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Buying a property on leasehold (Erbpacht)

If you’re looking at buying a house in Germany, you should also consider buying a house on a leasehold basis. Well it can definitely be a lot cheaper than buying a house in the traditional way. But you must also know that a lease also comes with its own expiration date and you do not become the owner of the land. I do get a lot of questions about this and would like to answer those questions in this article.

1. What is Erbpacht?

Erbpacht or Leasehold typically means that the owner of the land/plot gives the right to another person to construct/maintain a building on the plot. The owner of the land receives a rental fee which is called ground rent or hereditary lease which is currently about 2%-4% of the value of the plot. A ground lease usually extends over a period of several decades, between 50-99 years. During this period the plot remains the property of the owner of the plot while the constructed building is the property of the ground lease holder. The ground lease holder will be liable to pay certain fees such as the land transfer tax, property tax or development costs.

When the lease expires, the property is transferred to the plot owner who has to compensate the lease holder with at least two-thirds of the value of the building. They can also mutually extend the contract or create a new contract altogether.

For whom could Erbpacht / Erbbaurecht properties be interesting?

For families or people with modest incomes, leasehold properties are an intriguing choice. A leasehold property is frequently the only means for them to realize their ambition of owning their own four walls without accumulating excessive debt because land costs can be rather exorbitant, especially in large cities.

Also, some residential locations are only available on leasehold as the owners do not want to sell their properties and only want to lease them out.

Because they make up a relatively small portion of the real estate market, offers to award ground leases or the sale of property on a ground lease basis are rarely widely publicized. Both benefits and drawbacks might be associated with purchasing a property under a ground lease. One benefit is that the property’s immediate buying price is considerably less than that of a property with land. However, as was previously said, in this instance you do not own the plot along with it; rather, you pay for it for the duration of the contract through an annual leasehold, which, depending on the lease’s cost, may ultimately cost more than purchasing the land outright.

Who grants ground leases and who sells leasehold properties?

For instance, private individuals who wish to augment their retirement pensions with the steady income from a ground lease may award leaseholds. However, most ground leases are given by organizations like churches, towns, foundations, breweries, etc. that own substantial real estate holdings but have no desire to sell them.

Contrarily, leasehold properties are typically offered for sale by the respective owners of the leasehold properties rather than the landowners themselves. In most circumstances, the leasehold agreement has not yet expired or is still in effect, but the respective owner nevertheless decides to sell the property. Typically, the same factors that influence other real estate deals also influence this sale. A holder of a heritable building right is legally free to sell his property without restriction. Legally speaking, he is permitted to resell his inherited building right even while a contract is still in effect, making the sale of the actual property also feasible.

For a sale, he does require the ground lease owner’s approval, but under very specific circumstances, such as if the new interested party intends to utilise the building for commercial or similar uses rather than for residential ones, the ground lease owner can merely decline. The ground lease owner typically also has a contractual right of first refusal, which entitles him to take possession of the property himself in the event of a pending sale.

2. The leasehold contract

Legally speaking, the ground lease is a legal transaction that requires a form i.e. the contractual notarization must take place at a notary public. The hereditary building right is listed as a line item in the main land register as well as in a specific general land register (Grundbuch) at the district court . The contract must address the following issues:

– Term

The term is not subject to any legal constraints and may be freely chosen by the parties to the contract. Typically, terms of 50 to 99 years are agreed upon.

– Ground rent

Here, it must be stated how much and when the ground rent is to be paid.

It is possible to freely agree on the ground rent; for instance, 2 to 4% of the land value annually. It is possible to agree on a monthly, quarterly, or annual due date.

– Interest rate adjustment

A clause known as a value retention clause is typically added to the contract as well. Due to inflation and the resulting decline in the purchasing power of money, monetary value protection clauses have grown to be popular in contracts with long terms. This connects the monetary claim to the overall evolution of product and service prices. With this strategy, the ground rent is legally adjusted to a price index, often the German Federal Statistical Office’s consumer price index. As a result of the ground rent’s ongoing growth, the leaseholder’s financial burden grows with time.

– Right of the ground lease owner to have a say in the matter

Usually, the ground lease lender by way of contract secures a right to co-determine additions or alterations to the building and mortgage charges on the land.

