Real Estate 2020

Last Updated April 14, 2020

Germany

Law and Practice

Authors



Linklaters LLP is a full-service provider offering international advice on legal and tax issues in the real estate industry, which gives it a leading edge in meeting client requirements and demands. The cross-practice team not only includes real estate experts, but also specialists in corporate, tax, finance, investment, competition and regulatory law. With more than 60 real estate lawyers in the Frankfurt and Munich offices and 350 real estate lawyers globally, the Linklaters real estate team is chosen by leading global investors, developers, occupiers and financial institutions to advise on their largest and most complex or multi-jurisdictional real estate transactions and disputes. The practice inter alia advises private equity clients (eg, Blackstone, Cerberus), funds and institutional investors (eg, BNP Paribas, CBRE Global Investors, LaSalle IM) as well as a number of Asian clients (eg, Samsung, Capitaland). The firm acknowledges with thanks the contribution made to this chapter by Alexander Zitzl and Lisa Waizenhöfer at Linklaters LLP.

The main source of real estate law is the Civil Code (Bürgerliches Gesetzbuch).

Of further relevance are:

  • the Land Registration Act (Grundbuchordnung);
  • the General Terms and Conditions for Building Contracts (VOB/B);
  • the Mandatory Fee Structure Regulation for Architects and Engineers (HOAI);
  • the Federal Building Code (Baugesetzbuch);
  • the Federal Land Use Ordinance (Baunutzungsverordnung);
  • the 16 states’ individual building regulations (Landesbauordnungen);
  • the Notarisation Act (Beurkundungsgesetz);
  • the Heritable Building Right Act (Erbbaurechtsgesetz); and
  • the Condominium Act (Wohnungseigentumsgesetz).

According to various surveys, the boom in the real estate market in Germany continued over the last 12 months, although the purchase price increase slowed down slightly. The year 2019 was another record year in the volume of sales in spite of a shortage of offers. In particular, the demand for real estate connected with services continued to grow. Niche products such as micro living, student housing and shared offices are a big topic. The most popular investment cities remain the top seven cities: Berlin, Munich, Frankfurt, Hamburg, Düsseldorf, Cologne and Stuttgart.

The most significant deals in Germany were the takeover of Dream Global, the sale of the Millennium Portfolio, the Omega Portfolio, the office campus Tucherpark in Munich, Die Welle and The Squaire properties in Frankfurt am Main.

A survey recently conducted by the Foundation for International Blockchain and Real Estate Expertise (FIBREE) and published in the FIBREE Industry Report Blockchain Real Estate 2019, has confirmed that the hype regarding the use of blockchain seems to have arrived in the "Trough of Disillusionment" (Gartner Hype Cycle) in Germany. There have been interesting developments and endeavours to take advantage of blockchain concerning real estate transactions, or to create new opportunities regarding capital investments in the form of tokenisation of real estate assets. However, real estate data is kept in incompletely digitalised silos which means that neither quality data nor a decentralised data infrastructure have been achieved so far. Furthermore, regulatory questions have not been clarified so the legal framework has not been established. Therefore, although both applications are promising, these two major challenges are unlikely to be solved in the next 12 months.

Many of the reforms proposed for or implemented in the year 2020 concern residential properties. In February 2020, the state Berlin introduced a rent price cap (Berliner Mietendeckel) under which rents are frozen at the status of the year 2019 and rents for new lettings are capped. Several other states are considering introducing similar laws in 2020. It has also been decided to extend rent control (Mietpreisbremse) until the year 2025 allowing municipalities to designate areas in which rent for new lettings may not exceed 10% of the local comparable rent. It has been suggested that the rent price cap should be extended to commercial properties. Furthermore, comprehensive reform of the Condominium Act is planned to be implemented until the year 2021 at the latest.

Money Laundering Law

As of the beginning of the year 2020, the Money Laundering Law (Geldwäschegesetz) was tightened. As a consequence, estate agents must perform KYC checks on their clients not only for the brokerage of sale and purchase agreements, but also for lease agreements with a rent of more than EUR10,000 per month. Notaries must not notarise sale and purchase agreements with a foreign entity as buyer if such entity is not registered in the ultimate owner register of an EU member state.

Property Tax Act and Real Estate Transfer Tax

In addition, two major tax reforms are impending. The property tax act was adopted in 2019 and will be applicable from 1 January 2025 onwards. The federal states might make use of the opening clause allowing them to adopt their own bases for levying the tax in the year 2020. Furthermore, the reform of the real estate transfer tax (RETT) on share deals is still subject to ongoing legislative discussion. Currently, a share deal only triggers RETT if at least 95% of the shares in a corporation or partnership holding German real estate are directly or indirectly concentrated in one hand. Furthermore, RETT is triggered if at least 95% of the partnership interest of a partnership holding German real estate is transferred within five years to a new partner. The reform intends to lower the 95% threshold and extend the holding period. In November 2019, legislative discussions seized up as the presented proposals were deemed not to be sufficient by some parties; however, the legislator agreed to peruse a further reform of RETT on share deals in the first half of 2020.

Generally, there are freehold titles granting full and absolute ownership and heritable building rights (Erbbaurechte) giving the right to lease the land for a certain amount of time (30–99 years) and to erect buildings on it. Both categories can be split into condominium shares accompanied by special rights of use for a designated area of the property.

Properties can be encumbered with various rights in rem such as easements (Dienstbarkeiten), land charges (Grundschulden) and mortgages (Hypotheken).

The Civil Code and the Land Registration Act apply to every transfer of title. In addition, permits under other laws, in particular the Federal Building Code for properties located in special areas and the Real Properties Transfer Act (Grundstücksverkehrsordnung) for first-time sales in eastern Germany after 28 September 1990, might be necessary. Local authorities might have statutory pre-emption rights in certain designated areas.

The laws applicable to transfer of title do not distinguish between the type of use of the property.

Transfer of title requires a deed notarised by a notary containing an agreement on the sale (Kaufvertrag) and an agreement on the transfer (Auflassung). The notary applies for the permits necessary for the sale and for the waiver of pre-emption rights, which are required as a prerequisite for transfer of title and usually also for the payment of the purchase price. The notary also informs the tax authorities about the conclusion of the sale and purchase agreement. They will issue a clearance certificate confirming that real estate transfer tax has been paid, which is also necessary for registration of transfer of title in the land register (Grundbuch).

While economic transfer of title (transfer of possession, use and burdens) is usually agreed for the day following the payment of the purchase price, the actual legal change of ownership only takes place upon registration in the land register.

Title insurance is not relevant due to the title guarantee resulting from the so-called public belief in the land register. Its accuracy is protected by law and therefore a buyer can acquire ownership in good faith (bona fide) even if the property is purchased from an unauthorised person registered in the land register.

Legal and technical due diligence is usually performed on documents provided by the seller. Technical advisers often carry out site visits. Some information can be obtained from authorities with power of attorney from the seller and public registers. In some cases, separate environmental due diligence is performed.

The typical legal report contains information about title and encumbrances, leases, public building and zoning issues and other permits (if required), environmental information and, if relevant, acquisition documents, service agreements and litigation. In a forward transaction where the building is still to be developed, the report also covers development, project management, construction, architectural and other agreements relating to the development.

The extent of representations or warranties agreed depends on the market climate. Germany is currently a seller’s market, giving sellers enough leverage to avoid granting the buyer large-scale representation or warranties. Instead of objective guarantees, guarantees to the seller’s best knowledge are often given.

