Berlin’s rent cap ruled unconstitutional

Berlin's rent cap ruled unconstitutional

 Yesterday, 15 April 2021, one year after its entry into force, the Berlin Rent Cap Act (Mietendeckel) was ruled to be unconstitutional by the German Federal Constitutional Court (Bundesverfassungsgericht). 

This decision from the German highest court follows a major complaint from 284 members of the German Bundestag from the liberal and conservative parties which questioned the competence of the Berlin Land to legislate on rental policy.

The Federal Constitutional Court ruled that: “States are only permitted to make laws as long as the federal government has not made use of its law-making powers”. The regulation of rents falls within the scope of concurrent federal legislation since, the federal government has adopted the Mietpreisbremse (rent brake – milder form of rent control), which allows municipalities to limit prices in tight locations to ten percent above the local comparative rent for new leases. According to Karlsruhe Court, the Berlin rent cap essentially regulates the same situation as the rent brake but would intervene even more strongly in the contractual freedom of tenants and landlords than the federal regulations. 

The berlin rent freeze scheme in a nutshell

The nominal caps on rent levels applied in Berlin since last February were a resurgence of ‘first generation’ types of rent control, which widely disappeared since the 1980s. This unique measure affected 1.5 million apartments in Berlin, freezing rents at their 18 June 2019 level for a 5-year period. New rents could not go beyond that level and, from November 2020, existing rents that were still above it had to be reduced. 

The Rent Cap Act was not applying to publicly funded residential accommodations like social housing because the owner, the state of Berlin, had previously stated that it would temporarily forego rent increases. Also flats repaired or modernised with public funds subject to strict rent setting conditions, residential units in dormitories and living spaces held by publicly recognised welfare institutions were not included in the scope. In addition, to prevent new built and new housing shortage, the measure was not applying to new dwellings or newly rehabilitated former vacant spaces put on the market after 1 January 2014.  

 

the impact of the berlin rent freeze on the market

This reform, which came at the courtesy of Berlin city state’s “red-green-red” governing coalition between the three left-leaning German political parties, was meant to give renters a “breathing room” and stop rent increase in what used to be one of the cheapest capitals in Europe. Yet, after a year of implementation, empirical data were starting to come in showing the possible boomerang effect of the measure in the housing market.  

Those evidences, notably those of Munich’s Ifo Institute, corroborated trends traditionally observed in rent control systems: the creation of a dual housing market – with one large regulated market (for pre-2014 dwellings) and a much smaller one for unregulated new dwellings (post-2014 ones). If rents unsurprisingly dropped in the regulated market and house prices were following the downsizing curve (with landlords leaving the market), the supply of apartments basically froze – other sources were already mentioning that supply shrunk – suggesting already that a possible shortage of rental housing was not to be excluded in the future. On the other side, rents in the unregulated market raised much faster than in other big German cities and the objectives to build at least 20.000 new homes per year was impeded by traditional supply constraints (permit, planning, land shortage, etc.) and investors’ cautiousness and mistrust created by a bad environment and the risk of their new built to fall under the rent cap scheme after the initial exemption period. The probability of seeing once again a too strict rent price regulation that protects insiders on the market, but with adverse effects for outsiders, was not far.   

In addition to that, the measure also sent a bad signal for the wider climate agenda. If the rent cap was allowing for a rent increase in connection with a modernisation due to a statutory obligation, a thermal insulation or other energy saving measures, the installation of a lift, or the removal of barriers, the rent could not be increased by more than EUR 1.00 per square meter and could not exceed the maximum rent by more than EUR 1.00 per square meter; something that was not creating enough incentives for landlords to proceed to investments. 

 

next steps after court's decision

The decision of the Federal Constitutional Court is effective ex tunc and not ex nunc. This means that the law is declared null and void from the beginning of its force and, in many cases, landlords should have the right of referral. In other words, landlords whose rent has been unconstitutionally lowered are now entitled to get their money back from the tenants, and a large part of the rents that were lowered in violation of the Basic Law must be paid in arrears retroactively – for the period between November 2020 and now. If some large real estate companies have already started to announce that they will not ask for retroactive rent differences, a decision that might also be followed by smaller landlords on a case-by-case basis, this unfortunate situation demonstrates the irresponsibility of a somehow populist measure. The Berlin ruling authorities had literally put a Damocles sword above the heads of their constituents, repeatedly calling on Berlin tenants to keep the effective rental saving aside in case of such a decision from the highest court.  

 

CONCLUSION

Yesterday’s decision only concerns the Berlin rent freeze, while the federal rent control system still applies in Germany and other measures, such as the interdiction to shift the use of dwellings from rental to owner-occupation, are still impacting the housing market. The decision is also only on the federal legislative competence and not on the substance of the scheme. The partisans of this severe form of rent control are already calling for a federal level-based type of rent freeze ahead of the next federal elections. Yet, if robust evidence and conclusions could not be drawn in such a limited period of time, traditional patterns of the perverse effects of rent control were already showing by suggesting that such measures, far from being a remedy to Berlin and potentially Germany housing challenges, might on the contrary worsen it. 

Worst, such policies and their outcome create a level of defiance and resentments among housing stakeholders, instead of promoting well-planned and balanced policy from government’s side which would enable a level-playing field for all relevant parts. What remains to be seen is if lessons are indeed learnt. 

You can find the Court’s decision here. 

 

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