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01/02/2013 01:37 PM

Squeezed Out

Rocketing Rents Become Election Issue in Germany

By Horand Knaup, Alexander Neubacher and Ann-Kathrin Nezik

The exploding costs and dwindling supply of urban housing are slowly pushing Germans of average means out of the cities. As September's national election approaches, politicians are jockeying to find viable solutions to a problem they helped create.

When Jacopo Mingazzini's customers step off the plane in Berlin, they like to mix business with pleasure. First, the real estate broker's employees chauffeur the Italians to the city's top tourist attractions. Then they take the visitors to Wedding, a residential area in Berlin that is central if not particularly chic.

The potential buyers are on a tight schedule. Mingazzini's employees sometimes show them up to five apartments a day. The negotiations are conducted in Italian, and demand is high. Of the 1,200 apartments Mingazzini has sold this year, 150 were bought by Italians seeking to invest their savings in German real estate, which is seen as crisis-proof. "They know full well that if they buy an apartment that's currently being rented for €5 ($6.60) a square meter (about $0.60 a square foot), they can charge a lot more on a new lease," Mingazzini says.

The method being used by Italian teachers and lawyers to protect themselves against the euro crisis is causing turmoil in Germany's capital. Berlin's housing market is going haywire as local rents explode. Since 2007, average rents in the western part of the city have gone up by 20 percent, and other major cities are now experiencing the same development. Even apartments in second-tier cities have become nearly unaffordable for people with average incomes. Those seeking a new apartment in Hamburg, Munich, Berlin, Frankfurt, Düsseldorf or Cologne can expect to pay at least 25 percent more than they are accustomed to paying for the same size and standard of apartment elsewhere.

This is bad news for anyone hoping to move to a different city for a job or to attend a university. People who want to move around have to be prepared to pay for it, and couples planning to have children are scaling back their space requirements. The German Renters' Association (DMB) estimates that there is a shortage of about 250,000 apartments nationwide, and the latest government report on the housing sector concludes that a growing number of cities and regions "are likely to experience bottlenecks."

Self-Made Problems

The fight against what has been dubbed "rent shock" is forcing its way onto the political agenda. Germany will hold national parliamentary elections in September 2013, and no party wants to be accused of not taking voters' concerns about housing seriously. About half of German voters rent their houses or apartments. And even those who own their homes have often heard stories from family members or friends about skyrocketing costs, brazen brokers and overpriced hovels.

Both the opposition and the government of Chancellor Angela Merkel -- made up of her center-right Christian Democratic Union (CDU), its Bavarian sister party, the Christian Social Union (CSU), and the business-friendly Free Democratic Party (FDP) -- have proposed competing solutions. Transport, Building and Urban Affairs Minister Peter Ramsauer (CSU) has talked about anchoring hotel ships in university cities to replace the student dormitories that should have been but weren't built in recent years. Peer Steinbrück, the center-left Social Democratic Party (SPD)'s chancellor candidate, has announced a "National Plan of Action for Habitation and Urban Development" and is calling for a "revival of low-income housing construction." The Greens are proposing that landlords rather than tenants should be forced to pay brokers' fees. And even parliamentarians with the FDP, which tends to back the interests of property owners, recently voted for a federal law designed to prevent excessive rent hikes.

The message the parties are trying to convey to voters is that they are taking a proactive approach. But, in reality, there is plenty of hypocrisy at play when politicians suddenly discover a soft spot for renters -- especially since they are largely responsible for the price explosion on the real estate market themselves. Indeed, more than anything else, the government is driving up costs in the rental market, and at all levels.

Since the European Central Bank (ECB) has pushed interest rates down to historic lows, money for development is cheaper than it ever has been. At the same time, Southern Europeans seeking a safe haven for their assets are moving them to Germany. Rising demand drives real estate prices up and leaves renters in Germany with the bitter realization that they are paying a significant share of the added costs resulting from the euro crisis.

Many municipalities are also pushing up property prices and development costs by limiting the amount of land zoned for residential purposes and allowing sluggish bureaucracies to slow down the permitting process. Likewise, almost all of Germany's 16 states have scaled back low-income housing construction and are adjusting the property transfer tax. In the western states of Baden-Württemberg and North Rhine-Westphalia, for example, the tax recently rose from 3.5 to 5 percent.

Footing the Bill for Renovations

More than anything, though, it is the federal government's shift away from nuclear power and toward green energy, also known as the Energiewende, that is driving up housing prices. To reduce heating costs, the government subsidizes the installation of heat pumps, geothermal systems and triple-glazed windows. It's a good idea, but it has one major drawback: The costs are passed on to renters.

