I INTRODUCTION TO THE LEGAL FRAMEWORK
i Ownership of real estate
Under German law, two main types of ownership of real estate exist. The most important type is absolute ownership, sometimes also referred to as freehold, which extends, by operation of law, to land and to any buildings or other structures erected on and firmly affixed to the land, as well as to (immovable) fixtures and fittings and (movable) appurtenances.
The other type of ownership is the hereditary building right, sometimes also referred to as leasehold. It entitles its owner to erect and own a building or other structure on or under a certain piece of land owned by a third party against payment of a fee, most often paid in regular instalments over the term of the hereditary building right. Historically, the term of a hereditary building right was commonly 99 years, but it can be agreed for any other period; nowadays, the term is usually shorter. The hereditary building right can be sold and transferred, but the underlying contract with the owner of the land will very often provide for a consent requirement and a pre-emptive right in the (freehold) landowner's favour. Upon expiry of the hereditary building right, the building will be transferred back to the landowner against payment of compensation to the right holder, which is either pre-agreed or corresponds to the current market value of the building.
Real property can also be co-owned in typically two ways. The co-owners may hold an agreed co-ownership share in the land and building, or – more commonly, pursuant to the provisions of the Condominium Act – they may hold co-ownership shares in the land and structural parts of the building, and enjoy exclusive ownership or exclusive rights of use to the interior parts of residential apartments, or offices or other commercial space.
Real property or a hereditary building right can be made subject to in rem easements or encumbrances (such as land charges) in favour of a third party or the owner from time to time of another property, such as rights of way in favour of an adjacent property, or the right of a public utility company regarding electric lines or water pipes, etc.
ii Registration of real estate and in rem rights
Cadastral offices, operated locally by municipalities, keep property cadastres in which any piece of land within the boundaries of the municipality is registered according to situs, use and size, and cadastral maps depicting the situs, size and shape of such a piece of land. As a result, any piece of land can be clearly identified.
With certain exceptions for properties owned by public or quasi-public entities, any piece of land is also registered in land registers that are kept by land registry offices at the local courts. The land register contains information about the identity of the property (in accordance with that in the property cadastres), the owner, in rem easements and encumbrances (such as land charges). The system is highly developed and extremely reliable. The land register can generally be accessed electronically. It can be reasonably assumed that the contents of the registrations are correct, and so one can generally in good faith legally acquire the property or rights in the property as registered. As a result, title insurance is generally unnecessary for real estate transactions relating to German properties. Priority of title to and rights in a property with regard to third parties is determined in accordance with the point in time at which a filing for registration is received by the land registry office. The German land registers are not available for public inspection. Rather, only a person who can establish a 'legitimate interest', a term defined rather narrowly, can inspect and obtain a copy of the land register and of documents filed with the land registry office.
iii Choice of law for contracts for the sale and purchase of real estate
German law makes a strict distinction between the obligatory contract in which the parties agree on the obligation to transfer title to an asset against consideration in accordance with certain terms as agreed in the contract, and the contractual agreement on the transfer of title to the asset as such. While contract parties are free in their choice of the law applicable to the obligatory contract (including representations and warranties and other covenants), the agreement on transfer of title as such of a real property situated in Germany is, in accordance with the principle of lex rei sitae, mandatorily governed by German law.
Contracts for the sale and purchase of real estate, or for the creation of a land charge regarding real estate, must be notarised before a German notary and are very technical instruments with provisions specific to German law; the notary plays an important role in the implementation and registration of the transaction. For this reason, it is well-established practice to choose German law and have the documentation notarised by a German notary in case real property located in Germany is sold or transferred.
II OVERVIEW OF REAL ESTATE ACTIVITY
In 2019, the German real estate market continued to benefit from a combination of the unceasingly low interest rate policy of the European Central Bank and the volatility of financial markets, generally maintaining the appetite of investors for investments in safe, stable assets such as real estate, and safe, stable countries such as Germany.
The main focus of investors has remained on the metropolitan areas of Berlin, Düsseldorf, Frankfurt, Hamburg, Munich and Stuttgart with a slightly decreasing interest in Berlin due to political initiatives. Because of a lack of available assets in prime cities and prime locations, certain second-tier cities and locations are still receiving increasing level of interest.