A ground lease cannot, in theory, be canceled by either party prior to the lease’s official expiration date. There are, however, certain exceptions to this generalization. For instance, if the leaseholder is not able to continue to pay rent, the leaseholder has a specific right to terminate the lease. If the leaseholder allows the property to deteriorate or breaches his contractual responsibilities, there is also the potential of a particular termination. The leaseholder may also specify his own demands in order to secure a legal termination. However, in this instance, the leaseholder must receive cash compensation; by law, he is entitled to at least two thirds of the building’s value.

3. Options at the expiry of the leasehold contract

The leasehold agreed upon in the contract also expires once the leasehold period, which is typically 50 to 99 years, has passed. Neither of the contracting parties is needed to make any additional declarations. The contract merely expires and the controlled expiration is initiated if no further action is taken.

If nothing further is specified in the contract, the property is transferred to the landowner or leaseholder when it expires. According to the law, the leaseholder must get at least two-thirds of the building’s market worth in compensation. Only if this is specified in the contract is a higher compensation eligible for claim. And of course, when finalising the contract, one should be absolutely explicit about the amount of compensation and the assessment parameters to avoid any unpleasant surprises at the end of the agreement.

The regular course of events can be altered in a number of ways, such as by early contract termination, contract extension, etc. Let’s examine the potential outcomes in more detail here:

Early termination

As previously mentioned, a ground lease provider may, in certain instances, also exercise a special right of termination if the leaseholder is no longer able to make ground rent payments, has allowed the property to fall into serious disrepair, or if the ground lease provider registers other legally valid claims, such as own use. The two parties to the agreement may also mutually decide to end the contractual connection. The same rules that apply in cases of regular contract expiration also apply in cases of premature termination, such as those governing leaseholder compensation.

Extension of ground lease – extend ground lease early

The ground lease may, of course, be extended by the leaseholder and the leasehold owner. However, a leaseholder expressly lacks the legal authority to extend the lease; instead, they must give their permission. The prior ground lease holder, however, has a preferential right over other interested parties and can make a preference claim to the lease of the land if he wants it to continue if the land is to be used on a ground lease in the future.

Whatever the case, the leaseholder must take action promptly and get in touch with the landowner if he wishes to renew the ground lease agreement before the end of the current term. This is so that the contract extension can be legally recorded in the land register before the original contract expires. In reality, if one wants to keep the contract going, one should leave adequate time for this process since registering a property in the land registry can take some time. After all, the contract cannot be renewed after it expires. A new contract must be signed after the previous one has run its course. And with a new contract, leaseholders usually demand a higher ground rent.

Additionally, you must be vigilant because there are legal ploys like these in this situation: In some cases, a ground lease provider can avoid having to make compensation by offering the ground lease holder an extension of the ground lease before the agreement expires. If the leaseholder rejects a contract extension, his legal right to compensation payments expires, leaving him in the lurch.

Subsequent purchase of leasehold land

In most cases, mutual rights of first refusal are established. Sometimes, perhaps right before the lease is about to expire, a leaseholder is interested in purchasing the land on which his house is situated.  What are his chances?

Mutual rights of first refusal are typically agreed upon by leaseholders in the contract, meaning that if the leaseholder genuinely sells the land, he has a strong possibility of obtaining it if he desires. If the landowner decides to sell, the leaseholder will not be entitled to a discounted price.

The case when the leaseholder purchases a leasehold site, however, is quite uncommon. This is due to the common lack of interest in selling among landowners. Additionally, if the owner is a foundation, the land is typically not for sale because it is a component of the foundation.

End of contract and neglected property

If real estate is not maintained, it deteriorates and loses value. Not all property owners are capable of making the ongoing investments or are willing to do so.

Therefore, it is not excluded that at the conclusion of the lease, a leaseholder may have to assume ownership of a dilapidated or neglected home. What rights and claims does a person have in such a situation? First of all, the regular, legally stipulated expiration remains unchanged. At this time, the leaseholder assumes ownership of the property and receives the payment outlined in the lease agreement. However, the leasehold agreement typically also includes a clause stating that the leaseholder is required to maintain the property or to rebuild it in the event of a disaster, such as a fire or storm. If the leaseholder does not comply, it is typically stipulated in the lease that the leaseholder may have the property renovated, with the leaseholder covering the cost.