How can cities be kept affordable? A new attempt with rent controls in Germany

Many European cities experienced strong rent price increases over the last decade, which increasingly threaten to displace poorer parts of the society from urban centres. Despite the already tightly regulated housing market, rents in several German cities increased by almost 50% over the last 10 years, among them Berlin and Munich. A new law will now introduce stronger rent controls for certain areas that are declared to be in a “housing emergency”. Will it help to curb displacement of economically weak groups?

Tenants in many urban centres all over Europe have experienced above-average rises in rents over the past decade. On the one hand, central areas generally have become more demanded again after a long period of absolute suburbanisation - most cities entered into a period of population growth again already in the 1980s and 1990s. On the other hand, the financial crisis and along with it low interest rates have made real estate as a relatively safe asset class more interesting for (sometimes international) investors, leading to higher sales prices and accordingly to higher rents. In some cities, rents are now so high that even middle-income households are outpriced from central locations (Think of the notorious housing markets of London and Paris). At the same time many planning policies contain the aim of socially mixed neighbourhoods. What can be done to keep cities affordable?

Though Germany is sometimes praised as renter’s paradise due to its tenant-friendly legislation, rising rents also impacted German cities and towns, albeit many East-German cities (and Berlin) started from a low absolute state. Most affected were economically prosperous cities and university towns in the West. In some cases rents rose as much as 40% in five years. Overall, Munich is the most expensive place for renters in Germany, followed by Stuttgart, Cologne, and Frankfurt.

Even if rents are yet not in the same league as in the large European capitals, rent hikes were more and more addressed by the media with the demand for political action. This can partially be explained with the high social acceptance of renting and a comparably low homeownership rate in Germany, which is the lowest in the EU at around 50% (while Romania has the highest rate at around 98%). This makes tenants an important interest and voter group.

Homeownership rates in the EU, 2013. Source: Eurostat.

Subsequently, the government prepared a new law that is expected to enter into force on June 1 this year, dubbed ‘brake on rent prices’: Apartments rented out after that date must not be offered for prices higher than 10% above the local average rent for a comparable flat. The local average is determined every two years by an independent body of surveyors in consent with both the local tenants’ and landlords associations.

The new regulation applies only to areas defined by the federal states as ‘overheated’ residential markets. This spatial differentiation makes the law more interesting from a planning perspective, as opposed to a spatially blind policy. However, it also makes the regulation vulnerable to political influence: conservative or liberal state governments might be inclined to demarcate fewer areas than left-leaning governments. So far however all state governments want to adopt the law.

New construction in Munich: Renovations and amendments to flats are among the few remaining possibilities for landlords to increase rents above the local average.

Economic theory teaches us that rent caps will lead to less new flats being built, as incentives are reduced, and to less investments into the housing stock. This is also the most prominent critique by landlords’ associations, besides legal insecurity and bureaucracy. The government sought to circumvent the critique by exempting flats in newly constructed or significantly refurbished houses from the price cap, as well as existing rental contracts and flats that are already now rented for more than 10% above the local average.

Renters’ associations criticise the new law for these exceptions, as well as its time limit of 5 years, after which it will be reviewed. Another point is that it might only help middle-income households to attain cheaper rents, since they will be preferred by landlords as tenants, and not the very poor.

This and the many exceptions might indeed render the ‘price brake’ ineffective. Only if rental prices further rise significantly, the effects could be felt in 3-5 years. But even then, more social housing might help income-weak households more than the rent cap.

But the law furthermore stipulates that - in certain areas - permission by planning authorities is needed if rental units are converted to privately owned flats, as well as that commission for real estate brokers should be paid by the party who mandated the broker, not generally by tenants. Here, the effects should be more clearly felt by prospective tenants, at least in areas where the landlords cannot include the costs for the broker in the rent.

We can only theorise about the possible effects of the law now, but the continuously high level of construction shows the still high confidence of real estate investors.

How did governments respond to spiralling rents in other countries? Were rent caps ever successful? Feel free to use the comment area!