Pension funds, international private equity funds, (listed) real estate corporations, real estate investment trusts (REITs) and sovereign wealth funds, private investors, family offices and insurance companies are all important market participants.
Market activity and investment volumes have been very strong across most asset classes in 2019, including in particular office and logistics properties, as well as residential portfolios. The investment volume on the market for commercial real estate (excluding residential properties) again rose significantly compared to the previous year, setting new records. As a result of continuing yield compression, prices have still been rising.
While the interest in residential properties in the top cities has boomed significantly and price increases are still expected for 2020, new federal and state legislation as well as some municipal initiatives limit the rent and potential of rent increases and reliability of deals in particular in Berlin (see Section VII).
III FOREIGN INVESTMENT
Generally, no restrictions apply to the acquisition and holding of real estate by foreign investors. This is true for acquisitions by foreign individuals or legal entities, as well as indirect acquisitions through the formation by foreign individuals or legal entities of purchasing vehicles in the form of legal entities governed by German law. The acquisition of land by a non-EU entity may be subject to review by the Federal Ministry for Economic Affairs and Energy if it is part of an investment in a German company that may raise public order- or security-related concerns in certain sectors, for example, critical infrastructure. In line with the new EU regulation, the German legislator may also provide for the screening of foreign direct investments in real estate crucial for the use of critical infrastructure, irrespective of an investment in a German company.
Further, there are no restrictions on the free transferability of funds in relation to providing equity or debt for the acquisition of real estate or repatriation of profits. Foreign investors are naturally subject to generally applicable money-laundering laws. From 2020, foreign corporations have to be registered with their economic beneficiaries in the German transparency register when committing to acquire real estate in Germany. Also, (reporting) obligations for notaries and real estate agents when suspecting money-laundering were tightened in 2019. Cross-border money transfers must be reported under the provisions of the Foreign Trade Act and Foreign Trade Ordinance for statistical purposes only. From 1 July 2020, and based on the implementation of an EU Directive, investors or their intermediaries may also have to report cross-border tax arrangements with regard to the acquisition of real estate and its financing if certain hallmarks are present and implementation took place after June 2018.
Recent developments regarding the taxation of foreign investment in real estate located in Germany are the introduction of 'real estate corporations' and the waiver of loans relating to German real estate as a taxable event in Germany (see Section VII.iii). Foreign investors should carefully note these developments but not consider them as an obstacle for investment.
IV STRUCTURING THE INVESTMENT
Depending on whether the property is owned by an individual or a holding vehicle in the form of a legal entity, the acquisition of real estate can be structured as an asset deal, acquiring the asset from the individual or the holding vehicle, or as a share deal, acquiring the shares in the holding vehicle from the shareholders.
As the acquisition of – currently – 95 per cent or more of the shares in a legal entity that owns German-situs property (the relevant threshold is quite likely be lowered to 90 per cent according to most recent legislative initiatives (see Section VII.i)) triggers real estate transfer tax (RETT), structures are being used under which the seller retains more than 5 per cent (in the future quite likely 10 per cent, see above) of the shareholding in the holding vehicle. Under the current RETT regime, the remaining more than 5 per cent of the shares in a property owning corporation may be acquired RETT-free by an independent third party (which may be a separate fund managed by the same asset manager), but these structures allowing the RETT free transfer of 100 per cent of the shares in a corporation will no longer be feasible under the proposed new RETT regime.
Apart from RETT considerations, share deals are widely used in large portfolio transactions to simplify the transfer of the properties and to avoid the application of statutory pre-emptive rights.
On the buyer's side, a foreign investor may structure the acquisition either directly (as an individual or existing legal entity) or through a foreign or German acquisition vehicle.
If a German property is owned and let by a foreign investor (or a foreign acquisition vehicle), the rental income is subject to German income tax, but no trade tax applies unless a German permanent establishment exists. The property as such does not constitute a permanent establishment.
If the foreign investor wishes to create an acquisition vehicle governed by German law (which is often the case if the investor is a foreign investment fund), the full range of legal entities under German law is available, and the issues of limitation of liability and tax treatment of the acquisition vehicle and the investors are often relevant factors in deciding which form of legal entity is chosen.
