The Berlin rent cap has been overturned and declared unconstitutional. What does this mean for current and future contracts?

The Berlin rent cap’s undesirable impacts are serious. One year into the rent cap, our website had drawn its own conclusions and examined the issue from multiple viewpoints (LINK).

After the rent cap was overturned by the German Federal Constitutional Court, we received a large number of questions regarding the new situation. We took your questions to attorney Nils Holger Bayer..

Mr Bayer is an attorney (Rechtsanwalt) in Berlin and Avocat à la Cour de Paris. He advises French clients on German law and German clients on French law, with a particular focus on the acquisition and sale of real property.

L. Drewes:
Hello, Mr Bayer. I am so pleased at the opportunity to sit down and discuss this with you. Could you please briefly explain the developments in the legal situation since the rent cap was enacted?

N. H. Bayer:
The Berlin Residential Rent Cap Act (Gesetz zur Mietenbegrenzung im Wohnungswesen in Berlin, sometimes abbreviated as ‘MietenWoG Bln’), colloquially referred to as the ‘Berlin rent cap’ came into force on 23 February 2020. The law affected some 1.5 million properties in Berlin. It temporarily limited both the amount of rent to be contractually agreed as well as rent increases. Rents would not have been allowed to increase again before 2022, and by no more than 1.3%, in line with the rate of inflation. According to the Act, rents for Berlin residences built before 2014 were frozen in February 2020 at their June 2019 level. In addition, since November 2020, landlords have been required to reduce rents that were more than 20% above the limits specified in the rent cap. Fines of up to EUR 500,000 have been levied in the event of infringement. The rent cap did not apply to newly built properties completed from 2014 onwards and was limited to five years, i.e. until 2025.

The Act was highly controversial, both from a political and a legal point of view. Tenants have been advised to be prepared for landlords to demand back payment in the event the Act is found to be unconstitutional.

L. Drewes:
Although most experts did consider the rent cap unconstitutional from the outset, it has been in effect for over a year and has created a great deal of legal uncertainty – for everyone. This is also evident from the fact that even the politicians responsible for the law have advised tenants to save the amount saved on rent and not to spend it.

But how has the German Federal Constitutional Court now ruled on the rent cap?

N. H. Bayer:
On 15 April 2021, the German Federal Constitutional Court ruled that the Berlin Rent Cap Act was unconstitutional for lack of legislative powers by the State of Berlin (German Federal Constitutional Court ruling of 15 April 2021 in the matter of – 2 BvF 1/20 – 2 BvL 4/20 – 2 BvL 5/20).
The grounds for this decision lie in the fact that legislative powers in the Federal Republic of Germany are divided between the federal government and the individual German states (Länder) by Germany’s constitution (Grundgesetz, or ‘Basic Law’), and regulations on rent levels do not fall within the legislative jurisdiction of the states. Instead, pursuant to Article 74 Paragraph 1(1) of the Basic Law, the federal government is responsible for such matters and, in the opinion of the German Federal Constitutional Court, the federal government has already exhausted its powers on this matter in concurrent legislation, specifically Sections 556 to 561 of the German Civil Code (Bürgerliches Gesetzbuch).

L. Drewes:
That means the German Federal Constitutional Court has overturned the Berlin Residential Rent Cap Act because the state of Berlin is not authorised to make laws regarding rent levels, only the federal government is. So, the German Federal Constitutional Court has now declared the rent cap null and void. What does that mean going forward?

N. H. Bayer:
Being declared null and void means the rent cap must be considered non-existent. From a legal point of view that means that the invalidity also has a retroactive effect on the period prior to the decision of the German Federal Constitutional Court, since the Act is considered invalid from the outset.

L. Drewes:
So you have to consider the situation as if there had never been a rent cap in the first place. Does that also mean that tenants will need to pay the rent as if the cap had never been put in place?

N. H. Bayer:
Exactly. Underpaid rent now needs to be calculated for past periods and paid to the landlord. The amount owed is equal to the difference between the rent amount calculated according to the German Civil Code and that calculated under the Berlin Rent Cap Act.

L. Drewes:
So the rent that was agreed in contracts concluded before the rent cap came into force now applies again. The reduced rent must be repaid in full for the entire period. But what about contracts concluded after 23 February 2020 or in other words contracts originally concluded under the rent cap.

N. H. Bayer:
In many cases, the parties had already included clauses in these contracts regarding the possibility of the Act being declared unconstitutional. These clauses often included what is known as a ‘shadow rent’ (‘Schattenmiete’). The parties would determine what rental price would apply under the tenancy agreement in the event the rent cap was declared unconstitutional. Were this to happen, as it now has, the amount of rent arrears results directly from the contract. This means that the amount owed can be readily determined and is payable immediately.