The parties can agree on the type of remedies – either compensation in cash or actual repair of the damages. The parties often agree on a cap of the overall maximum amount of compensation. This agreement is regularly accompanied by both a de minimis method, granting damages only if the claim exceeds a certain amount, and a basket method, granting compensation only if the sum of all claims exceeds a certain threshold, resulting in the seller having to cover the total amount of the claims rather than just the difference between the total and the threshold.

The buyer carries the risk of the seller's insolvency often without being especially secured. Possible security would be paying a certain amount into an escrow account, holding back on a certain amount of the payment, or simply lowering the purchase price.

Often the statutory period for expiration of claims of approximately three years is limited to 12 or 18 months.

In addition to the civil and public law provisions mentioned in 1.1 Main Sources of Law, the provisions contained in the Anti-money Laundering Law (Geldwäschegesetz) are particularly important for investors and the required know-your-customer checks sometimes create unexpected bureaucratic hurdles. Company register excerpts, passport copies etc have to be provided to those who are obliged to carry out the checks. Corporations, partnerships and foundations operating on the financial market and/or buying real estate in Germany have to report their beneficial owners to the register of ultimate beneficial ownership (Transparenzregister). Checks and notifications not only have to be carried out by providers of financial services, but also to a certain extent by brokers, law firms and notaries.

Under the Federal Soil Protection Act (Bundesbodenschutzgesetz), the polluter, all current and former users, and all current and former owners of a property can be held liable for environmental laws irrespective of whether they are aware of the contamination or if it was caused by them. When requesting remediation measures, the authorities act solely on the basis of the principle of effectiveness and will usually charge the most financially sound party, which is often the owner. However, the owner may take redress from the actual polluter if their actions or fault can be proved.

A property owner has a right to a building permit if the proposed building complies with public building law. The issued building permit will ensure the legality of the building and its permitted use.

In many areas, the general public building law is substantiated in local development plans (Bebauungspläne) issued by the local authorities that make provisions for the permitted use and size of the property. If there is no development plan, the permitted use can be determined by the Federal Building Code and the Federal Land Use Ordinance. If no local development plan exists or significant amendments are required for a development to be permitted, the owner might enter into an urban development agreement (städtebaulicher Vertrag) with the local authorities with the aim of establishing/amending the project-related development plan in order to secure its building project.

The fundamental right to property is protected by the German constitution, which only allows the government to expropriate for public interest, if authorised by German law, for appropriate cause and against compensation. There are federal and federal state laws enabling expropriation. The procedure varies, depending on the law it is based on. Compensation is based on the market value of the property at the time of expropriation. 

Municipalities also have the right to expropriate as a last resort to fulfil their goals under the Federal Building Code, especially if the real estate is located in a development area (Entwicklungsgebiet).

Asset deals are subject to RETT, with the percentage varying between 3.5% and 6.5% depending on the federal state. VAT is normally not applicable to the sale of real estate. If the property is sold business to business, the seller can waive the VAT exemption, thus having VAT of 19% apply. The buyer has to pay this VAT to the tax authorities (reverse charge). If the buyer intends to use the real estate to render non-VAT-exempt supplies, the VAT triggered may be reclaimed as input VAT; hence no VAT would actually be payable.

Share deals may be structured in a RETT-optimised way. Usually less than 95% of the shares are transferred to one buyer with either the seller retaining the remaining stake, or a second buyer acquiring the remaining shares. If the interest in a partnership is transferred, RETT is not triggered if less than 95% of the interest is transferred to a new partner within five years. As a result, a buyer normally acquires less than 95%, with an option to acquire the remaining interest after five years. However, the German legislator plans to tighten these rules in the first half of 2020.

Generally, there are no legal restrictions on foreign investors acquiring real estate in Germany. 

However, as a consequence of stricter money-laundering rules from the beginning of 2020, a notary may only notarise a real estate sale and purchase agreement with a foreign entity as buyer and therefore a foreign entity can only acquire real estate in Germany if the entity is registered in the German ultimate beneficial owner register (Transparenzregister). Due to the European single market, registrations in an equivalent register of an EU member state are also sufficient. 

Generally, acquisitions are financed by both debt and equity with the ratio between the two depending on the market. Equity is often provided downstream in the form of shareholder loans which are expected to be subordinated to the debt financing. If insufficient equity is available in the company’s group, additional funds may need to be obtained from mezzanine lenders. For mezzanine loans there will typically be an increased margin, giving the lender a way to participate in the profit and/or the possibility to transform the loan into an equity participation (“equity kicker”).

Portfolios are often financed by syndicated loans involving different lenders and secured debt is traded between the lenders. For refinancing, the so-called “Pfandbrief” is often used. In this case, the loan and the granted security must comply with a strict standard. 

Furthermore, sale-and-leaseback transactions can be seen as a different form of financing, as the former owner and now tenant of the property activates new liquidity. 

The most important security granted over real estate is the land charge (Grundschuld) or mortgage (Hypothek). While the more often-used land charge is non-accessory in nature and connected to the secured claim via a security purpose agreement, the mortgage is accessory in nature and attached to the underlying claim. Both are registered as rights in rem in the land register as encumbrances over the freehold property or a hereditary building right. 

In addition, the typical security package includes the assignment of rental income, claims under the acquisition agreement, the property management agreement, insurances and contractor agreements. Bank accounts and shares or interest are pledged to the financing bank. The property/asset manager is expected to conclude a duty of care agreement.

If developments are financed additionally, cost overrun and/or finance costs shortfall guarantees are commonly granted by the sponsor.

There are no restrictions on granting security over real estate to foreign lenders and there are no restrictions on repayments being made to a foreign lender under a security document or a loan agreement.

However, the payment of interest to foreign lenders can be restricted. Under German tax, banks and other financial services providers must withhold taxes on interest payments made to foreign lenders that do not themselves qualify as a bank or financial services provider. 

If a foreign lender has a permanent establishment in Germany and the loan is attributable to this establishment, the foreign lender is subject to German taxation on the profit resulting from the loan. Depending on the applicable double taxation treaty, the interest will generally either be tax-exempt in the foreign jurisdiction or the German tax will be credited against the tax liability arising in this jurisdiction.

Land charges/mortgages as well as share pledges require notarisation which triggers mandatory statutory notarial fees. Furthermore, the mandatory registration of land charges/mortgages in the land register triggers registration fees. If the land charge/mortgage is granted by a foreign entity, the land registry often requests a cost advance before registration.

Enforcement of security is done via court proceedings for which court fees are payable. The court will only initiate the proceedings once the secured creditor applying for the proceedings has paid a cost advance.

No taxes apply to the granting and enforcing of security. However, if a land charge/mortgage is enforced by way of public auction, RETT (between 3.5% and 6.5% depending on the German federal state in which the property is located) is payable, for which the successful bidder and the property owner are jointly liable. 

Additionally, interest on loans granted by a foreign lender and secured by German real estate would trigger German domestic income for the lender; ie, interest would in principle be subject to German income tax if no double tax treaty excludes a German right to tax this income.

Depending on the security granting entity, financial assistance and corporate benefit rules must be complied with.

The prohibition on financial assistance only applies to German stock companies (Aktiengesellschaften). If there is a control agreement or a profit transfer agreement (Beherrschungs- oder Gewinnabführungsvertrag) in place between the stock company and the financially assisted company, the prohibition on financial assistance does not apply. A transaction carried out in violation of the financial assistance rules is void.

