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Weakening of Berlin residential rent freeze fails to soften blow for landlords

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Capital Markets View – January 2021


Weakening of Berlin residential rent freeze fails to soften blow for landlords

A bill that proposes freezing residential rents in Berlin for five years will result in a period of uncertainty and lower returns for landlords if passed by the city's senate, according to local industry experts.

The final draft bill, the content of which has been agreed upon by the Berlin senate's ruling coalition, is expected to come into law in January after it passes through the legislative process. The latest version, published Oct. 22, contains a number of changes from previous drafts, which were met with stinging criticism from the German real estate sector and some politicians.

The final draft is "somewhat watered-down" compared to the previous version, according to an Oct. 21 note by Thomas Rothaeusler, real estate equity analyst at global investment bank Jefferies. "Basically, it's a five-year rent freeze of in-place and re-letting rents with more limited rental cuts," he said.

Still, the weakening of the rent control measures does nothing to address the lack of supply driving the Berlin residential rent problem, according to Till Johannes Bruhofener-McCourt, head of research at banking and real estate consultant Ziegert, a specialist in the Berlin residential market. "The bill is just continuing in the wrong direction," he said in an interview. "It will not help to build more residential units."

The most significant change to the first draft bill is the removal of a measure to cap rents at 30% of a household's income, said Andreas Polter, head of residential portfolio investment at real estate services firm Cushman & Wakefield. The move isn't as positive for landlords as it initially appears, he said.

"Those backing the bill are selling it as a positive sign [for landlords]," said Polter. "But in the first draft, only households whose rent exceeded the 30% threshold could decrease the rent. Now every household can decrease the rent if it exceeds the rent cap [for the classification of property they live in]."

If the bill is passed into law as expected, the market for older residential properties in Berlin will likely collapse, said Bruhofener-McCourt. The bill retains limits on rental increases for properties that have undergone modernization work, according to Rothaeusler's note. Modernization programs have provided major listed residential landlords such as Deutsche Wohnen SE and Vonovia SE with significant rental growth opportunities in recent years.

"I've had discussions with residential portfolio owners and they have said that [the limits on modernization-driven rental increases] mean their business cases won’t work any longer," said Bruhofener-McCourt.

The proposals in the final draft bill also cast doubt on the prospect of the German federal court overturning the rent freeze. This was expected as landlords plan to challenge the law on the grounds that it violates property rights enshrined in the German constitution, Bruhofener-McCourt added. "Since the law has been diluted, there is uncertainty if the federal courts will rule it unconstitutional," he said.

This will only exacerbate the impact that the looming rent freeze has already had on the market, said Polter. "There is still interest from a lot of investors to invest in Berlin, but the investors see more risk," he said. "It's very uncertain how to project cash flows with the current situation."

Many investors are demanding significant discounts as a result of the proposals and the uncertainty around how long they will be in place, he added. This is reflected in a change to the market's pricing. "There is more product in the market now with price reductions compared to six or nine months ago," Polter said.