Energy Efficiency Renovations. Who Foots the Bill?

Steinbeis study investigates the passing on of renovation costs for rental accommodation

According to an agreement signed by the two parties of the coalition government, the percentage of money invested in the renovation of rental real estate that can also be passed on to tenants will go down from the current rate of 11% of chargeable costs to 10%. This figure should also be limited to the period of amortization. The ruling is currently being implemented by the justice department. It is based on a false premise, however, regarding the actual revenues landlords can generate through renovations – this is the opinion of the experts at the Center for Real Estate Studies, a Steinbeis Transfer Institute belonging to Steinbeis University Berlin. Under the scientific chairmanship of Prof. Dr. Heinz Rehkugler and Prof. Dr. Marco Wölfle, the experts conducted a study which came to the conclusion that limiting the amortization of renovation costs weighs heavily on the revenues of landlords, which mostly become negative. They believe that the new law had a much greater impact on the financial standing of landlords than another hotly debated measure: rent control.

The basis of the project was a close examination of the financial viability of energy efficiency renovations. Drawing on a variety of possible rent price scenarios, the researchers at the institute developed a calculation model for simulating the profitability of measures based on different reference value models. This made it possible to estimate the impact – not just for landlords but also for tenants – of the following factors: increases in energy costs, renovation costs, increases in reference rental prices, the level of the original rent, the nature of financing and backing for completed renovations, the duration of the tenancy agreement after renovations. The calculation model showed that handing on 11% of renovation costs now and only 10% of costs in the future, did not actually correspond to returns of 11% and 10% in nearly any of the cases studied. If anything, according to the base model, the yield rate before and after tax was around 5.5%, with a relatively long amortization period of around 22 years. This had a particularly dire impact if, as is often the reality, it is assumed that the average rental agreement lasts 10 to 15 years. In such cases, renovations to improve energy efficiency are practically never worth it if landlords want to rent out real estate again and the achievable rental price is less than the extra cost of the renovation. In re-renting situations when rental prices are indeed much higher than reference rates in the area, there is a strong incentive for landlords to “drive out” tenants with the threat of higher rent after renovations – and then charge more for rent, which they would not have been able to by continuing with the current agreement.

From the tenants’ viewpoint the renovation costs they have to meet contrast with the savings they can make on heating costs. Even when renovations do make sense from a financial standpoint, the higher rent significantly outweighs the savings on heating costs for many periods, which is a burden on tenants. Since the costs that can be handed on to tenants are not linked to the savings they make, tenants will often not actually see net savings in the long term. Again, this strengthens the weight of the argument people use regarding short tenancy agreements:

Tenants pay for potential savings in the long term – savings they will never benefit from. For the tenants, the equation is basically the same as it is for the landlord: If tenants move out within 10-15 years of the renovation, and the renovation costs were handed on at the permissible rate, generally tenants have to pay more rent for the entire period than they can save in energy costs.

The German rental market reflects this dilemma. The renovation costs that are actually handed on to tenants are on average much lower than is permissible by law. The price just about stays level for rent, so increases in rent cancel out the savings that can currently be made on heating. The costs that can be handed on to tenants do not make it possible for landlords to make reasonable returns on their capital.

The Steinbeis study shows that the main drawback with the current law on handing on the cost of renovation work will also not be eradicated by the new amendment: It does not even start to solve the “landlordtenant dilemma,” it practically completely kills off any incentive for landlords to carry out energy efficiency renovations, yet it still does not prevent tenants from being unduly burdened with costs, nor does it prevent renovations being misused to evict tenants. This is because the handing on of renovation costs is still not in any way linked to how successful renovations were.

According to the Steinbeis experts, it would therefore be necessary to radically change the approach used to regulate increases in rental prices after energy efficiency renovations. A model of proportions, linking the handing on of renovation costs to the actual success of the measures, would be a much better solution to the outlined problem. This would ensure that renovations are only carried out

  • if they make sense
  • if landlords make suitable yields on their capital investments
  • if the renovations to save energy are not misused and tenants are not exploited

To keep promoting energy efficiency renovations, it would seem to make sense to leave the gains made by using public support in place, as an incentive to landlords.

Contact

The full version of the study is available in German on the CRES website.

Prof. Dr. Marco Wölfle
Steinbeis Transfer Institute Center for Real Estate Studies (CRES) (Berlin/Freiburg)
su1477@stw.de

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