As a corporate benefit rule, managing directors are legally obliged vis-à-vis their company to act as prudent business people. In upstream or cross-stream loans within a group, there is an obligation on the lending entity to take security if there is a credit risk in relation to the borrowing entity. Furthermore, the German Code of Corporate Governance applies to members of the managing board and the supervisory board of German listed stock companies. An infringement of corporate benefit rules does not lead to the invalidity of a transaction, but to the possible liability of the directors, managing board, and/or supervisory board. 

In addition, other rules deriving from corporate and insolvency law apply, including rules relating to capital maintenance, restrictions on transactions between a company and its affiliates other than its own subsidiaries, and provisions relating to transactions that disadvantage creditors and have been entered into within certain periods before the commencement of insolvency proceedings. 

In addition to contractually agreed pre-requisites for the enforcement of security, such as serving an enforcement notice to the security grantor and the borrower and giving the chance of healing the default, additional statutory requirements apply to the enforcement of a land charge/mortgage. It must be terminated with a mandatory six months’ notice period and the enforceable copy of the land charge/mortgage deed must be officially served to the property owner. Only once this has been done, can enforcement proceedings via forced administration and/or forced auction commence.

Additional steps to give priority to a lender’s security interest are not required.

Existing secured debt can be subordinated both by agreement and by law.

A creditor can agree to subordinate its existing debt to that of another creditor by means of a subordination agreement or an intercreditor agreement. If the existing debt is secured by a land charge/mortgage and such land charge/mortgage will be subordinated to a newly created land charge/mortgage, registration in the land registry of such subordination is required in order for it to become effective.

Shareholder loans and other arrangements equivalent to shareholder loans are subordinated to the claims of all other creditors by law, except:

  • when the relevant shareholder is not a director of the company and does not hold more than 10% of the registered share capital in the company (minority shareholding privilege – Kleinbeteiligungsprivileg); or
  • when the shareholder has acquired shares with the intention of rescuing the company from insolvency (restructuring privilege – Sanierungsprivileg). 

In addition, newly created debt is subordinated by law to outstanding debts towards public authorities.

A lender holding or enforcing security over real estate cannot be held liable under environmental laws due to its position as lender/security beneficiary. 

Under the Federal Soil Protection Act, the polluter, all current and former users and all current and former owners of a property can be held liable for contamination. The lender can therefore be held liable in the unlikely circumstances that they were in possession of the property or that they are themselves the polluter.

In certain circumstances, a borrower's insolvency administrator may challenge agreements entered into by the borrower between one month and ten years prior to the filing for the opening of insolvency proceedings. The following reasons exist for challenging security interests granted by the borrower:

  • the creditor had knowledge of the borrower's illiquidity, or the borrower had already applied for the opening of insolvency proceedings, or the creditor is aware of circumstances leading directly to the conclusion that the borrower is illiquid or has applied for insolvency proceedings; 
  • the creditor is a shareholder of the borrower; 
  • the borrower provided the security intending to discriminate against the rights of other creditors and the creditor was aware of this intention; 
  • the creditor did not have a valid right to obtain the security that he was not due to receive, or was not yet due to receive, or was due to receive in a manner that was otherwise inconsistent with the original agreement between the borrower and the creditor; 
  • the interests of other creditors were directly prejudiced at the time the security was granted (it not being sufficient that they might have been prejudiced as a result of granting the security); or 
  • the security interest was granted gratuitously.

If immediate and adequate consideration was received by the borrower for the transaction for which the security was granted, it can only be challenged by the insolvency administrator if the transaction was undertaken wilfully to discriminate against other creditors' rights. 

If a transaction is successfully challenged, the secured creditor has to repay any amounts already received or release the respective security interest.

In German financings, reference is made to EURIBOR (Euro InterBank Offered Rate) and not to LIBOR (London Interbank Offered Rate), ie, the expiry of LIBOR is less relevant. Where applicable, it will most likely result in a change in the fair value of the underlying financial instrument, which may require adjustments to the contracts. For borrowers, this may involve additional internal and external transaction costs.

Currently, there is still a lot of uncertainty and loan agreements usually provide for a transmission to other rates including re-negotiations. 

In Germany, strategic planning and zoning are governed by federal statutory law and the relevant statutory law of each of the 16 German states, as well as regional and local development plans (Flächennutzungspläne, Bebauungspläne). Particularly important codes are the Federal Planning Act (Raumordnungsgesetz), the Zoning Codes of the German states (Landesplanungsgesetz), the Federal Building Code and the Federal Land Use Ordinance.

The design, appearance and method of construction of new buildings or refurbishment of existing buildings are governed by legislation, specifically the Federal Building Code and the Federal Land Use Ordinance. Concerning the safety of buildings (fire safety, layout and structural safety), the building codes of the respective federal states apply.

The municipality is responsible for the regulation of the development and use of individual parcels of land. The federal government of Germany lays down "leading concepts" (Leitbilder), such as the guarantee of equal living conditions within Germany, the protection of the natural environment, and the necessity of correcting structural imbalances between former East and West Germany.

The federal states establish comprehensive plans (Raumordnungspläne) covering the entire state. Those plans and their objectives are binding on all subordinate planning authorities. They mostly cover the requirements for the desired structure of settlements, the need for areas to remain undeveloped, and infrastructure locations and routes.

The municipalities' planning functions are carried out at two levels:

  • the development plan for the entire territory of the municipality (Flächennutzungsplan), which lays down the main features of the various types of land use that will be permitted on the basis of intended urban development and the anticipated needs of the municipality, like areas earmarked for development, transport, public infrastructure, green spaces, etc; and
  • a detailed plan for individual areas within the municipality (Bebauungsplan), which designates the permitted land use and usually refers to the Federal Land Use Ordinance, giving a detailed description of the building areas (such as residential, industrial, retail or business) and restrictions on the size, height and floor area of permissible buildings.

In order to obtain entitlements to develop a new project or complete a major refurbishment, an application specifying the planned construction works and the use of the land must be submitted. The responsible authorities will then forward the application to any other authority with a potential interest in the planned project.

The responsible authority itself verifies whether the project complies with planning law. If it does, and if no relevant concerns are raised by the other authorities involved, the responsible authority must grant the building permission. 

Legal action can be taken against the relevant authority's decision to refuse planning permission. Third parties, such as neighbours, can commence proceedings against the issuance of a building permit if they can prove that the decision may unlawfully affect their rights.

Arrangements known as urban development agreements can be entered into between building owners or developers and the relevant municipality. In these contracts, the municipality undertakes to support the building owner/developer, or the building owner/developer undertakes to support the municipality in its planning goals.

Local planning authorities can take certain steps to enforce restrictions on development and designated use. They can issue an injunction against proceeding with construction works where the relevant regulation has not been complied with (Baueinstellungsverfügung) or an injunction against using a building that has been erected in contravention of the regulations (Nutzungsuntersagung).

Generally speaking, any entity, including foreign entities, that has legal capacity can hold real estate in Germany, unless prohibited by law or court or administrative order. Limited liability companies (GmbH) and limited partnerships (KG) are most commonly used to acquire and hold real estate.

German law also recognises real estate investment trusts (REITs), which are listed real estate stock companies. However, there are only five REITs listed in Germany.

Limited Liability Company

A GmbH as limited liability company is a corporation acting fully independently of its shareholders, subject to rights and obligations. Only the company assets of a GmbH serve to discharge the company's obligations vis-à-vis creditors, and any personal liability of the shareholders is excluded if the capital contributions have been fully paid. The applicable legal framework is quite flexible, and the company's articles can be adjusted to specific needs. Its foundation requires a notarial act. The management is vested with one or more managing directors, who are generally bound by the instructions of the shareholders. The company may have a supervisory board (Aufsichtsrat).

