The Real Estate Law Review: Germany

Introduction to the legal framework

i Ownership of real estate

Under German law, ownership of real estate mainly takes the form of absolute ownership (freehold), or a hereditary building right (HBR) (leasehold). Absolute ownership is the most common and most important type extending, by 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.

An HBR 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, most often in regular instalments over the HBR's term (historically commonly 99 years, but nowadays usually shorter). An HBR can be sold and transferred, but the contract with the landowner will very often provide for a consent requirement and a pre-emptive right in the (freehold) landowner's favour. Upon expiry of an HBR, the building is transferred to the landowner against compensation.

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 an HBR can be 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, including cadastral maps. As a result, any piece of land can be clearly identified.

With certain exceptions for properties owned by (quasi-)public entities, any piece of land is 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 the property cadastres), the owner, in rem easements and encumbrances. The land register system is developed and very reliable. 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 in real estate transactions relating to German properties. Priority of title to and rights in a property with regard to third parties are determined in accordance with the point in time at which a filing for registration is received. 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 – generally electronically – obtain a copy of the land register and documents filed with the land registry office.

iii Choice of law for contracts for the sale and purchase of real estate

German law strictly distinguishes between the obligatory contract in which the parties agree on the obligation to transfer title to an asset 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 mandatorily governed by German law (lex rei sitae).

Contracts for the sale and purchase of real estate, or for the creation of a land charge, must be notarised before a German notary and are very technical instruments with provisions specific to German law. It is well-established practice to choose German law and have the documentation notarised, registered and implemented by a German notary when real property located in Germany is sold or transferred.

Overview of real estate activity

In 2020, the German real estate market continued to benefit from a combination of unceasingly low interest rate policies 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, Cologne, Düsseldorf, Frankfurt, Hamburg, Munich and Stuttgart with a slightly decreasing interest in Berlin due to particularly strict regulations for residential premises (see Section VII.iv). Due to a lack of available assets in prime cities and locations and the appetite for slightly higher yields, various second-tier cities and locations are still seeing an 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 overall still been strong across most asset classes in 2020, including in particular residential portfolios and logistics properties. The investment in other commercial real estate slowed down in early to mid-2020 mostly due to the covid-19 pandemic, but increased again in the third and fourth quarters 2020. Prices in general have still been rising, mainly based on the increasing prices for residential properties and also for offices and logistics, whereas in particular retail and hotel premises have suffered as a result of the covid-19 pandemic.

Foreign investment

Generally, no restrictions apply to the acquisition and holding of real estate in Germany by foreign investors. Further, there are no restrictions on 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.

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 FDI Screening 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.

Since 2020, foreign corporations have to be registered with their economic beneficiaries in the German transparency register when committing to acquire real estate in Germany. Obligations (including reporting obligations) for notaries and real estate agents when suspecting money-laundering were already 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. Since 2020, 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.

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 triggers real estate transfer tax (RETT), structures are being used under which the seller retains more than 5 per cent of the shareholding in the holding vehicle (for proposed changes to the respective fractions see Section VII.i). 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 shall no longer be feasible under a 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 generally 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, the full range of legal entities under German law is available, and the choice of legal form often depends on issues of limitation of liability and tax treatment of the acquisition vehicle.

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: a GmbH & Co. A KG is a limited partnership where the general partner is a GmbH.

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 subject to trade tax, additional structures are used to minimise 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. It is, therefore, common practice to use a separate vehicle for the acquisition and subsequent letting of business equipment (fixtures) and ensure that third parties (and not the letting entity) provides specific services for the business of the tenant. Other structures – such as the use of German limited partnerships where the only general partner is a foreign corporation – have come under intense scrutiny especially by German banks and are currently no longer best practice.

It is expected that the significance of civil law partnerships will generally decrease for structuring investments in real estate by several investors (see Section V.v). It will, however, likely remain important for family offices and similar privately organised groups.

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. The GbR and its partners are also registered in the land register (see Section I.ii).

Real estate ownership

i Planning

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 federal 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 in land-use plans. The planning process involves extensive consultation with other authorities, particularly on environment, safety, water, nature or monument conservation, and participation by the general public. The land-use plans regularly restrict 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 (see Section VII.v).

Individual building projects as well as changes of use generally require a building permit stating whether they are in accordance with planning law and building regulations.

ii Environment

Under public law, if soil or groundwater contamination 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 for industrial or business premises – tenant. Along with public law liability, there is private law liability for clean-up or damages with regard to neighbours or other third parties.