Property owners normally have little latitude when it comes to raising rents. The only time they can set rents at their discretion is when units are rented to new tenants. By law, rents for existing tenants, excluding utility bills, cannot increase by more than 20 percent in three years.

But the conditions are different if property owners perform what is officially known as an "energy upgrade" on their buildings. In that case, the government relaxes restrictions on landlords with the justification that the upgrade will serve a good purpose.

An owner is permitted to pass on up to 11 percent of renovation costs to tenants each year. If a landlord spends €20,000 to insulate an apartment, for example, he or she can increase the rent by up to €183 a month. The reduction in the tenant's heating bill, on the other hand, is relatively small by comparison. What's more, the government's latest amendment to the tenancy law requires tenants to put up with months of construction noise if the work is being done in the interest of climate protection.

The consequences have been dramatic, as retiree Ursula Falk can confirm. She has lived in an eight-story, concrete apartment building in the Hallschlag neighborhood of the southwestern German city of Stuttgart for the last 30 years. Her children and grandchildren grew up there. Falk prefers to stay in the neighborhood even though there are nicer places to live in the city.

The exterior walls and windows of the buildings in her development were recently brought up to the latest energy standards. But residents are worried because the landlord, the Stuttgart Housing and Urban Development Association (SWSG), wants to pay for the renovations by adding a surcharge to rents.

Falk and the other 120 tenants received a letter from the SWSG a while back. It stated that once the renovations were complete, their rent, excluding utilities, would go up 60 percent, from €475 to €770.

The SWSG is now prepared to make concessions, but Falk says she still can't afford even the proposed 40 percent jump in rent. Either her grandchildren will have to help her, or she'll have to move out and find an apartment she can afford. However, even that will probably be challenging because rental prices on new leases have risen by some 20 percent over the last five years.

What's more, if politicians deeply involved in environmental policies have their way, this is only the beginning. In many cases, renovating older buildings to bring them up to the latest energy standards can end up being a money pit, as even the Federal Environment Agency recently learned. The agency's headquarters, located in the eastern city of Dessau, was built in accordance with the strictest environmental and energy-conservation standards. For example, it boasts a ground-source heat pump instead of a conventional heating system, and a solar-powered cooling device provides air-conditioning in the summer.

But then it turned out that the technology was more expensive than planned, and maintenance costs exceeded all estimates. As a result, the Federal Audit Office recently calculated that operating costs for the supposedly "green" building were about 50 percent higher than those of other government structures.

Luckily for the agency, taxpayers can be counted on to make up the difference. Ordinary renters, however, are victims or what lawmakers refer to as a "conflict of objectives." The faster the government pushes ahead with the Energiewende, the faster housing costs rise.

Declines in Subsidized Housing

New environmental regulations aren't the only thing making housing more expensive. For example, the government in the southwestern state of Baden-Württemberg, led by a coalition of the SPD and Green Party, unveiled its plans for an amendment to the state building code in early December. Under the proposed new rules, new developments would have to provide more space for bikes -- even on properties where there is no obvious need for such space.

Likewise, as the scope of building regulations is expanding, individual states are scaling back their own spending. Since 2006, states and municipalities have been jointly in charge of building low-income housing. Although the federal government provides them with annual subsidies totally €500 million, reforms in laws governing its interactions with state governments bar it from imposing any regulations.

But, for years, municipalities have been investing very little in low-income housing, preferring to spend the federal government's money on other things. The city-state of Berlin, for example, collects about €32 million a year for this purpose. But instead of spending the money on new low-income housing, it uses it to repay old loans.

Over the last decade, such practices have led to a decline in the number of subsidized housing units in Germany, from about 2.6 to 1.6 million. At the same time, municipal housing associations are the first to force green renovation and the corresponding rent hikes on their tenants.

For far too long, lawmakers believed that the housing shortage was an old problem that had already been solved. Given that the population is aging and no longer growing, they reasoned, why should they worry about a lack of housing? Instead, they believed it was necessary to demolish empty prefabricated concrete apartment buildings and abandoned villages.

For a long time, they were right: Except in a few booming regions, rents rose more slowly than other living expenses. But now the situation has fundamentally changed. Although Germany's total population is stagnating, more and more people are crowding into its urban areas. And since more and more people are living alone, the number of households nationwide is actually climbing. Likewise, people who commute to their jobs sometimes need two residences, and many Germans expect each new apartment or house they move into to be a little bigger than the last one. The average citizen now uses 43 square meters of living space, or eight more than they did 20 years ago.