One option is to incorporate the acquisition vehicle in the form of a stock corporation (AG) or limited liability company (GmbH), which both provide for limitation of liability. The AG and the GmbH have, however, the disadvantages of not being transparent for income tax purposes and, by virtue of legal form, of being in principle subject to trade tax. Profit repatriations from such corporations are generally subject to German withholding tax, although certain relief may be available if further requirements are met.
Civil law partnerships (GbR) and limited partnerships (KG) have the advantage of being transparent for income tax purposes, and profit repatriations are per se not subject to withholding tax. The GbR, however, has the disadvantage of full liability for all of its partners. Because in a limited partnership only the general partner of the limited partnership is fully liable, the legal form of choice is a combination of both elements: a GmbH & Co. A KG is a limited partnership where the general partner is itself a GmbH, namely a limited liability company.
As, however, a limited partnership whose general partner is a GmbH, which manages the business of the limited partnership, is by virtue of legal form – like the GmbH – subject to trade tax, additional structures are used to minimise the trade tax liability. In particular, if a German tax-resident acquisition vehicle derives income from trade or business solely because of its legal form, but in fact generates no income other than rental income from its property, trade tax may be avoided by properly structuring the leases. Because in such a case only rental income from the letting of land and buildings is exempt from trade tax, whereas the letting of office or other commercial space often includes fixtures and fittings or appurtenances that may qualify as business equipment of the tenant, the rental income relating to business equipment is not exempt from trade tax and may render the rental income from the letting of the space subject to trade tax as well. It is, therefore, common practice to use a separate vehicle for the acquisition and subsequent letting of business equipment. As this rental income is subject to trade tax in any case, a GmbH is most often used for this purpose. Other structures – such as the use of German limited partnerships where the only general partner is a foreign corporation – which have been quite widely used in the past have come under intense scrutiny especially by German banks and are currently no longer best practice because of uncertainties under German corporate law.
A widely used form for structuring investments in real estate by several investors has been the civil law partnership (GbR). It is expected that its significance will decrease, as it is no longer a permitted legal form for a closed-ended investment fund within the meaning of the German Capital Investment Code (KAGB) (see Section V.v). It will, however, likely remain important for use by family offices and similar privately organised groups of investors, as investment vehicles set up for such predetermined groups do not fall under the scope of the KAGB.
Since the civil law partnership is generally not registered in any public register, the partners can only be identified from the GbR constitutional documents and through the partnership's authorised representatives – unless the GbR including its partners and the natural persons benefitting from the GbR have to be registered in the 2017 newly established transparency register in case the GbR holds shares of another legal entity. In the past, this often led to difficulties in the land register registration process. The Federal Supreme Court held that if the partners state in a real estate sale and purchase agreement that they are in fact all partners of, and are authorised to represent, the partnership, the land registry is not required or entitled to request further evidence as to the existence, identity and authority of representation of the partnership. The GbR is entitled to be the owner of rights and obligations, be party to legal proceedings and be registered in the land register. The partners of the GbR have to be added in the land register as well.
V REAL ESTATE OWNERSHIP
The legal framework for planning and zoning is essentially set out in the Federal Building Act, the Federal Building Use Regulation and building regulations of the individual states.
Planning and zoning is usually based on a large-scale regional plan for the use of land, which the competent municipality then specifies authoritatively and in greater detail for particular areas within that municipality in land-use plans. The planning process will involve extensive consultation with other competent authorities, such as environment, safety, water, nature or monument conservation, and participation by the general public. The land-use plans regularly contain restrictions on development and use. Municipalities also enjoy some statutory pre-emptive rights applicable to the sale of land that they can exercise to protect, inter alia, certain planning requirements. While such statutory pre-emptive rights have historically been rarely exercised, certain cities with significant housing or office shortages like Berlin and Munich have recently started to use these rights more aggressively.
Individual building projects as well as changes of use generally require a building permit to be issued by the competent building authority stating if the project or change is in accordance with planning law and the state's respective building regulations. The admissibility of a building project outside the area of a land-use plan will generally be judged by its surroundings.