Limited Partnership

The KG is a limited partnership under German law and must have at least two partners. The partnership agreement does not require notarisation, unless it contains obligations requiring the observation of specific form requirements (eg, contribution of real estate). It is characterised by having at least one general partner, personally liable without limitation, and one or more limited partner(s) only liable to the extent of their liable contribution (Hafteinlage) registered in the commercial register. Additional contributions can be agreed. The management is vested with the general partner.

The minimum share capital for a GmbH is EUR25,000. Capital contribution in kind is possible but is subject to further restrictions. 

No minimum capital requirements apply for a KG.

No specific governance requirements apply to real estate investments as such. However, regulatory requirements apply if the investment vehicle qualifies as an investment fund under the German Investment Code (KAGB) – ie, any collective investment undertaking that raises capital from a number of investors, with a view to investing it in accordance with a defined investment policy for the benefit of those investors, and that is not an operative business outside the financial sector. The German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht) supervises German fund managers and investment funds offered by such companies under the provisions of the KAGB.

The annual entity maintenance and accounting compliance costs depend on the individual circumstances of the entity and the property itself.

German law differentiates between Pacht, entitling the tenant to use the property and to benefit from it, and Miete, which only entitles the tenant to use the property. For example, the lease of a hotel including all fixtures and equipment and the right to operate the hotel is regarded as a Pacht contract.

There are no different types of commercial leases, apart from the general differentiation explained above.

Leases are subject to the Civil Code, which regulates basic contractual matters. Within that scope, contracting parties may freely negotiate the contractual provisions, as long as they do not violate any mandatory law, eg, regulations on the maximum rent payable and its increase for residential leases.

Fixed leases typically run for a period of between five and ten years. Often extension options are agreed. It is possible to negotiate terms up to 30 years. 

The landlord is obliged to maintain the premises in the agreed condition– therefore, the landlord must bear all costs for repairs and decoration. It is market standard for maintenance and repair works to be overburdened to the tenant at its own cost. In most cases, the landlord remains responsible for structural and major repairs, and the tenant carries out internal repairs and maintenance as well as repairs solely for interior decoration.

Case law regards clauses that oblige the tenant to repair the roof and structure of the leased premises, to decorate at fixed intervals, to comply with unlimited renovation obligations at the end of the term, or to pay for renovation irrespective of the premises’ actual state at the end of term, to be unfair and invalid. 

Triple net leases (in which the tenant agrees to pay all real estate taxes, building insurance and maintenance) are generally not permitted unless individually agreed, for example, in sale-and-leaseback transactions.

Rent is mainly paid on a monthly basis. In rare cases quarterly, six-monthly or yearly rents are agreed.

In principle, the parties are free to agree on the amount of the rent and its increase under commercial tenancy law. The parties generally agree on rent adjusting systems, such as indexation rent, graduated rent or turnover-linked rent. For residential leases, limitations apply to the possible rent increase and it is likely that those will become stricter in the near future.

It is usual to agree on the rent adjustment system in the lease agreement itself. It is seldom agreed to negotiate a new rent based on the then-applicable average market rent after a certain number of years or if the tenant has exercised an option right. Generally, commercial rents are adjusted according to changes in the Consumer Price Index (Verbraucherpreisindex). A graduated rent will be raised continuously by a certain amount after a certain period of time. A turnover-linked rent will be adjusted to the change of turnover of the tenant for a certain period of time; in order to mitigate the risk of falling sales, a minimum fixed rent is usually agreed.

In principle, rent is VAT-free. However, the landlord may waive the VAT exemption, thereby entitling it to deduct input VAT. This is only possible if the tenant exclusively uses the premises to render supplies which do not exclude the right to deduct input VAT; ie, the landlord’s input VAT deduction depends on the tenant’s use. Hence lease agreements normally provide for a compensation claim if the landlord’s waiver fails due to the tenant’s use.

Rent securities such as deposits or bank guarantees are often requested before the commencement of a lease, if agreed upon in the lease agreement. In landlord-friendly markets such as Berlin, Frankfurt and Munich, landlords also increasingly demand a lump sum payment for administration costs of between 1% and 5% of the annual rent. Such lump sum payment has to be made irrespective of whether such administrative costs have actually been accrued by the landlord.

Generally, the landlord must pay for the maintenance and repair of commonly used areas, provided no other agreement has been made in the lease. In commercial leases, those costs usually have to be borne by the tenants in proportion to their leased area and are normally capped at 5–10% of the annual net rent.

The Civil Code provides for two ways of regulating such costs: either the actual costs can be allocated to the tenants on an annual basis, or an annual lump sum can be fixed to cover these costs. It is also possible for specific utilities to be allocated to the tenant according to the actual consumption, and a lump sum payment agreed for other utilities. The parties can also agree that the tenant will enter into direct contracts with the utility provider for specific utilities. Leases generally provide for a monthly utility cost prepayment together with the rent. The actual costs will be settled regularly within 12 months of the end of each rental year.

It is market standard for the landlord to procure an all-risk insurance policy for the building, usually covering the risks of fire, storm, hail, water damage and other natural disasters. The incidental insurance premiums are allocated to the tenant as part of the operating costs. The landlord's insurance policies, however, do not cover any personal property of the tenant; therefore, the tenant should cover possible damages with liability insurance. Landlords also often take out loss of rent insurance and, depending on the location of the property, terror insurance at their own cost.

The specific use of the real estate is generally agreed between the parties in the lease agreement. Any change of use is usually subject to approval by the landlord. Public building law and the respective zoning plan also impose what uses are possible and the building permit for the property is issued for a specific use based on this. If the tenant intends to use the real estate in deviation to the use granted in the building permit, a change-of-use permit must be obtained from the responsible building authority. Such permit might require additional building requirements to be adhered to. The agreement between the parties who bear the related costs and carry out the necessary measures very much depends on the market situation. 

Regarding subletting, the landlord may restrict the use to the extent that it is only permitted with the landlord's consent. Furthermore, the landlord generally lays down house rules – ie, general conditions for the use of the property – to avoid conflict between and with tenants.

The tenant may not cause any damage to the real estate, which might also – from the landlord’s point of view – include any alterations or improvement. It is important for the tenant to clear the conditions the landlord has set in the lease agreement before starting to change anything substantially and irreversibly. Any alterations by the tenant are generally subject to the landlord’s prior consent.

Besides the Civil Code, there is no special regulation or law regarding the lease itself. However,operation of the tenant’s business in the premises may be subject to particular laws and regulations, which might have an impact on specific provisions in the lease. Furthermore, specific laws and regulations can apply to the rent payable by residential tenants and its increase.

A landlord does not have the right to terminate a lease due to the tenant’s insolvency. A termination due to rent arrears is only possible before the opening of insolvency procedures over the tenant’s assets. 

If an insolvency administrator is appointed for the tenant under insolvency legislation, the administrator has an extraordinary termination right regarding the lease. During the insolvency proceedings, any claims of the landlord against the tenant must formally be filed with the insolvency administrator. 

A rent security is usually agreed between the parties. For residential leases, a cash deposit or pledged account is typical, while various other rent securities can be found in commercial leases, particularly bank guarantees or letters of comfort (Patronatserklärungen). For residential leases, German law prohibits a rent security exceeding three months’ net rent.

Additionally, the landlord has a lien (Vermieterpfandrecht) over the movable assets of the tenant in the leased premises. This lien has priority over contractual liens.

