HUSEN ADVOKATER: New legislation in Denmark may deter foreign short-term investments in Real Estate08/31/2020
PARLEX 2020 – News
New legislation in Denmark may deter foreign short-term investments in Real Estate.
(Kristian Paaschburg, Partner, Husen Advokater, Denmark)
Since the financial crisis of 2009, foreign investment in the Danish real estate market has risen sharply. The increase seems mainly driven by investments in residential properties, which has more than quadrupled since 2012. Last year, total investments in residential properties ended up at DKK 38.2 billion. The typical investment range from DKK 75 million upwards, with Copenhagen being the most popular location, and with foreign capital behind almost 80 percent of investments in residential real estate.
Traditionally, foreign investments in the Danish Real Estate market come from Norway, Sweden, Germany and the USA, with Sweden being the biggest investor. In recent years, the American equity fund Blackstone has massively bought up in Copenhagen, now holding residential properties for DKK 5.7 billion. As of 2019, the company's total assets under management worldwide were approximately USD 545 billion making them the world’s largest. They are said to work based on the strategy 'Buy it, Fix it, Sell it', and their approach in trying to implement this strategy in Denmark has created debate in Danish society, as it created a general fear that ordinary wage-earners will not be able to pay for city living, making the big cities lose their diversity.
The main theme has been the "Fix it" part of the strategy. Owners of older properties from before 1991 could increase the rent by renovating leases according to art. 5.2 in the Housing Control Act. This provision has been effective in getting private investors to modernize dilapidated older Danish properties, which was a major problem in Danish cities in the 1980’s and -90s.
Rent can be fixed in various ways, depending on the type, age and condition of the lease. In very simple terms, rent may be fixed at market value for leases situated in properties, built or used for residence for the first time after 1st January 1992. Leases situated in properties, used for residence before 1992, must be fixed at cost basis, which may be increased by adding improvements to the lease, in which case the added rent is calculated based on the cost of the improvements made.
The final way in which rent may be fixed is at a level close to market value, defined as the rent paid for similar leases in the neighborhood, being of about the same type, size, quality, equipment and level of maintenance.
It is this last type of rent fixation, known as Art. 5.2 leases, that has come under heavy criticism, and has now been moderated.
Denmark has close to 2.9 mio. private residences. Of these, approx. 565,000 are leased out in accordance with the rules and regulations of the Danish Tenancy Act and the Housing Control Act. Approx. 57,000 units have already been improved under the conditions of article 5.2, and another 111,300 residential units could possibly be improved under the provision.
The number of renovations has increased after the foreign private equity funds entered the Danish market, and as a result, property prices have seen a substantial rise since 2010.
The last 30 years of renovations have increased the quality of housing estates significantly, and the rent has become significantly higher. The political majority's attitude to the problem has changed in line with this, which is why the Danish government has now decided that there is no longer the same need for renovation as before, but rather a need to stabilize / maintain the rent level, so that all Danes can afford to live in big cities.
The Danish Parliament has therefore passed a change in the tenancy legislation, in an attempt to change the development. The changes entered into force on 1st July 2020. The legislation has three purposes: To limit short-term (foreign) investments in residential properties, focus investments on environmental development and strengthen the legal position of the tenants.
The law contains most importantly for the foreign investor the following measures:
Waiting period of 5 years: An owner cannot make art. 5.2 renovations until he has owned the property for 5 years. This should stop short-term investments and reward the owners who invest long-term. The renovations and the accompanying rent increase are the way in which an owner can increase the value of his property unrelated to general market conditions. Future investors in the Danish real estate market can thus in this way not increase the value of their property during the first 5 years of ownership, and the calculations of an investor's return on a purchase of a rental property must take this into account, which may well lead to a fall in the Danish real estate market. Potential new tenants, on the other hand, are secured against this type of rent increases for 5 years from the time a new owner buys the property.
Energy requirements: In order to take advantage of art. 5.2, a property must be categorized in energy class A-C, or the property must be lifted two energy classes from the energy class it had as of 1st July 2020. This change should ensure "green" renovations. Landlords must therefore mainly prioritize renovations that raise the property's energy class, and tenants are likely to be assured of lower heat consumption.
Burden of proof/fixing the level of rent: In lawsuits between a landlord and a tenant about the size of the rent according to art. 5.2, the landlord always has the burden of proof. By collecting comparative leases, the landlord must document that the rent corresponds to the rent in similar leases (the value of the lease). Previously, the landlord had to document that the rent was not significantly higher than the value of the rent. Significance has been interpreted in case law as a maximum of 10%, which is why the landlord had to prove that the rent was no more than 10% higher than the comparative leases. The word significant has now been deleted, whereby the landlord must document that the rent is not higher than the comparative rent paid. The purpose is to maintain the rent level, in that landlords cannot add 10% to the known rent in the area but must determine the rent on the basis the exact known rent.
Prohibition of payment for termination: Art. 5.2 can only be implemented in tenancies, that are empty, i.e. free of any leases. Blackstone offered some of their tenants substantial cash incentives to vacate the leases, but that has now been banned. If such a termination agreement is entered into on the landlord’s initiative, the tenant can terminate the agreement, stay in the tenancy and keep the money. The Landlord risks imprisonment. The purpose is to prevent aggressive landlords from succeeding in emptying their properties so that they can renovate them more quickly and raise rents by type. 5.2.
The purpose of the changes in the legislation is to protect the Danish tenants against foreign short-term investors, wanting to take advantage of the art. 5.2 investments for a quick turnaround of the investment. The impact on established Danish or foreign long-term investors is unclear, however it is for certain, that administration becomes more complicated. As for the general real estate market only future will tell how and whether these changes will impact on potential new foreign investments, and whether the changes will have the desired effect, however for now, the debate in Denmark has ceased, as the market takes in the changes.