L. Drewes:
And what about rent increases that had been contractually agreed but could not be implemented? For example, in the case of graduated tenancy agreements?

N. H. Bayer:
If rent increases were initially stipulated in the contract but not implemented as a result of the rent cap, the subsequent payment amount that has now taken retroactive effect is calculated as the difference between the capped rent amount and the amount that would have had to be paid in line with the contractually agreed rent increases.

L. Drewes:
So again, the contract can be enforced retroactively and the tenant will have to pay the difference from the amount they would have had to pay had the Act never been enacted.

How do I currently go about setting a rental price or increase? We do have a rent index, which is now considered valid again. However, the 2019 rent index is set to expire in May 2021. What’s the situation here?

N. H. Bayer:
In terms of the current provisions, uncertainties may remain in the wake of this new jurisprudence by the German Federal Constitutional Court since the State of Berlin has so far failed to adjust the rent index according to the regular two-year cycle. As a result, it is difficult to establish an upper limit for rent levels currently permitted for new tenancy agreements and rent increases.

Until this rent index adjustment is published and enters into force, a comparable rental price typical of the local area must be set in the absence of an up-to-date, qualified rent index when renewing tenancies. It is necessary to determine the comparable level of rent typical of the local area when renewing tenancies because residential tenancy renewals in areas with a tight housing market may not exceed comparative local rent levels by more than ten per cent.

In this respect, the soon-to-be expiring 2019 rent index can help property owners set rental prices. For the purpose of determining the comparative rent, the tenant is entitled under Section 556 g (3) German Civil Code to be provided with the information necessary to determine the comparative rent, which the landlord may obtain without difficulty, i.e. with reasonable effort. This includes, for example, the previous rental price.

Despite all this, the parties will be able to roughly determine the comparative rent until a new qualified rent index comes into force. Between May 2019 and January 2021, the consumer price index increased by about one per cent, and that’s probably the direction comparative rents will move. This would be an easy calculation for all parties involved.

Incidentally, Berlin is also working on the new rent index, which is expected to be made available as early as May.

L. Drewes:
This means that we can currently use the 2019 rent index to re-calculate rents, and that properties can be let at a maximum of ten per cent above the calculated amount. It is unclear whether and when exactly the new rent index will enter into force. In any case, it should be increased in line with the purchase price index.

What is clear is that the 2019 rent index will expire at the end of May.

N. H. Bayer:
Accordingly, everything will stay the same for now. In that sense, the legal situation is identical to the situation before the rent cap came into force. Only the comparative rent is expected to increase, by around one per cent.

However, those who have not included any ‘shadow rent’ increases in tenancy agreements concluded after the rent cap came into force will not be eligible for reimbursement of rental income losses by the State of Berlin or by the tenant since they were not prohibited from agreeing such a ‘shadow rent’. If rent increases had already been agreed previously, however, the landlord may now invoke them.

L. Drewes:
This means that only what has already been contractually agreed applies. If you simply complied with the Act when you entered into the contract, this cannot be changed retroactively. Whatever has not been contractually agreed cannot be claimed retroactively.

N. H. Bayer:
At no time could we seriously assume the legality of the Berlin rent cap since comparable rent caps in other German states had already been declared unconstitutional on the grounds that the states in question did not have the legislative power to enact such laws. Lawmakers who pass blatantly unlawful legislation also fail to create a robust protection of legitimate expectation, which could lead to claims for damages. Government liability suits are unlikely to be successful here.

L. Drewes:
I see. What do you think the near future holds?

N. H. Bayer:
The legal uncertainties that have temporarily hampered investment have now been eliminated, which should help ensure a market revival. Low-cost rents in prime locations will likely not be available for the time being. It remains for the federal legislature to take even more drastic measures to facilitate less affluent tenants being able to continue to live in inner cities. However, this can only work in conjunction with state policy, regardless of legal issues. This requires the speedy approval of large-scale, mixed-income housing projects, combining luxury, middle-class and social housing. And investors in Berlin are also lining up for these kinds of opportunities. At this point, the Berlin authorities responsible can help ease pressure on the housing market by issuing permits in a timely manner for the benefit of all. Until then, tenants will continue to face rent increases.

L. Drewes:
You’re completely correct on that score. It will only work if everyone involved pulls together and key investors are allowed to act. We are facing an extraordinary election year in Germany, and we will soon elect a new government on both the federal and state level (in Berlin). Housing is a key issue in these election campaigns. It remains to be seen how voters will decide and which measures will find their way into a coalition agreement.

Mr Bayer, thank you for this enlightening conversation. I’m certain it will be a great help for our clients. I am looking forward to continuing our cooperation in helping our clients with their property purchases.