Environmental issues should, therefore, be considered in a due diligence, and in the representations and warranties, indemnity provisions or other covenants of a sale and purchase agreement.

iii Tax

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 – currently – 95 per cent 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. 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 (reduced to 16 per cent during the covid-19 pandemic in the third and fourth quarters of 2020). 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 letting with an option to VAT). Lettings can also be made subject to VAT (see Section VI.iv). The issue of whether an input VAT deduction has been applied in the past should be carefully addressed in due diligence, 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.), 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 paid by the natural or legal person, to whom the real estate is economically assigned, in most cases the owner (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, an HBR 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, 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.

v Real estate investment funds

In line with the AIFMD, the German Capital Investment Code (KAGB) comprehensively regulates all types of investment funds, including 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.

The KAGB provides for a lock-up provision prohibiting investors from redeeming units in an open-ended public REIT for a period of at least 24 months. Further, investors are only entitled to redemptions of fund units once a year. The KAGB further requires that one or, if the previously determined value of the property exceeds €50 million, two independent experts must value the property. In addition, one or two experts who are different from the experts that are responsible for the regular valuation, must value the property before acquisition. Funds are required to maintain liquidity of 5 per cent of their net asset value.

The above-described restrictions do not apply to special open-ended REITs, which are only open to professional and semi-professional investors. The only mandatory restrictions 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).

Since 2018, open-ended public real estate 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 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 REITs 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 REITs 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 REIT.

To obtain marketing approval for public REITs as well as special REITs from another EU Member State or a non-EU country, the management company must prepare and submit to BaFin a sales prospectus and key information document.

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. A lease for a fixed term exceeding one year must be concluded in compliance with certain written form requirements, otherwise the contract can be terminated in accordance with statutory termination periods. The respective provision has occasionally been used to exit inconvenient leases. Proposed changes are currently under legislative review. 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 (residential and commercial) also have an extraordinary termination right if modernisations will result in an increase of the rent payable by the tenant. Landlords should guard against exploitation of this right by tenants seeking to terminate long-term leases 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 have become more widely used in the past 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.

iv VAT

If the lessor (or 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 VATable and not VAT-exempt supplies or services; that usually excludes certain tenants rendering VAT-exempt services such as banks, insurance and medical doctors. 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 are generally 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. If withheld, the tenant has a right of termination, unless there is a due reason for refusal in the person of the sublessor. 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 Covid-19 pandemic

As an initial response to the covid-19 pandemic, legislation also dealing with certain aspects of (commercial as well as residential) lease agreements was implemented with effect as of April 2020. The termination-suspension-provision contained in such legislation excludes the right of a landlord to terminate a lease agreement because of any non-payment of rent due in the period of 1 April to 30 June 2020 if non-payment is caused by the covid-19 pandemic. The suspension continues until 30 June 2022, allowing tenants to settle any payment arrears until then. Secondary rights such as, for example, default interest rights, are not excluded.

Following a debate in legal literature and case law in the course of the covid-19 pandemic (concerning whether a tenant has the right to renegotiate its lease, in particular to reduce the rent, due to measures initiated to combat the covid-19 pandemic on the basis of the legal doctrine of frustration of contract), further legislation was implemented with effect as of December 2020. It provides for a refutable presumption that the conditions that have been agreed as basis of a commercial lease have significantly changed where the lease object cannot – or only with considerable restrictions – be used for the tenant's business due to governmental measures to combat the covid-19 pandemic. Unless the landlord can refute the presumption, the tenant may have a claim against the landlord for contract adjustment by way of, for example, a reduction or deferral of rent, or termination of the lease in extreme cases. While the new provisions should apply to leases that are subject to governmental orders to close the business or to limit it to certain types of activities, (i.e., to most retail spaces, restaurants and hotels), it should likely not affect offices or logistics assets to the extent there have (at least so far) been no general governmental restrictions. Quite a few other aspects of the brand new legislation remain currently unclear and disputed, in particular the question of how to refute the presumption, and what exact claims a tenant will have under which circumstances.

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, 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. The 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): currently 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 2019. Due to the covid-19 pandemic, the schedule to proceed and decide in 2020 was not met. 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 still not clear yet, not even the implementation of the reform before the end of this parliamentary term in the autumn of 2021. In the current discussions with officials from the federal states, there are also suggestions to lower the threshold to 75 per cent and allow for an exemption for stock listed companies for which the regular free-float would already trigger RETT under the draft law proposal.

