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.

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 asset deal transactions. 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. Instead, 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 a 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 2021, the German real estate market continued to benefit for another year in a row from ongoing low interest rate policies, 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. Due to a lack of available assets in prime cities and locations and the appetite for slightly higher yields, a large number of 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 2021, including in particular residential portfolios and logistics properties. The investment in other commercial real estate slowed down in 2020, mostly due to uncertainties at the beginning of the covid-19 pandemic; however, investment increased again and, during 2021, it remained at a high level. Prices in general have still been rising, mainly based on the increasing prices for residential, offices and logistics properties.

Foreign investment

Generally, no restrictions apply to the acquisition and holding of real estate in Germany by foreign investors. Furthermore, 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.

Foreign corporations have to be registered with their economic beneficiaries in the German transparency register when committing to acquire real estate in Germany (whether by way of direct asset deals or indirectly via share deals). From 1 August 2021, this has also applied to all German private legal entities and registered partnerships irrespective of a specific (real estate) activity. Obligations (including reporting obligations) for notaries, legal advisers and real estate agents when suspecting money laundering were already tightened in 2019 and have been further tightened from the beginning of 2021. 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 90 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 10 per cent of the shareholding in the holding vehicle. Following recent legislative amendments, the remaining more than 10 per cent of the shares in a property owning corporation may no longer be sold to an independent third party but must be kept as a RETT blocker to ensure that the transaction remains RETT-free (see Section VII.i).

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 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 – depending on the configuration of the lease – not apply.

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 currently 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. The GbR and its partners are also registered in the land register (see Section I.ii). A new law, which will enter into force in 2024, will provide for the option of registration for a partnership in a newly created public register; for real estate acquisitions by a partnership, the registration will be mandatory.

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 are 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 with 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 90 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 rates depend on the location of the real estate and differ from state to state, from 3.5 to 6.5 per cent (5 per cent in most states) 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 is the transaction value.

Generally, the sale and letting of real property is exempt from value added tax (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 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 with 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 and doctors), 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 overwhelmingly manage and use their own real property; in the past, other minor activities have endangered the trade tax reduction but are, from 2021 onwards, permitted to an extent of 5 per cent of the rent income (10 per cent for income from charging e-vehicles) if the services are provided to tenants and separately recorded and taxed. 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 is most commonly created by way of a land charge 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 Alternative Investment Fund Managers Directive (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. Furthermore, 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 who 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 to the one applicable to open-ended real estate funds. Thus, 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 remain under legislative review and have already been discussed for a number of years. 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 generally 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

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, the right of a landlord to terminate a lease agreement because of any non-payment of rent was suspended for rents due in the period of 1 April to 30 June 2020 if non-payment was 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 based on 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 still relatively 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 legislation remain unclear and disputed even after one year of its implementation. The lower- and medium-instance case law to date ranges from a blanket sharing of risk between landlord and tenant for periods concerned (i.e., 50 per cent rent reduction) to a complete denial of a reduction in rent, based on the reasoning that the covid-19 pandemic does not constitute a defect in the rental property itself, but only affects the risk of its use, which rests solely with the tenant. The Federal Court of Justice, which only very recently ruled on the first covid-19 case, has indicated in its ruling that lower instance courts deciding on covid-19 cases must not tend in their rulings towards a general and simple risk sharing between tenant and landlord; instead, several aspects would need to be examined in detail in each individual case, including to what extent the tenant had actually been impaired and whether the tenant had received governmental subsidies. The broader implication of such ruling in lower instance court cases will have to be awaited.

Developments in practice

i Extensions for RETT applicability to share deals

The current regime for exempting certain share deals on companies holding real property has become for quite a while a sensitive political issue and has triggered legislative amendments.

Since 1 July 2021, the threshold for the applicability of RETT to share deals has been lowered from 95 per cent to 90 per cent of the transferred interest. The lower threshold applies to both partnerships and corporations. Additionally, there has been a shift in focus for corporations (mirroring the existing concept for partnerships): formerly, only the acquisition of shares in a corporation above a certain threshold was subject to RETT (focus on acquisition); however, under the new rules, 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 have been prolonged from five to 10 years (some possibly even 15 years).

In addition, there are certain exceptions to the applicability of RETT, including the transfer of shares in a corporation listed on the stock exchange and, under certain conditions, in the case of transformations, contributions and other acquisitions within a group of companies. Apart from that, transformation by merger or demerger triggers RETT.

