Overcoming the split incentive barrier in the rental housing market: Germany’s approach of green premiums in rent regulation

With a market share of nearly 57 %, Germany’s rented housing sector is among the largest in Europe with a total of about 23 million residential units. About 40 % of the total rental housing stock is older than 40 years. Given these figures, increasing energy efficiency investments in the rental sector is considered crucial by the German federal Government. In order to provide sufficient incentives for investment, national rent regulation offers a two-pillar strategy for cost-benefit sharing: A cost based approach that allows annualised modernisation costs to be transferred to tenants, and a ‘willingness-to-pay’ approach that enables rent premiums for superior efficiency standards in contract rent ceilings. In terms of rental regulation, Germany adopts a generally well balanced second generation rent regulation regime with dynamic rent ceilings (“Vergleichsmiete”) that are formed as moving average of average recent market rents, sorted by size, quality standards and location criteria.While the first pillar may look more attractive for investors, it is a lengthy and bureaucratic process that increases transaction costs, thereby frustrating especially the private and small institutional landlords. On the other hand, the rent premium approach can only work when transparent market information on contractual rent levels is available. To increase market transparency and reduce the legal costs of any rent renewal process, most medium-size and larger cities in Germany implement legally standardised rent information systems (“Mietspiegel”) that are based on empirical rent surveys, some if them using a hedonic regression approach. This makes the German rent regulation the only known regime with an empirical based willingness-to-pay “green premium” approach. While initial attempts to integrate energy efficiency premiums in this kind of rent regulation regime go back to the early 2000s, its real-world implementation still faces several problems.Based on a decade of practical experience with the empirical and legal issues associated with the topic, this contribution will both present empirical evidence on green premiums in the German rental market and a discussion on unresolved problems of the methodological approach. In addition, survey data on the actual state of implementation in German cities will be presented.