat comes back on the market. This will simply spell the end of housing construction as it wipes out the profits for the developer. The ones hardest hit are likely to be the tenants, because the housing supply will keep contracting.
Lowering the rent increase cap will have similar consequences. By the end of August 2001, the cap limited rent increases to a maximum of 30% over a three-year period. It has since been lowered to 20% by a coalition government of Social Democrats and Greens. The incumbent Government of Christian Democrats and Liberals recently resolved to lower it further to 15 percent. Not to be outdone, the Social Democrats now seek to extend the period for which the 15-percent cap applies from three to four years.
What does this mean in practical terms? As the above-quoted figures suggest, rental growth does not follow a linear curve. They may stagnate or actually decrease over extended periods of time. These are offset by catch-up phases – such as the ongoing one – where the pace of rental growth will pick up. The idea underlying the legal initiative is to curtail these catch-up phases, and radically so.
The very debate concerning demands such as these is bound to make investors nervous sooner or later. This hazard bothers the Social Democrat ideologists no more than it bothers the French Socialists under Hollande that their 75% income tax rate will drive high income earners out of the country. After all, they carried the French elections on this platform, and Germany’s Social Democrats now hope to recover from their slump in recent polls by fielding populist demands of the same kind.