Under public law, if soil or groundwater contamination of a property presents a danger, significant detriment or disturbance to individuals or the public, the competent authority may issue an order for decontamination, remediation, investigation or monitoring addressed to the current owner of a property, any previous owner thereof, any party who is responsible under corporate or commercial law for the owner, any party holding actual possession of the property or the party actually responsible for the contamination or the polluter's universal successor. Usually, the authorities will select the party that it can most effectively hold responsible to undertake the necessary measures, which is normally the present owner or – in particular in the case of industrial or business premises – the tenant of the property. Along with public law liability, there is civil law liability for clean-up or damages with regard to neighbours or other third parties affected by the contamination.
Environmental issues, therefore, are an important consideration in the due diligence of a real estate transaction, and in the representations and warranties, indemnity provisions or other covenants of a real property-related sale and purchase agreement.
Any sale and comparable conveyance of real estate is subject to RETT. If the real estate is held by a legal entity, the purchase of 95 per cent (in the near future quite likely the change of ownership of 90 per cent, see above) or more of the shares in such a legal entity is likewise subject to RETT (see Section IV and Section VII.i). The RETT tax rates depend on the location of the real estate and differ from state to state, from 3.5 to 6.5 per cent of the purchase price.
In addition, fees for the notarisation of the sale and purchase agreement, and land charges required for the financing, will accrue, as will registration fees for the land registry office for the registration of the priority notice securing transfer of title, the transfer of title, any land charges and the deregistration of existing land charges. These fees are fixed by law and amount to regularly less than around 0.5 per cent of the transaction value with a decreasing percentage figure applying the higher the transaction value is.
Generally, the sale and letting of real property is exempt from VAT; however, under certain circumstances it is possible to opt for its application at the normal rate of 19 per cent. The seller of a property that has accepted the previous seller's option for VAT upon purchase in the past may want to sell the property not exempt from VAT; otherwise, the seller may be required to repay previously deducted input VAT to the tax office. The purchaser will have to pay the VAT in addition to the purchase price (reverse charge). This may be commercially acceptable if the VAT can be deducted as input VAT (i.e., when the property is used by the purchaser for supplies and services that are not exempt from VAT, including, but not limited to, letting with an option to VAT). Lettings can only be made subject to VAT if and to the extent the tenants are enterprises within the meaning of the VAT Act and render VAT-able and not VAT-exempt supplies or services (see Section VI.iv) – that is, use the premises for a business involving the delivery of goods and services subject to VAT. The issue of whether an input VAT deduction has been applied in the past should be carefully addressed in the due diligence procedure, particularly when acquiring multi-tenant commercial buildings, as the seller may have let space to non-professionals or professionals who render VAT-exempt services (such as banks, doctors, etc.) in the past, or the purchaser may want to do so in the future. As a result of changes in circumstances, the purchaser may be required to repay input VAT to the tax office.
Companies owning only German real estate with a permanent establishment in Germany are generally subject to trade tax but can deduct the part of the trade income that is attributable to the management and use of own property if they exclusively manage and use their own real property. While the requirements for this deduction should be closely monitored, the trade tax amount for real estate companies would be substantially mitigated.
Real estate is subject to real property tax, which is a municipal tax and is presently calculated on the basis of certain tax values of 1964 and 1935, respectively. Because of a 2018 ruling of the Federal Constitutional Court, legislative amendments were adopted in late 2019 to change the historically low tax base to represent current values of the real properties (see Section VII.ii).
iv Finance and security
Real estate transactions will usually be financed by banks or other providers of debt financing such as insurance companies. Security can be created by way of a land charge over a property, a hereditary building right and a co-ownership share or, in the event of a share transaction, by a pledge or security transfer of the shares of the holding company to be acquired. For a share transaction involving a German GmbH or AG, because of applicable capital preservation rules, the availability of the property as security for the financing of the share purchase price is limited. Senior and junior debt financing can be secured with different ranking. Land charges are registered in the land register and, if no other agreement is made, the time of receipt by the land registry office of the filing for registration will generally determine the ranking of the land charge with regard to all other registered rights.
v Real estate investment funds
In line with the AIFMD, the KAGB takes an all-encompassing approach and regulates all types of investment funds, including since 2013 closed-ended investment funds. The regulation entails a licence requirement for managers of investment funds, requirements as to the eligibility and acting of depositaries and product regulation, as to the permitted legal form of investment funds and limitations as to the investment policy.
