European Union: Draft Bill On The "Rent Increase Cap" In Residential Tenancy Law And The Orderer Principle In Housing Agencies

Originally published July 9, 2014

Keywords: Tenancy Law Amendment Act, Housing Markets, Rent, tenant

The Federal Ministry of Justice has submitted the draft bill of a Law to Curb the Increase in Rent in Tight Housing Markets and to Encourage the Orderer Principle in Housing Agencies" (Tenancy Law Amendment Act – MietNovG) dated March 18, 2014. The law aims to resolve two identified deficits in the housing market that promote the gentrification" brought about by the displacement of the low income resident population, and increasingly, average income households as well. On the one hand, it is intended to prevent an unchecked increase in rent in prosperous cities due to high demand and short supply of housing space. On the other hand, in order to relieve the financial burden on tenants, the customary passing on of letting agent fees to the tenant irrespective of an exclusive order by the tenant, is to be prohibited. Instead, the letting agent's client will pay the fee in accordance with the Orderer Principle. According to the rationale of the draft bill, the landlord is almost always the client in tight housing markets.

Cost aspects

The draft assumes an annual saving for tenants of just above 854 million euros and an annual additional expenditure for landlords of nearly 521 million euros. Whereas annual potential savings of 282.8 million euros in rent are envisioned for tenants, for landlords it will mean an annual burden of 301.79 million euros in expenditure to determine the permissible rent and to fulfil duties to supply information to tenants. The draft envisions potential annual savings of nearly 572 million euros in letting agent fees, offset by a mere 219.09 million euros of additional expenditure for landlords. The comparatively low burden for landlords is accounted for in that they will be letting the premises themselves instead of calling upon a letting agent, and in a reduction of letting agent fees due to increased competition between letting agents.

Rent Increase Cap

The legal options currently in place to curb exaggerated rent increases are deemed insufficient. The ministry considers the civil law instruments to be inadequate. For example, under Section 558 the long-standing limit on rent increases up to the reference rent refers only to increases in existing tenancies. The option to lower the legally stipulated cap in tight housing markets from 20% to 15% for five years by means of State government's ordinance, newly introduced as part of the amended tenancy law, merely applies to the maximum amount that existing agreements may be adjusted to the reference rent within three years. Until now there has been no provision governing the rental of flats that have returned to the market.

The penalty under criminal law (usury) requires as facts a noticeable incongruity, which generally is only assumed to be the case when the market rent is exceeded by 50%. In addition, there are high standards to be met to determine the intentional exploitation of an identified individual dilemma by a landlord or a reprehensible attitude. This may be able to stave off individual cases, but cannot correct undesirable developments arising from a special market situation. The regulatory offence (excessive increase in rent) under the Economic Offences Act is likewise deemed to have not taken effect. It penalises disproportionately high fees for renting housing space. This is the case if the rent (i.e. the fee) exceeds the reference rent by 20% as a result of an exploitation of a reduced supply of comparable housing spaces. The facts rely on an exploitation of the reduced supply, but also draw on the reference rent for the entire community area. Here again, the tenant must be in a dilemma, unable to fall back on more affordable flats for valid reasons, and must prove his unsuccessful attempts. The provision may only take effect if this is apparent to the landlord. The draft deems this provision to be too complicated and therefore impractical. It is thus to be abrogated without a replacement.

For this reason the draft envisions the introduction of new paragraphs Sections 556(d) ff. to the Civil Code. They will stipulate a maximum increase in rent of 10% over the reference rent when existing flats are re-let. This will apply only in areas subject to tight housing markets". Said markets must be expressly specified as such for up to five years by State government.

In order to protect the landlord from being required to let below the effective rent agreed previously, the landlord may also set the new rent above the 10% cap up to a maximum of the rent paid by the previous tenant (previous rent"). To protect against fraudulent use however, changes to rent agreed in the year prior to re-letting will not be considered when determining the previous rent. As an alternative to agreeing the previous rent, the maximum increase may also be exceeded if refurbishments were undertaken within the last three years prior to re-letting. As with an existing tenancy, costs for refurbishment may be included in the new rent by way of a surcharge of up to 11% of the refurbishment costs per year. The restriction to the last three years is based on the assumption that only costs incurred during this period are not already included in the previous rent. In order to avoid double consideration in the landlord's favour, the surcharge is made on 110% of the reference rent that would be applied to the flat in its nonrefurbished condition.

This cap on rent increases does not apply (i) to agreements made later in an existing tenancy, (ii) to newly constructed and thus newly let units, or (iii) to the rental of extensively refurbished flats. The rationale of the draft considers extensive refurbishments to be those of a scope comparable to a new building. The rationale consults adjudication on council housing law as its point of contact. According to this, a comparable scope is found to be the case if the expenditure reaches one third of the costs for a comparable newly built flat.

The rent increase regulations governing the rent increase cap are likewise inapplicable to housing let for temporary use, furnished rooms in the landlord's flat, and special council offers for persons with an urgent need for housing. Such constitute special tenancies outside the normal housing market.