The Civil Code gives the tenant the right to occupy the premises even if the contractually agreed fixed term has ended, if the landlord does not object within two weeks after the official termination date. In this case, the lease will continue, and statutory ordinary termination rights (usually between six and nine months) will apply. Parties regularly exclude this provision in lease agreements. Leases do not typically contain any further stipulations to ensure that the tenant leaves on the termination date, as the tenant is obliged to vacate the premises after the lease has ended under statutory law. Therefore, the landlord cannot arrange for timely eviction by the tenant in advance, but can claim for damages if the tenant does not vacate the property on time.

The right to sublet to third parties is commonly accepted, and in the case of residential leases it cannot be excluded. Subletting is usually subject to the landlord’s prior written consent which can only be withheld for good cause. The main tenant remains fully liable for rent payment and compliance with other obligations under the lease agreement vis-à-vis the landlord. It is sometimes agreed that the surplus rent generated in the sub-lease or a certain percentage thereof has to be paid out to the landlord. If VAT is payable in addition to rent, subletting is often only permitted to parties which must pay VAT as well.

Non-authorised subletting constitutes a serious offence and justifies extraordinary termination of the lease agreement without notice. 

For a transfer of the entire lease agreement to a third party, an agreement involving the landlord, the old tenant and the new tenant is necessary. In commercial leases, a transfer without the landlord’s involvement is sometimes permitted to affiliated companies. 

Commercial leases are usually agreed for a fixed term and ordinary termination rights are excluded. Sometimes break options towards a pre-determined date are granted to the tenant. The Civil Code grants both landlord and tenant extraordinary termination rights if the other party cannot reasonably be expected to continue the lease, considering all circumstances of the individual case. 

The tenant may terminate if:

  • the property is not handed over on time;
  • if the tenant is deprived of its use; or
  • if the landlord has increased the rent.

The landlord may terminate if:

  • the tenant violates the rights of the landlord by substantially endangering the property; or
  • if the tenant is in significant rent arrears (for two successive due dates or for payments amounting to at least two months’ rent).

The Civil Code also grants both parties a right to terminate the agreement 30 years after the start of the lease, with a statutory notice period of six to nine months.

In addition to this, in commercial leases parties typically agree on further extraordinary termination rights in favour of the landlord, such as unauthorised subletting. If the property is sold due to foreclosure or the insolvency of the owner, the new owner has an extraordinary termination right. 

There are no registration requirements for leases and the lease as such cannot be recorded in the land register. However, form requirements apply. Leases of a fixed term of more than one year need to be in writing, signed by each party, and contain all terms and conditions. If a lease contains a pre-emption right or is part of a sale-and-leaseback transaction, it needs to be notarised. 

Tenant easements (Mieterdienstbarkeiten) preventing an early termination in case of the landlord’s insolvency or a forced auction over the premises and permanent right of use (Dauernutzungsrechte) for which statutory lease law only applies if expressly agreed, must be registered in the land register. 

For such registration, an approval certified by a notary is required. Statutory registration fees are applicable. The parties can freely agree who bears these fees and the costs are usually seen in the context of the entire commercial agreement. No matter what the parties decide, vis-à-vis the land registry, the party that files the registration application will be liable for the fees.

A tenant can be forced to leave after a lease agreement is effectively terminated or has expired. If the tenant will not leave voluntarily, the landlord can file for an action for eviction (Räumungsklage). If the tenant does not follow the court's order, the landlord can file with the local authorities for a forced eviction (Zwangsräumung). However, due to various regulations protecting the tenant and the inevitable court proceedings, this can be a long process and an average timeframe cannot therefore be given.

If the leased premises are sold due to the landlord’s insolvency or due to foreclosure, the buyer of the leased premises has a statutory extraordinary termination right regarding existing leases. In such instances, the tenant generally cannot claim compensation for lost expenditure but may be able to claim against the buyer for unjustified enrichment if the buyer is able to lease the premises to a third party for a higher rent than the rent agreed with the tenant.

Protection against such extraordinary termination right can be granted in the form of a tenant easement, which gives the tenant a right in rem to continue to occupy and use the premises in accordance with all conditions set forth in the lease agreement, irrespective of the termination. The tenant easement is an encumbrance that needs to be registered in the land register. 

For construction agreements, two types of prices are usually agreed on: either a unit price (Einheitspreis) for partial services or a fixed price (Pauschalpreis) for the completion of the entire project. If the parties choose to agree upon a unit price, all individual services provided to complete construction as a whole are listed separately. In this case, the price is not fixed in the beginning but will be calculated depending on the services and units actually delivered for construction. The construction contract therefore includes only a cost estimate, which is not final until the final invoice for the work is rendered.

Hourly-rate contracts (Stundenlohnverträge), cost-plus contracts (Selbstkostenerstattungsverträge) and guaranteed maximum-price contracts are relatively rare.

Often the responsibility is split between a constructor for construction work and an architect for the planning of the project. In this case, the cost of the architect's remuneration is prescribed by law (HOAI, the official scale of fees for services by architects and engineers); for the constructor it is – as usual in German Civil Law – freely negotiable.

The other possibility is to instruct a general contractor for all construction services, including planning tasks. In this case, the HOAI is not applicable, although architect services are included in the general contractor agreement.

To manage construction risks on a project, a constructor's all-risk insurance is a general liability insurance normally used to reduce risk. Additionally, the Civil Code offers a liability system, which usually applies to every construction, architect and engineering contract. Furthermore, it offers a special liability system including a longer limitation period regarding construction contracts, taking the general terms and conditions for building contracts into account. The liability of a contractor is generally not limited. Some contracts provide limitation of liability in the amount of the insurance coverage or to the extent of purpose or gross negligence.

Under the Civil Code, the contractor is liable for construction delays if they are caused negligently or wilfully.

Furthermore, the parties may agree on contractual damages (Vertragsstrafe) for the delay of contractually agreed milestones. In this case, the parties agree on a certain amount the contractor has to pay for each day's delay after the breach of a milestone, with a usual maximum cap of 5% of the overall fee. The parties may agree intermediate milestones or the finalisation date of the construction work, which will be subject to liquidated damages. According to High Court judgments, the maximum amount of damage per day may be 0.25% of the net purchase order for the finalisation of construction work and 0.15% of the net purchase order for any agreed intermediate milestones. In any case, the liquidation damages have to be deducted from any damages for delay of works under the Civil Code.

A warranty bond of 10% of the net fee is market standard to secure the performance of the contractor's work until completion. 

From completion onwards, a warranty bond of 5% of the amount of the final invoice for malperformance within the liability period is market standard. 

Generally, the warranty bonds are provided as bank guarantees.

Contractors of a construction project (or parts of such) may acquire a right over the property, comparable to a lien, in the form of granting a mortgage on the property to secure the contractor's remuneration (Sicherungshypothek des Bauunternehmers). However, this is only applicable if the buyer is also the owner of the relevant property on which construction work is performed and the work whose value is to be secured has already been performed. In addition, the contractor may claim a lien (Werkunternehmerpfandrecht) on movable items the contractor has been instructed to create or modify for the buyer.

Once the contractor’s payment claim has been satisfied, it is obliged to approve of the deletion of the encumbrance in the land register and to return the movable item to the buyer.

For all building projects, the necessary building permits must be obtained before the start of construction work. This includes the official approval of necessary fire safety standards and other technical certificates by the building authority or the responsible engineer. In some, but not all federal states, the building project is formally accepted by the building authority after completion. 