Most importantly to investors, the KAGB provides for a lock-up provision prohibiting investors from redeeming units in an open-ended public real estate investment fund for a period of at least 24 months. Further, investors are only entitled to redemptions of fund units once a year. In line with the AIFMD, the KAGB requires with respect to the expert committee responsible for the valuation of the properties that an independent expert or, if the previously determined value of the property exceeds €50 million, two independent experts must value the property. In addition, in the case of an acquisition of a property, one or two experts, as the case may be, who are different from the experts that are responsible for the regular valuation, must value the property proposed to be acquired. To enable a fund to meet certain redemption requests, it is required to maintain liquidity of 5 per cent of its net asset value.
The above-described restrictions do not apply to special open-ended real estate investment funds, which are only open to professional and semi-professional investors within the meaning of the KAGB. The only mandatory restrictions applicable are a limitation of leverage of up to 50 per cent of the value of the real estate assets held in the fund, and a prohibition to invest more than 20 per cent of the fund's assets in private equity (excluding real estate companies).
On 1 January 2018, the tax regime applying to open-ended public real estate funds significantly changed. Under the current regime, the funds themselves are subject to tax with certain items of German-source income (including rental income and capital gains resulting from German-situs real property). At investor level, a second layer of taxes applies; to mitigate the resulting 'double taxation', the investors may enjoy a (partial) tax exemption depending on the investment strategy of the fund.
The KAGB nowadays subjects public and special closed-ended real estate funds to a regulatory regime broadly comparable with the one applicable to open-ended real estate funds. Hence, the fund rules for public closed-ended real estate investment funds must be approved by the German Federal Financial Supervisory Authority (BaFin). Closed-ended investment funds may only be established in the legal form of an investment limited partnership or an investment stock corporation with fixed capital. Public closed-ended real estate investment funds may only take up leverage of up to 60 per cent of the gross value of the fund. If the fund is not risk diversified (which is deemed to be the case if it holds less than three properties, unless the risk diversification is commercially present with a view of the type of property), it may only be acquired by investors committing to invest at least €20,000 and passing a suitability test.
The above-described investment limitations do not apply to a special closed-ended real estate investment fund.
To obtain marketing approval for public real estate investment funds as well as special real estate investment funds from another EU member state or a country outside the EU, the management company must prepare and submit to BaFin a sales prospectus and key information document.
VI LEASES OF BUSINESS PREMISES
Leases of business premises usually contain provisions concerning the following.
i Use and public permits
The intended use by the tenant of the premises is usually precisely defined. Any change of use will be forbidden or subject to the consent of the landlord. The landlord usually does not guarantee that the premises are fit for the use intended by the tenant, and the tenant is responsible for any public permits required for the conduct of its business on the premises.
ii Term and termination
Leases are generally for fixed periods (five, 10 or 15 years) with options in favour of the tenant to extend the term for consecutive periods (often one or several five-year periods). A lease for a fixed term exceeding one year must be concluded in compliance with certain written form requirements. Failing compliance with these requirements, the contract can be terminated in accordance with statutory termination periods, although it should be noted that the relevant statutory termination right provision is currently subject to legislative scrutiny. The same termination right applies after the expiry of 30 years if a lease contract was concluded for a rental period exceeding 30 years (through initial fixed term or by means of exercise of extension options). Both are critical issues with many pitfalls, and require careful attention in the due diligence of multi-tenant commercial real estate.
Tenants also have an extraordinary termination right if modernisations will result in an increase of the rent payable by the tenant. The law applies to commercial as well as residential leases. Therefore, landlords will have to guard against exploitation of this right by tenants seeking to terminate their long-term lease early for other reasons.
iii Rent and service charges
Rent for commercial leases with a term of more than 10 years is often linked to inflation by way of an index clause linked to the German consumer price index that needs to work upwards and downwards to be effective. Rent reviews at the time of the exercise of an extension option are still rather the exception than the rule, but have become more widely used in the last few years. It is usually agreed that the tenant must pay in addition to the rent any service charges, other ancillary costs as well as taxes and duties.