Despite the reform just being implemented, the new federal government has announced the closure of loopholes for RETT on share deals as a counter-financing measure to introduce a RETT deduction for home buyers.

ii Reform of the real property tax

Following a decision of the Federal Constitutional Court in 2018 declaring the current system of real property tax unconstitutional, that is, to infringe the principle of equal treatment to the extent it is still based on the perpetuated values of real properties in 1964 and 1935, respectively, a reform of the real property tax was adopted in late 2019. 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 the land value, property size, the rent value as well as the age and type of existing buildings on the property. Several states have announced that they will make use of an opening clause for state legislation provided by the new federal legislation. Some states have already enacted a respective law or are soon expected to do so. Under some of these state laws, real property tax is assessed, among others, only according to the size of the plot and the building, according to the property size and the residential location or according to the property size as well as the land value.

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. This is intended to create incentives to build on land and create more living space.

It has been common ground that the financial outcome of real property tax shall not change overall. Nevertheless, 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

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.

Most notably, since 2014, states may additionally set up a limit on rent levels for certain areas with tense housing markets (rent brake). These limits have been set up for all major cities as well as for many 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 rent brake. Tenants may reclaim overpaid rent retroactively for the first 30 months of the lease.

In 2019, annual rent increases because of modernisation costs have been limited to 8 per cent of the modernisation costs. In absolute numbers, increases based on modernisation are 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.

An additional, very strict state limit on rent levels introduced in Berlin in 2020 (the Berlin rent cap) was declared unconstitutional by the Federal Constitutional Court in 2021. The Court found that the state of Berlin did not have legislative power in light of the comprehensive federal rent regulation. As a consequence, landlords legally had the right to claim from their tenants any outstanding rent differences that tenants had not paid due to the Berlin rent cap; however, many of the larger real estate companies waived this right.

v Increase of municipal pre-emptive purchases and social preservation areas

Municipalities have a general pre-emptive right for real properties, 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. 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 increasingly exercised their pre-emptive rights in recent years. In particular in areas with tense housing markets (for example in Berlin), the municipal pre-emptive right has increasingly been used with the explicit aim to safeguard tenants from rent increases. However, in autumn 2021, the Federal Administrative Court pushed back on such practice. The Court found the way district authorities in Berlin have been exercising their pre-emptive right in preservation areas to be illegal, if – as is usually the case – the property has been developed (i.e., building built on it) in line with the object and purpose of the preservation area, it is being used in line with these and the erected building does not have certain major deficiencies at the time of purchase.

The pre-emptive right does generally not apply to the sale of shares in a company holding real property. Nevertheless, in 2021, a district authority in Berlin exercised a pre-emptive right for the first time in a share deal. The district authority considered the share deal to be a purchase-like circumvention triggering the pre-emptive right. There is no court decision yet on the legality of such practice.

In addition to triggering the municipal pre-emptive right, social preservation areas also limit landlords' freedom 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 it 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 Restrictions on conversion to condominiums

From June 2021, states may determine certain areas with tense housing markets in which converting an apartment building into a condominium is further restricted. In such an area, a permit is required for the conversion to a condominium if there are more than five apartments in the residential building (states may determine an alternative threshold between three and 15 apartments). Conditions for obtaining the required permit are rather strict; for instance, a permit would be granted if at least two-thirds of the converted apartments are to be sold to tenants for their own use.

vii Socialisation referendum in Berlin

On 26 September 2021, the – legally not binding – referendum Deutsche Wohnen & Co enteignen successfully passed by popular vote in Berlin. The aim of the referendum is to socialise all apartments owned by companies with more than 3,000 apartments in Berlin. However, the subject of the referendum was not on a concrete law on socialisation, but only on a decision to request the Berlin government to draft such a law. Due to doubts on the constitutionality of such socialisation, the new (and old) Berlin government has decided to appoint a commission of experts to examine whether and how to implement the referendum. Within one year, the commission shall recommend the next steps to the Berlin government, which will take the ultimate decision on how to proceed.

viii 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. Furthermore, 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

The recently enacted new regulations on RETT for share deals and the slightly increasing focus on enivronmental, social and governance topics also in the context of real estate investments will need to be taken into consideration when investing in German real estate. The 2021 new federal government has also announced the further extension of rental regulations for residential units. In particular, the rent brake will be prolonged until 2029 and rent increases based on the comparable rent in existing leases will be limited to 11 per cent in three years. Furthermore, the – regularly underlying – rent index for comparable apartments will, in the future, take into account the past seven years (recently extended from four to six years). Investors in German residential real estate will need to carefully monitor the forthcoming new rules.

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 2021 on the market both for residential and commercial (particularly office and logistics) real estate despite the ongoing 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.

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