In some instances, if the building is intended for a specific commercial or industrial purpose, a business licence must also be issued.

VAT is normally not applicable for the sale of real estate. If the property is sold business to business, the seller can waive the VAT exemption, triggering VAT at a rate of 19%. The buyer owes the VAT triggered to the tax authorities (reverse charge). If the buyer intends to use the real estate to render non-VAT-exempt supplies, the VAT triggered may be reclaimed as input VAT; hence no VAT would actually be payable.

These principles do not apply for operating facilities (Betriebsvorrichtungen), the transfer of which is always subject to VAT. Furthermore, no VAT would be triggered if the real estate is transferred by way of a transfer of a going concern (Geschäftsveräußerung im Ganzen) which is not subject to VAT by law. A transfer qualifies as a transfer of a going concern, if the buyer continues the VAT-able business rendered by the seller, which typically applies if the buyer continues the existing lease agreements.

German tax law does not provide any commonly used methods to mitigate the RETT burden in asset deals. However, share deals may be structured in a RETT-optimised way; see 1.4 Proposals for Reform and 2.10 Taxes Applicable to a Transaction. Furthermore, if partnerships are affected, a pre-transaction conversion of these partnerships into corporations might be reasonable, to avoid RETT being triggered by the mere transfer of at least 95% of the partnership interest to new partners within five years, as this rule only applies to partnerships.

The municipality charges property tax. It is assessed on a value (Einheitswert) usually below the market value; the average tax rate varies between 1.3% and 1.5%, depending on the municipality. However, reference is made to the reform plans for the property tax regime mentioned in 1.4 Proposals for Reform.

Generally, no income tax withholding applies to foreign investors for rental income they derive from German real estate.

Corporations are subject to corporate income tax which is levied at a rate of 15% (plus solidarity surcharge of 5.5% on the corporate income tax). 

Corporations are generally subject to trade tax if they maintain a trading business or a permanent establishment for the purpose of this trading business in Germany. Leased real estate does not qualify as a permanent establishment for this purpose. In addition, the lease of real estate can be exempt from trade tax due to proper structuring, ie, if the investors limit their activities in Germany to the mere letting of real estate and do not render any harmful activities (eg, the letting of operating facilities). Trade tax is levied by municipalities at rates varying between 7% and 17.15%. 

If a partnership leases out real estate, the rental income will be subject to income tax at the level of the partner. However, trade tax triggered will be due by the partnership. Unlike corporations, partnerships may be structured in a way that they are not subject to German trade tax but qualify as a mere asset-managing partnership (vermögensverwaltende Personengesellschaft).

The same applies to the capital gains from the sale of real estate.

Capital gains from the sale of shares in a corporation holding German real estate are generally subject to German income tax. However, if the shares are held by a corporation, a participation exemption of 100% or 95% might apply.

Buildings are subject to depreciation at an annual rate of 2% or 4% on the acquisition costs. Land and shares are not depreciable. Taxable rental income will further be reduced by costs incurred for rendering the lease (eg, interest, maintenance).

If the investor has a permanent establishment in Germany, profits from the sale of real estate allocable to this permanent establishment can be offset by accounting for a reserve that reduces taxable income, subject to specific circumstances. This reserve will reduce the acquisition costs of real estate that is acquired in later years. Thus, the gains built in real estate do not have to be taxed upon their revelation (ie, the sale of real estate property) but can be delayed by transferring the built-in gains to newly acquired real estate.

Linklaters LLP

Taunusanlage 8
60329
Frankfurt am Main
Germany

+49 69 71003 0

+49 69 71003 333

info@linklaters.com www.linklaters.com
Author Business Card

Trends and Developments


Authors



GSK Stockmann is a leading independent European corporate law firm with more than 200 professionals across offices in Germany and Luxembourg. It is the law firm of choice for real estate and financial services. It also has deep-rooted expertise in key sectors including funds, capital markets, public, mobility, energy and healthcare. The dedicated teams provide expertise and experience in M&A, private equity and venture capital, dispute resolution, tax, compliance, restructuring, IP and IT, data protection, antitrust and employment law, enabling them to find the right solution for clients' business needs.

A Market Under Pressure – Growing Interest in Project Developments at Increasingly Early Stages – The Basics of Forward Funding (Deals)

Market Overview

2019 was an excellent year for the German real estate sector, with the market for commercial real estate investments achieving record results. According to the spring report of the German Property Federation (ZIA), EUR72.6 billion was invested in commercial real estate in 2019, which is far above the investment volume of around EUR65 billion invested in the previous record year of 2007.

2020 started out very strong, but then, the COVID-19 pandemic hit the European market with full force. The real estate industry as well as the entire economy is trying to find a way through the COVID-19 crisis.

Against this background, it is no surprise that the transaction market is currently slowing down. According to a survey conducted by Engel & Völkers Investment Consulting (Evic) in March 2020 47% of the responding investors continue their transactions, 43% are suspending ongoing transaction processes and 10% have cancelled processes in the last two weeks.

The long term consequences of the COVID-19 crisis remain to be seen. But, apart from the stock and bond market, real estate will remain the most important asset class. It is therefore likely that the real estate market will continue to be of utmost importance for national and international investors. This assumption is backed up by various expert reports (eg, by Prof. Dr. Michael Voigtländer, head of the German Economic Institute; bulwiengesa, “Coronavirus Crisis:10 Expert Statements”, etc) which hold the opinion that the German real estate market will presumably face a “V-shaped” recession, ie, a fast drop and recovery of the economy, supported by the numerous state aid programmes and by solidarity among the market players. Some asset classes, such as logistics, food-anchored local supply centres or industrial facilities, might even come back stronger.

It is more than unlikely that the European Central Bank (ECB) will raise its key interest rates in the near future, the European Union as well as the European countries are even pumping more money into the market. The general attractiveness of Germany as a real estate location and the perception of real estate as a safe and stable investment harbour will also continue to play an important role. But above all, the unchanged lack of investment alternatives will presumably reinforce this trend in a few months’ time.

However, in times of a remaining shortage of real estate on the market, especially of available existing buildings, real estate investors will continuously have to be prepared to take risks in order to get ahead. One effective way to achieve this is to buy real estate at an early development stage. This is where forward deals come into play. In certain segments, there have been more acquisitions of project developments than existing buildings in the last few months. 

Forward Purchase vs Forward Funding

What is a forward deal?

Forward deal purchase contracts are so-called mixed-type purchase contracts and contracts for work and labour. The seller sells the buyer a plot of land and also owes him or her a work/service: building the property. At which project stage the buyer acquires the development varies from case to case. Often, the purchase contract is concluded after the building permit has been obtained, construction has begun and the first rental agreements have been signed. However, the purchase contract can also be concluded much earlier, sometimes even before the building permit for the project has been issued.

There are two common types of forward deals: forward purchase deals and forward funding deals. In a forward purchase deal, the buyer pays the purchase price after the project development has been completed and accepted and, if necessary, only once a certain occupancy rate has been reached. In a forward funding deal, on the other hand, the buyer pays the purchase price “MaBV-like” (in line with the German Brokers’ and Commercial Developers’ Ordinance applicable to developer contracts with consumers): according to the progress of the construction work. With the exception of the final instalment, the tranches are due before construction is complete.

In a forward purchase deal, the construction risk is almost entirely on the seller. The buyer does not pay the purchase price until after acceptance. Before paying the purchase price, the buyer can verify whether the building project has been completed in its entirety and without defects. If this is not the case, the buyer may refuse acceptance or – if the project is generally ready for acceptance – at least retain a portion of the purchase price. This is a safe position for the buyer to be in.