If the lessor (or, as the case may be, the sublessor) has opted for VAT, it will be charged in addition to the rent. The lessor will only be entitled to opt for VAT and to deduct input VAT if and to the extent that the tenant is an enterprise within the meaning of the VAT Act and renders VAT-able and not VAT-exempt supplies or services. This requirement must be carefully addressed in the due diligence procedure for the purchase of commercial properties (see Section V.iii).
v Maintenance and repair, insurance
While German statutory law is quite tenant-friendly and imposes most of the maintenance and repair obligations on the landlord, rental contracts for commercial properties generally are more landlord-friendly and shift most of the maintenance and repair obligations to the tenant.
vi Subletting, transfer of the lease
Subletting will normally require the consent of the landlord (not to be unreasonably withheld). Transfer of the lease by the tenant is generally not possible, but tenants may wish to be allowed to transfer the lease within their group of companies or as a result of a corporate reorganisation.
VII DEVELOPMENTS IN PRACTICE
i Expected extensions for RETT applicability to share deals
As the current regime for exempting certain share deals on companies holding real property has become for quite a while a sensitive political issue (see Section IV), different proposals have been discussed to restrict such RETT exemptions.
According to a proposal by the German Federal Ministry of Finance of May 2019, the threshold for the applicability of RETT to share deals shall be lowered from currently 95 per cent to 90 per cent of the transferred interest. Such lower threshold shall apply to both partnerships and corporations. Additionally, there shall be a shift in focus for corporations (mirroring the existing concept for partnerships): at the moment, only the acquisition of shares in a corporation above a certain threshold is subject to RETT (focus on acquisition). According to the new proposal, RETT is triggered if ownership interest is transferred above a certain threshold (focus on change of ownership), now 90 per cent. As a consequence, future RETT blockers in corporations can only be existing shareholders of the corporation. RETT may no longer be avoided by 'bringing along' a new, independent minority shareholder. Finally, time limits for RETT exemption to hold the shares shall be prolonged from five to 10 years (some possibly even 15 years).
Rather controversial discussions with experts on new rules for real estate share deals were held in the federal parliament in October 2019. The coalition parties agreed to postpone a decision on the RETT changes from late 2019 to the first half of 2020. As the draft law has been challenged both regarding the exact proposed changes (drop to 90 per cent, extension to 10 years) as well as the general direction (catching rather company restructurings than changing applicability to share deals), the exact changes – and likely new models for real estate transfers – are not clear yet.
The European Court of Justice decided on the non-state aid character of certain RETT exemptions in December 2018. According to the clear opinion of the Advocate General, exemptions are not to be considered state aid when they are non-selective, that is, in general applicable to all sectors and companies (e.g., RETT exemptions for mergers within a group structure). The European Court of Justice did not follow key aspects of the Advocate General's reasoning, but also held that the German RETT exemption for mergers within a group structure does not constitute state aid, because it is not selective.
ii Reform of the real property tax
In a 2018 case, the Federal Constitutional Court has declared the current system of Real Property Tax unconstitutional to the extent it is still based on the perpetuated values of real properties in 1964 and 1935, respectively. It considered the current method to infringe the principle of equal treatment as property values have developed at different rates over the last decades. The court declared the law to remain valid until the end of 2019, to give parliament time to enact new legislation. Further, the current law may still be applied until 2024 once a new law has passed but is not applicable yet.
The reform of the real property tax was adopted in late 2019, but the new assessment process will start in 2022 and will only apply to the taxation of real estate owners from 2025. According to the new regulations, the amount of the real property tax will depend on both the land value and the rent value of existing buildings on the property. The law provides for an opening clause for state legislation to set up other evaluation procedures, thus possibly leading to a patchwork of calculation systems within Germany.
Also from 2025 onwards, municipalities can levy an increased real property tax rate for undeveloped real estate if development is possible and deemed necessary for urban development reasons by the municipality.