Proposed Solutions

Local communities, however, have been far too slow in reacting to these developments. Ulrich Pfeiffer, a former Building Ministry department head who now serves as the supervisory board chairman of Empirica, a real estate appraisal and consulting firm, accuses city and town officials of hoarding land available for building and only selling it to investors at exorbitant prices. In fact, there has been a sharp decline in the number of residential building permits issued in recent years, from 639,000 in 1995 to 228,000 in 2011. In addition, Pfeiffer claims that local authorities are imposing unnecessary but costly conditions on developers. "In the end," he says, "all of this affects rents."

But what can policymakers do? Building Minister Ramsauer's proposal to house students in floating dormitories, for example, doesn't solve the problem and is more indicative of a general helplessness than anything else. By comparison, proposals by local politicians and tenant advocates to enact legislation to reduce costs ought to be taken more seriously.

Experts agree that such a radical approach can work, but the question is whether the risks and side effects of new market interventions won't actually make the patient even sicker.

The DMB renters' association, for example, has proposed a rule that would limit rents on new leases to no more than 10 percent above comparable local rents. At first glance, this seems like a good idea: At times when the demand for housing is artificially inflated by cheap money and capital from Southern European investors, the government has to find ways to prevent the development of real estate bubbles.

But the real question is how this concept should be structured. If the government sets a nationwide ceiling on price increases, as the DMB proposes, it will deter investors in regions where there are genuine housing shortages. But if the ceiling only applied in booming markets, the authorities would have to identify the cities in which price increases are excessive and those in which they are acceptable. Experience has shown that government agencies are rarely right when it comes to making such assessments.

A no less dubious plan is that of the local administration in Berlin's northern Pankow district, which entails imposing a ban on so-called "luxury modernizations." Starting in January, it will be prohibited in much of the district to install a second bathroom or radiant floor heating system. This is the local administration's way of preventing a sharp rise in housing prices after renovations.

The initiative is well intentioned, but experts doubt it will produce the desired results. A family with several children will not necessarily perceive a second bathroom as a luxury. On the other hand, speculators could hit upon the idea of upgrading their properties by installing platinum-plated fixtures. These examples illustrate why officials with property owner associations, among others, believe that such programs are mostly ineffective.

City planners are also hardly likely to be galvanized by SPD chancellor candidate Steinbrück's proposal to start building low-income housing again like it was done in the 1960s and '70s. They remember all too well how the government-subsidized bedroom communities of the day often deteriorated into ghettos for welfare recipients.

Needed Legislation

Indeed, it is worth noting that the construction of low-income housing no longer plays its traditional role in the Social Democrats' campaign platforms. The most recent plan stems from Achim Grossmann, a former senior official in the Building Ministry, developed with a small team of experts at the request of SPD Chairman Sigmar Gabriel. The document envisions a stronger social integration of redevelopment areas in large cities as well as the targeted promotion of housing cooperatives.

The SPD is also thinking about simplifying the so-called "Wohn-Riester" (a government-subsidized home loan and pension-savings plan), blocking the sale of public housing associations and strongly limiting the share of residential spaces that can be converted into vacation rentals or offices.

Granted, such measures can create a few more housing units. But they will not forcibly bring about a real shift in trends affecting the real estate market. Instead, fundamental reforms are needed in the areas of politics that caused the problem in the first place. If rent increases are to be limited, state and local governments will have to invest more money in the construction of residential housing, simplify their building codes and classify more property as residential. As Hamburg Mayor Olaf Scholz puts it: "The amount remains the deciding factor. Believing in other panaceas would be an illusion."

It would also be helpful to adjust the goals of the Energiewende to better conform to financial realities. For example, instead of insisting on complete renovations, which are hardly worthwhile for either landlords or tenants, it would be better for the environment if property owners insulated doors and windows at a minimum.

The most important thing, though, is to tackle the problem of real estate speculation, which many experts believe has taken hold in a considerable portion of German cities. This, of course, is the most difficult task for politicians, as it is based on no less of an assumption than that the euro crisis will someday end.

Until then, to the delight of Berlin brokers and their customers from Southern Europe, rents will continue to rise. Italian small investors remain very interested, says broker Mingazzini, adding that all of Berlin is in demand, and that the reputation of an individual district doesn't really matter. "If an apartment is only a few subway stations from Friedrichstrasse, it's perfect," he says, referring to a major culture and shopping street in downtown Berlin.

Translated from the German by Christopher Sultan

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