In practice, forward purchase deals are more complex than transactions of existing properties. In particular, the details of the completed building project and acceptance must be well defined. It must be very clear what the seller has to build by when, when the buyer has to pay the purchase price and how the buyer is indemnified.

In a forward funding deal, buyers bear an even higher risk because they are paying purchase price instalments before the building project is completed. Forward funding agreements are therefore considerably more complex than forward purchase agreements.

Why should I consider forward deals at all?

Forward deals offer the great advantage of early planning security for both the seller and the buyer.

The seller has already sold his property before construction is completed (sometimes even before construction has begun). The risk of having to find a buyer is eliminated early. The seller has nothing more to do than to “just” erect the building in accordance with the agreement. The buyer scoops the property from the market at an early stage. In these times of real estate shortage, this is an especially decisive advantage. Many project developments do not even make it onto the market for existing buildings any more; if you do not buy them by way of a forward deal, you cannot buy them at all.

From the sellers’ perspective, the financing side is also important. It is often easier for sellers to obtain financing in a forward purchase deal. After all, they have already secured a buyer who will pay a fixed (minimum) purchase price. In a forward funding deal, the financing aspect goes a significant step further. The investor can replace the bank as he is paying the tranches. Ideally, the investor will be making the payments in the same “rhythm” as the sellers fulfil their obligations vis à vis the contractors. This means that – if set up well – financing can be replaced altogether. But why would investors do that? It allows them to secure a property and place investor money earlier.

The fact that the purchase price is determined well before construction is complete is both an opportunity and a risk for both parties. They build up a “long” or “going short” position, depending on how they anticipate market developments. For example, sellers may intend to secure the currently (still) high prices. However, if the prices go through the roof later, sellers may regret this decision afterwards. In contrast, the buyer regularly speculates on a further price increase.

Pitfalls – defining the terms of forward funding

Forward purchase deals and forward funding deals are identical in many areas. In particular, both require precise stipulation of the property acquisition, the owed building details and the construction phase, albeit with varying levels of detail.

For instance, the parties need to define a structure that does not yet exist. A precise definition is necessary in order to be able to compare the owed building with the building that is actually constructed. This is important not only from the point of view of the buyer as the purchaser of the building project, but also from the perspective of the buyer as the future landlord. If the building project deviates negatively from the owed building agreed in the rental contract, the rental relationship is hampered before it even began. Such a situation must be avoided at all costs.

Various aspects must be taken into account when determining the owed building details. It is particularly important to clarify and regulate the planning stage. Is the project at the stage of a building application? Or has a building permit been issued already? Has the approval planning already been transferred to the implementation planning? Has the seller already concluded rental contracts that affect the owed building details?

Additionally, the agreement should provide for rules on subsequent changes made to the planning. Such changes may become necessary or desirable out of the sphere of the seller, the buyer or third parties (especially tenants).

The payment of the purchase price differs considerably between forward purchase deals and forward funding deals. A forward purchase buyer pays after acceptance, while a forward funding buyer pays in instalments according to the progress of construction. It is therefore essential to determine what happens in case of the seller’s default, particularly in the case of a forward funding deal. Refund guarantees are only provided in exceptional cases. Bank guarantees are too expensive in any case. The guarantee commissions for refund guarantees are high. Depending on the creditworthiness of the seller, they must also be backed by equity. As a result, forward funding deals are often no longer worthwhile because the costs of the guarantees and equity eat up the economic advantages of financing the project through the buyer’s tranches.

Thorough due diligence

The starting point for an appropriate purchase contract design and structure is always a thorough legal, tax, economic and technical due diligence.

In contrast to forward purchase deals where the purchase price is only due after the project has reached a state that is at least generally ready for acceptance, forward funding transactions make the buyer pay the first purchase price instalments as soon as the usual preconditions for purchase price maturity are met – ie, a priority notice has been registered, and a waiver of the right of first refusal and, if applicable, the cancellation authorisations for land charges listed in section III of the land register that are not to be transferred have been issued. Therefore, the examination of all contracts for work and labour and all planning contracts is of even greater importance than in forward purchase deals. The financial stability of the other party and the executing contractors is also important. If the buyer enters into the general contractor’s agreement (see below), forward funding deals – unlike forward purchase deals – require a thorough examination of the contract performance securities to be provided under such general contractor’s agreement, in particular with regard to its compatibility with laws on general terms and conditions.

Drafting the purchase contract – purchase price

The purchase contract must primarily specify timing, the preconditions for and the amount in which the purchase price instalments are to be paid. As explained above, the first purchase price instalment is regularly due after the usual preconditions for purchase price maturity have been met and – depending on the position in the negotiations – also after additional preconditions have been met (final and binding building permit, signing the first rental contract, etc). The amount of further payments subsequently corresponds to the respective project value – ie, the value of the land and the construction project at the respective point in time. The amount of the individual tranche is normally based on the tranches owed by the seller under the general contractor’s agreement. The seller’s profit is paid either pro rata across the individual tranches or in total with the last tranche – ie, after acceptance of the construction project.

The synchronisation of the buyer-seller tranches with the seller-general contractor tranches is also important to avoid the need for interim financing as far as possible. If the seller owes money to the general contractor before the buyer is due to pay the corresponding tranche, the seller will have to provide interim financing or use equity for the time being.

The payment plan is therefore of particular importance for both sides, and should be prepared with the assistance of technical advisers/evaluators. This ensures that the buyer always pays only those amounts that correspond to the value of the property, the planning services and the respective construction progress.

The buyer must also be given the opportunity to verify the progress. In order to constantly maintain an overview of the project, it is common practice to agree on comprehensive rights of inspection, control and information (either by the buyer or by an experienced construction control surveyor).

Finally, the buyer should have the option of withholding a share of the respective payment in the event of poor or reduced performance. As a general rule, the law allows withholding an amount of twice the costs required for remediation of the defects/completing the remaining services – see Section 641(3) German Civil Code (BGB). Often, however, somewhat lower retentions are agreed, such as 1.5 times the costs.

Whether or to what extent retentions are justified may be subject to disputes in individual cases. Looking at a tranche of EUR100, for instance, the seller may consider the defects to justify a retention of EUR10. The buyer, however, considers a retention of EUR30 to be appropriate. So what is going to happen with the EUR20 in dispute? Not stipulating rules for such cases is probably the worst solution because that would leave the decision to the courts, and their decision may take longer than the entire construction phase. Therefore, such cases should be covered in arbitrator clauses. This means that, in the event of a dispute, an independent arbitrator makes a decision that is binding for both parties regarding the amount of the permissible retentions. This decision does not necessarily have to be binding when it comes to the warranty-related question of whether a defect is present or not. However, the arbitrator may decide on the amount of the tranches to be paid. This considerably accelerates the execution of the purchase contract.

The arbitrator can and should be named in the purchase contract. At best, it should mention engineering offices offering specialists for all relevant trades and crafts. In addition, the arbitrator should be involved in the construction process from the very beginning, especially in order to be able to make short-term decisions, if needed. This does cause additional costs, but also creates a situation where disputes can be settled quite quickly.

In order to ensure maximum synchronisation between the instalment payments under the general contractor’s agreement and the purchase contract, sellers should have the foresight to endeavour to place this arbitrator also as a binding decision-maker in case of disputes in the general contractor’s agreement. Otherwise, there is a risk that, because of retentions, an instalment due as per the purchase contract will be lower than the tranche due as per the general contractor’s agreement.