It is common ground so far, that the financial outcome of real property tax shall not change overall. Yet it is expected, that in particular real property tax in attractive inner-city locations may rise considerably. Real property tax can be fully levied as service charge to the residential and commercial tenants of a real property. However, this on-charge has come under scrutiny, although the criticism appears to relate predominantly to residential tenants.
iii Other tax reforms relating to real estate
Capital gains derived by foreign investors from 'real estate corporations' have become subject to taxation as of 1 January 2019. Real estate corporations are now defined as corporations whose share value related directly or indirectly to German real estate to an extent of more than 50 per cent at one point in time during the 365 days prior to the sale, irrespective of the place of management of the corporation and without any threshold. The 50 per cent ratio shall be calculated on the basis of the book value of the assets. The change applies only to the extent that any change in value relates to the period between 1 January 2019 and the sale of the shares. In practice, a significant tax burden increase is only possible in transparent structures for investors that cannot rely on the 95 per cent tax exemption for corporations as set out in the German participation exemption. The recent domestic development is not yet reflected in many German double taxation treaties so that there is often no German taxation right. Even clauses in double taxation treaties addressing real estate companies are often not applicable since they do not include the retrospective view for 365 days or refer not to book values but to fair market values.
In addition, capital gains resulting from the waiver of debt by foreign companies relating to German real estate has become subject to tax in Germany as of 1 January 2019. If and to the extent a loan that relates to German real estate is waived, the waived amount will be added to the profit of the disposal of such German real estate. The legislation is effectively overriding an investor-friendly decision of the Federal Fiscal Court from December 2016. The change affects all non-German investors in German real estate irrespective of the extent of their overall involvement into the German real estate market.
Finally, legislative acts addressing climate change should be closely monitored: In late 2019, a tax credit system for energy-saving measures in buildings used for own residential purposes was adopted. The tax credit equals to 7 per cent of the taxpayer's expenses in the calendar year of the completion of the energy measure and in the next calendar year, up to a maximum of €14,000 each, and in the following calendar year after that by 6 per cent of the taxpayer's expenses, up to a maximum of €12,000. While some further tax incentives can be expected, there are also discussions on a general carbon tax, which may affect the building industry.
iv Recent and envisaged reforms of rental regulations for residential units
Overall in Germany, rent increases in existing leases for residential units are only permissible in limited cases defined by statutory law. With investors increasingly interested in German residential portfolios and rent levels in metropolitan areas rising significantly faster than wages and inflation, federal and state lawmakers have been active in further limiting the possibility of raising the rents for residential units.
Effective since 2019, annual rent increases because of modernisation costs are limited to 8 per cent of the modernisation costs (lowered from previously 11 per cent). In absolute numbers, increases based on modernisation are now capped at a maximum of €3 per m² over a six-year period (and at €2 per m² in case of a rent of less than €7 per m²). Certain modernisations directed at expelling tenants will be subject to stricter civil – and also criminal – law consequences.
Since 2014, states may additionally set up a limit on rent levels for certain areas with tense housing markets. The Federal Constitutional Court recently upheld the constitutionality of this 'rent brake'. These limits have been set up, inter alia, for all of Berlin, Cologne, Düsseldorf, Hamburg, Munich and Stuttgart, as well as for several medium-sized and smaller municipalities. In these areas, new rents may generally not exceed the rent index for comparable apartments in the area by more than 10 per cent or the prior (legal) rent. New apartments and substantially refurbished apartments are exempt from the limit on rent levels. In the event of a higher rent than permissible, the tenant may reclaim overpaid rent from the moment he or she has notified the non-permissibility of the rent to the landlord. Effective beginning 2019, landlords have to provide future tenants with written information on the legal grounds for a rent higher than 10 per cent over the rent index or they cannot claim the higher rent. A draft bill to prolong the federal rent brake for another five years (thus until 2025) and to enable the tenants to reduce the rent retroactively in the first 30 months of the lease is currently pending in the federal parliament. The period relevant to calculate in particular the rent index has been extended from four to six years (favouring tenants) and is effective as of 1 January 2020. The parties that currently form the federal government agreed in August 2019 also to further increase the protection of tenants, for example, by restricting conversions into condominiums, but specific proposals thereon are not known yet.