The prohibition of deviation common in residential tenancy law is also standardised for the new regulations. Accordingly, any deviation from the legal stipulations that put the tenant at a disadvantage will render that contractual provision ineffective.

However, restitution claims are governed explicitly. And yet it is only clear from the rationale of the draft that a rent agreed in violation of the maximum limit is not wholly ineffective due to the prohibition of deviation. It is merely that part of the rent which exceeds the permitted maximum limit that will not be due. The tenant is only entitled to claim restitution of that part which exceeds the ineffectively agreed rent, yet prior to doing so, the tenant must have made a complaint in text form (such as by e-mail) specifying the material facts of a violation of the provisions. The tenant is privileged with respect to the law of unjust enrichment, as the tenant is always the weaker party in a negotiation in a tight housing market. Therefore the tenant's claim for restitution is possible despite payment made in the knowledge of the ineffectiveness or despite a violation of a statutory prohibition.

A right to information from the landlord will be included in order to permit the tenant to verify the facts. Accordingly, the landlord must provide the tenant in text form with all facts that generally are not publicly available and are relevant to the permissibility of the agreed rent.

Finally, the provisions on the rent increase cap also apply to stepped rent and index rent agreements, whereupon for index rents it is only applied to the starting rent, while stepped rents are subject on the date on which the respective step-up becomes due.

Orderer Principle

Generally, a person looking for a flat will answer an ad placed by the letting agent commissioned by the landlord. In order to prevent that person from being required to pay a (separate) fee or the fee owed by the landlord, the law governing housing agencies will be amended.

Accordingly, a person looking for a flat will only owe a fee if he or she has instructed the letting agent in writing to find a flat, and the letting agent also becomes active solely on the basis of this mandate.

Any deviating agreements are ineffective on the one hand, and on the other constitute a regulatory offence that may be punished by a fine of up to 25,000 euros.

Outlook

It is not expected to enter into force before 2015. Particularly, if extensive changes to the draft are demanded within the coalition government. The legislator would increase its market regulation in social tenancy law with these planned provisions.

The existing instruments would be complemented by a cap on rents when flats are re-let.

As the cap for adjusting existing rents is only reduced across-the-board for entire towns and municipalities, it can be assumed that the State governments will also introduce the rent cap for re-letting in a similarly undifferentiated and broad manner. For example, Berlin and Hamburg have each been sweepingly and jointly defined as municipalities in which the population is particularly at risk of experiencing a shortage of rented flats at reasonable terms1. North Rhine-Westphalia and Bavaria have also enacted decrees introducing the cap in major cities such as Munich and Dusseldorf, as well as a large number of other cities and municipalities (59 in North Rhine-Westphalia and 89 in Bavaria). With the exception of Munich, however, the cap was only agreed in Bavaria until the end of 2015. This means that the application of the new rent cap can be anticipated to be very widespread. Particularly as it is not clear that the federal legislator will limit the State regulators in their assessment by stipulating clear and verifiable criteria for determining if a market is tight.

However, the rationale of the draft does contain considerations discussing what an appropriate assessment would need to consist of, to also satisfy constitutionally guaranteed protection of property. Landlords would be required to challenge an unjustified blanket designation themselves, with corresponding court proceedings potentially dragging on for years.

Stepped rents, which previously were easy to manage, might lose in appeal as the rent increase cap provision is applied to each step-up increase. As a result, the index rent might grow in popularity.

It is also problematic for landlords that they can only obtain legal certainty from (qualified) rental indices. It is only possible to make a reasonably reliable calculation if a reference rent can be determined. If not, the risk of the rent turning out to be excessive will increase, and the landlord will be faced with a tenant's claims for restitution.

While the rent increase cap may be suited to curb the price development in the housing market, it is questionable as to whether it improves the chances of low-income and average-income earners in residential areas that are in high demand. It merely secures the financial possibility to rent. This may potentially result in (even) more applicants for one flat, and will not do much to change the fact that landlords prefer tenants with a good credit history for obvious reasons. However, according to a publication accompanying the draft, the federal government plans further measures to ease the shortage of housing.

Footnote

1 Bavaria: Decree on the areas under Sections 577(a) and 558 Civil Code (Residential Area Decree – WoGeV) of 15 May 2012 (GVBl. 2012,189), amended on May 3, 2013 and most recently on July 23, 2013; apparently municipalities will apply to be included in the decree issued by the state government, although it is unclear which documents if any municipalities will be required to submit. Berlin: Decree to lower the cap pursuant to Section 558(3) Civil Code (Cap Decree) of May 7, 2013 (GVBl. 2013, 128); Hamburg: Decree on the reduction of the cap in the case of increases in rent up to the reference rent customary in the locality in accordance with Section 558(3) Civil Code (Cap Decree) of July 30, 2013 (HmbGVBl. 2013, 350); North Rhine-Westphalia: Decree to determine the areas with a lowered cap (Cap Decree – KappGrenzVO NRW) of May 20, 2014 (GV. NRW 2014, 298).

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