Beyond that, it may be useful to include a right for the buyer to make direct payments to the general contractor or the commissioned work contractors so that the buyer may fulfil the seller’s payment obligations vis à vis the contractor(s). This ensures that they receive their payments on time and that the building progress is not interrupted. Finally, this also allows the buyer to reduce the risk of insolvency.

From the buyer’s point of view, the total purchase price should be agreed as a fixed price. Additional costs caused by any modifications requested by the tenant are to be passed on to the tenants via the rental contracts. The same should also apply to the general contractor/the work contracts, even though the current market for now does not allow the easy implementation of this, making it rather expensive. This is important if the buyer terminates the work contract component due to delays in the construction process and takes over the general contractor’s agreement/work contracts.

Drafting the purchase contract – buyer option to complete the project themselves/taking over the contracts/rights of termination

Forward funding purchase agreements are often very extensive. One reason for this is the need to adequately hedge against a failure of the seller “in all directions”. As an example, the parties have agreed on the latest possible completion date. Taking this date into consideration, the buyer has agreed a latest handover date with a tenant. However, in the course of construction it turns out that the seller is considerably behind schedule, contrary to the construction schedule. There is risk that the seller may not be able to keep the latest possible completion date, which may entitle the tenant to claim damages.

In such cases, it may be important for the buyer to have the option of terminating the work contract component of the purchase contract; triggering the transfer of ownership; and, if desired, taking over the general contractor’s agreement/the works contracts by paying off the current project value step by step – if not yet effected by the tranches – and completing the construction himself/herself with the retained part of the purchase price.

All these points must be decidedly regulated. It is particularly challenging to find fair solutions that are in everybody’s interest. Buyers, for instance, may wish to keep the conditions for termination as broad as possible in order to be able to react flexibly to a delay in construction. However, sellers will have a strong interest in keeping the termination possibilities as specific and narrow as possible because they may be of the opinion that they will be able to make up for a delay in construction throughout the further course of the project. Additionally, the COVID-19 pandemic demonstrates that there is also a need to address force majeure appropriately.

It is also important that the general contractor’s agreement/work contracts provide for appropriate options for the buyer to take them over. To cover the risk of their insolvency, the contractors should also provide sufficient securities that can actually be realised if it should come to it. In addition, buyers should make sure to maintain the option of easily entering into other contracts relevant to the building project, such as neighbourhood agreements, urban development contracts, etc. In this context, it is worth pointing out an issue with rental contracts that may already have been concluded: as the rental space has not yet been handed over, rental contracts do not transfer automatically to the buyer as they would have under Section 566 BGB, but can only be transferred after additional conditions as per Section 567a BGB have been fulfilled.

As these claims are each an assigned claim, their content and value should be ensured from the outset by means of a thorough due diligence and corresponding information and approval provisions in case of changes in the purchase contract.

Furthermore, the information, approval and participation provisions in the purchase contract are of decisive importance, if only because the buyer must be in a position to take over and continue the project immediately if the seller defaults. The buyer must know which works are to be completed next by the general contractor, which partial acceptances are coming up, which concerns the general contractor may have already addressed towards the seller, the extent to which tenants have already submitted special requests, etc. In short, the buyer must constantly monitor the project.

If the seller encumbered the property with land charges of third parties as part of the financing, the buyer must finally also have a direct claim vis à vis the third parties for cancelling these land charges, even if only part of the purchase price has been paid at that point (according to the progress of construction).

Drafting the purchase contract – securing withdrawal scenarios

In certain cases, however, it may also be important for the buyer to be able to withdraw from the purchase contract altogether. This may be the case, for example, if the project cannot be realised as planned for reasons arising from planning law, or for actual reasons.

Exercising the right of withdrawal triggers a reverse transaction obligation, which means that the services received must be returned. In the event of the seller’s insolvency, however, there is a considerable risk that the seller will not be able to fully repay the purchase price tranches since they were used for the project and cannot easily be retrieved as assets.

The priority notice registered for the buyer does not help either, because the buyer no longer wants to buy the property. A provision of a bank guarantee by the seller is usually rejected because it at least partially counteracts the economic advantages of forward funding (see above).

Therefore, a land charge in favour of the buyer is then normally entered in the land register of the object of purchase. This land charge is intended to enable the buyer to realise the property and thus recover the tranches paid, as far as possible. In this respect, the rank of the buyer’s land charge is very important, also in relation to any existing (partial) financing land charge for the financing bank of the seller.

In addition, a guarantee, a letter of comfort or a suretyship of a solvent parent company of the seller (who is usually a special purpose vehicle with no or little other assets) is often provided.

Summary

Forward funding schemes offer both investors and project developers advantages that should not be underestimated. This is particularly true in a market where there is a shortage of good properties.

A careful legal and technical due diligence, a solidly drafted and structured purchase contract and consistent and close monitoring of the construction work can adequately and fairly reflect the risks for both parties.

However, regardless of this, it cannot be excluded that the seller may not complete the project. Any investor must be aware of this scenario. Investors must decide whether they are able and willing to complete the project themselves, should the case arise. This will only be possible if they have expertise of their own in this area, or if they have a reliable partner with the appropriate expertise.

Sellers, on the other hand, must be aware of the fact that they will have to co-ordinate the construction phase with a third party – ie, the investor. For example, significant changes to the planning during construction require the buyer’s approval. Project developers often underestimate this fact and its practical implications.

Regardless of the challenges, however, forward funding deals are, above all, exciting projects that hold many advantages for all parties involved.

It has proven beneficial to view such deals as joint projects and to work together constructively like joint venture partners. This is particularly true in a situation like the one at hand, where all parties involved are hit more or less equally hard by an exogenous event - the COVID-19 pandemic.

GSK Stockmann

Karl-Scharnagl-Ring 8
80539 München
Germany

+49 89 288174-0

+49 89 288174-44

christine.stroem@gsk.de www.gsk.de
Author Business Card

Law and Practice

Authors



Linklaters LLP is a full-service provider offering international advice on legal and tax issues in the real estate industry, which gives it a leading edge in meeting client requirements and demands. The cross-practice team not only includes real estate experts, but also specialists in corporate, tax, finance, investment, competition and regulatory law. With more than 60 real estate lawyers in the Frankfurt and Munich offices and 350 real estate lawyers globally, the Linklaters real estate team is chosen by leading global investors, developers, occupiers and financial institutions to advise on their largest and most complex or multi-jurisdictional real estate transactions and disputes. The practice inter alia advises private equity clients (eg, Blackstone, Cerberus), funds and institutional investors (eg, BNP Paribas, CBRE Global Investors, LaSalle IM) as well as a number of Asian clients (eg, Samsung, Capitaland). The firm acknowledges with thanks the contribution made to this chapter by Alexander Zitzl and Lisa Waizenhöfer at Linklaters LLP.

Trends and Development

Authors



GSK Stockmann is a leading independent European corporate law firm with more than 200 professionals across offices in Germany and Luxembourg. It is the law firm of choice for real estate and financial services. It also has deep-rooted expertise in key sectors including funds, capital markets, public, mobility, energy and healthcare. The dedicated teams provide expertise and experience in M&A, private equity and venture capital, dispute resolution, tax, compliance, restructuring, IP and IT, data protection, antitrust and employment law, enabling them to find the right solution for clients' business needs.

Compare law and practice by selecting locations and topic(s)

{{searchBoxHeader}}

Select Topic(s)

loading ...
{{topic.title}}

Please select at least one chapter and one topic to use the compare functionality.