Currently, the Berlin state parliament is discussing an additional state limit on rent levels. According to the draft proposal, landlords shall generally not be able to claim a rent higher than that of 18 June 2019 for residential units in Berlin. Additionally, rents in new rent contracts shall not be higher than certain values in a rent table based basically on rent values as of 2013. Modernisation costs shall only be levied up to €1 per m² and up to €1 above the rent table values. The draft proposal is – if adopted – currently envisaged to come into force in the first quarter of 2020. Nine months later, tenants in existing rent contracts shall further be enabled to reduce their rent via application at the administration to basically 120 per cent of the rent table values. The draft law faces severe constitutional concerns, both regarding the competency of the state of Berlin to enact it in light of the federal rent regulation and also regarding proportionality of the infringement of the property right also in light of the recent decision by the Federal Constitutional Court on the federal rent break.
v Increase of municipal pre-emptive purchases and social preservation areas
Municipalities may have a general pre-emptive right for real properties. It exists by law especially in certain particular land-use areas, such as reallocation areas, formal refurbishment areas, urban development areas and preservation areas and can also be set up by municipal statute. In relation to a pre-emptive right, the municipality has to be informed of the sale and purchase agreement of a real property and may step into it instead of the planned buyer within two months. The agreed purchase price may even be lowered to represent the market value.
Some municipalities have become increasingly active in acting on pre-emptive rights in recent years. In particular in areas with tense housing markets (for example in Berlin), the municipal pre-emptive right is increasingly used with the explicit aim to safeguard tenants from rent increases. The measures have been criticised for being far more expensive than building new residential units by the municipal housing companies, but were still on the rise. The pre-emptive right does generally not apply to the sale of shares in a company holding real property.
Besides triggering the municipal pre-emptive right, social preservation areas also limit the landlords' availabilities to modernise buildings as all alterations and changes require a special permit by the social preservation authority. The permit will be denied if the modernisation is considered a threat to the composition of the current resident population, but has to be granted if it does not go beyond the contemporary standard for comparable apartments. The possibility of converting an apartment building into a condominium is also restricted.
vi Energy efficiency
The Energy Savings Ordinance requires the use of energy saving materials for all new buildings and in the event of major refurbishment of existing buildings. Owners are required to prepare energy passports for their buildings, which they have to make available to potential purchasers or tenants of the property. Pursuant to the Renewable Energy Act, renewable energies must constitute part of the energy supply of newly constructed buildings. The federal government agreed in October 2019 on a reform for a consolidated building energy law, in particular to further its climate protection agenda and to incorporate the Energy Performance of Buildings Directive (EU) 2018/844 into German law until 10 March 2020. Changes to the draft law, which will, inter alia, limit certain oil heating installations, have been proposed by the federal council in December 2019, and will subsequently be discussed in the federal parliament.
Because energy efficiency has also become an important political issue, in particular to reduce climate change, the real estate market is following this trend: real estate owners and tenants such as large corporations wish to use green buildings as part of their corporate identity, demonstrating responsibility for the environment. In the absence of a legal definition of a 'green building', certain systems of certification (e.g., BREEAM, LEED and the German DGNB seal) are being used to arrive at a common understanding of the term, and these certificates are becoming increasingly popular. Therefore, investors will have to look carefully at the energy efficiency rating of a building at the time of acquisition in relation to investments necessary during the holding period and subsequent exit strategies.
VIII OUTLOOK AND CONCLUSIONS
On the legal front and regarding the structure of real estate investments, the new regulations on RETT for share deals (see Section VII.i) will be of particular importance in 2020 and beyond. The changes – if enacted – may lead to new purchasing structures that should be carefully advised. Further, the implementation of the recently enacted new valuation methods for the real estate property tax and the federal state's potential deviations (see Section VII.ii) will have to be carefully observed. Still, the financial burden on property owners by the real estate property tax is comparably low. The recently enacted and further envisaged limitations on rent increases for residential housing in particular in Berlin (see Section VII.iv) will need to be carefully considered when making an investment decision.
Still, the German real estate market continues to provide very interesting investment opportunities in most asset classes, proven by substantial 2019 increases in the investment volume on the market for commercial real estate.
1 Jan Bonhage and Thomas Lang are partners at Hengeler Mueller. The authors would like to thank their colleague Sebastian Heinrichs (tax) for his input.