The European Court of Justice decided on the non-state aid character of certain RETT exemptions in December 2018 considering the exemptions in question as non-selective.

ii Reform of the real property tax

In a 2018 case, the Federal Constitutional Court 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.

A 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. Several states announced to making use of an opening clause for state legislation that the new Law provides. In 2020, Baden-Württemberg enacted a respective Law, and Saxony and Bavaria presented proposals.

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 has been common ground 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 tenants. However, this on-charge has come under scrutiny regarding residential tenants.

iii Other tax reforms relating to real estate

From 2019 onwards, capital gains derived by foreign investors from 'real estate corporations' are subject to income and corporate taxation. This is in line with recent trends in double taxation treaties, even though the overwhelming majority of German double taxation treaties do not provide for Germany's taxation right, which renders the legislative change still rather irrelevant for practical purposes. Even clauses in double taxation treaties addressing real estate companies are often not applicable since they deviate from the domestic definition of real estate companies. It remains to be seen whether this provision becomes more relevant in the future with the updates of the current double taxation treaties.

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. While some further tax incentives can be expected, the Act on the Trading of Fuels' Emissions was amended in late 2020, increasing the taxing of carbon emissions, which may affect the building industry. As a compensation for some other legislation addressing climate change and increasing the costs of commuting by car, the commuter expense allowance is increased for long-distance commutes of more than 20km until the end of 2026. This – together with the increased deductibility of work-from-home arrangements introduced by covid-19-related legislation – may be seen as a further boost for residential real estate further away from the main commercial hubs in Germany.

iv 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. 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 for 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 (and prolonged in 2020 to 2025), states may additionally set up a limit on rent levels for certain areas with tense housing markets. The Federal Constitutional Court upheld the constitutionality of the 'rent brake' in 2019. 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 and – since 2020 – retroactively for the first 30 months of the lease.

Berlin recently introduced an additional state limit on rent levels (the Berlin rent cap) applicable to most residential units in Berlin built before 2014. According to the Law, landlords are generally not able to claim a rent higher than that of 18 June 2019 for residential units. Additionally, rents in new rent contracts cannot be higher than certain values in a rent table based basically on rent values as of 2013. Modernisation costs can only be levied in certain cases and only up to €1 per m² and up to €1 above the rent table values. Rents in existing rent contracts were reduced in November 2020 to basically 120 per cent of the rent table values. The 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. A decision by the Federal Constitutional Court on the Berlin rent cap law is currently expected for the second quarter of 2021. If declared unconstitutional, tenants will have to pay back the rent differences saved previously. New leases in Berlin regularly include both a Berlin rent cap rent, and a regular rent in case the law is declared unconstitutional.

The parties that currently form the federal government agreed to further increase the protection of tenants, for example, by restricting conversions into condominiums, but specific proposals thereon are not known yet.

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 Act on the Energy Quality of Buildings that incorporates the Energy Performance of Buildings Directive (EU) 2018/844 into German law came into force on 1 November 2020. It replaced, inter alia, the Energy Savings Ordinance and consolidated further energy laws in an overall effort to combat climate change. The new law applies to any building that is heated or air-conditioned. As a core principle, any building has to be constructed as 'lowest energy building'. The law sets up a comprehensive regime of detailed mandatory standards for construction and modernisation, inter alia, limiting certain oil heating installations. Owners are – with slight changes – still required to prepare energy passports for their buildings, which they have to make available to potential purchasers or tenants of the property. Further, pursuant to the Renewable Energy Act, renewable energies must constitute part of the energy supply of newly constructed buildings.

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.

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 2021 and beyond. The proposed changes – if enacted – may lead to new purchasing structures, for which the purchaser should be carefully advised. Further, the implementation of the 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 limitations on rents for residential housing in Berlin (see Section VII.iv) will need to be considered when making an investment decision. A decision by the Federal Constitutional Court, which is currently expected for summer 2021, may yet overturn these limitations.

Overall, the German real estate market continues to provide very interesting investment opportunities in most asset classes, proven by an overall more than robust investment volume in 2020 on the market for commercial real estate despite the covid-19 pandemic.

Footnotes

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.

Get unlimited access to all The Law Reviews content