Time to put a stop to the refurbishment of old housing stock?

The acquisition of a large portfolio of old-stock residential rental properties in Copenhagen by US private equity fund Blackstone has attracted massive attention in Denmark.

However, it is important to emphasise that the vast majority of such properties are currently owned by domestic pension funds.

Danish legislation allows for the modernisation of old and outdated flats as they become vacant for the purpose of reletting the flats at a higher rent post-modernisation. Such modernisation may involve only vacant flats and cannot be forced upon existing tenants, who are therefore shielded from rental increases. 

Public debate seems to overlook the fact that if you make it impossible for property owners to charge a higher rent for higher-quality flats, you eliminate their incentive to invest in upgrading their properties.

In addition, future tenants are at any time free to have the rent amount tried before a municipal rent control board, which is able to ascertain if the scale of modernisation is satisfactory and reduce the agreed rent if required.

Up until 1996, when the Danish Residential Rent Regulation Act introduced the rules on section 5(2) modernisation schemes – under a government led by the Danish Social Democratic Party and with the backing of the left-wing – the old housing stock in Copenhagen consisted mainly of low-quality dwellings, offering no or poor bathroom facilities, old kitchens and outdated installations. Investments were only made in the old housing stock if and when the public sector footed the bill through contributions to urban renewal.

The vast majority of rental units in the old housing stock is owned by domestic pension funds as well as domestic or Scandinavian property companies. They diligently look after their properties, happy to be incentivized to invest in upgrading their property assets, modernising outdated dwellings, thereby improving the quality of the housing supply in the biggest cities and creating jobs for builders etc. in the process.

This means fewer inexpensive and outdated dwellings mainly in Copenhagen and Aarhus – but at the same time it means more good-quality dwellings.

We are convinced that the right outcome of the ongoing Danish committee deliberations is the realisation that the provisions of section 5(2) modernisation schemes give the owners of private rental properties a proper incentive to invest in improving the quality of flats, while shielding existing tenants from rental increases as a result of individual modernisation schemes. In addition, new tenants of modernised flats that consider the rent to be unreasonably high compared to the quality of modernisation are already today entitled to have the rent amount tried before a rent control board.

It may make sense to review the amount thresholds applying to such modernisation schemes, just as it may be necessary to raise information awareness about rent control boards.

It may also be an idea to introduce mandatory reporting to the Landowners’ Investment Foundation (Grundejernes Investeringsfond, abbreviated GI) in connection with section 5(2) modernisation schemes. as GI would be able to conduct spot checks of such modernisation given that GI already today conducts spot checks of the maintenance accounts of the properties in question.

 

Demand for more small-sized dwellings and more social housing
It should not be overlooked that Copenhagen needs more housing at a rent affordable by ordinary people and families.

This may be achieved by introducing local plan provisions that allow for the construction of more small-sized dwellings, targeting single households and families with no dependent children, and it may be achieved by constructing social housing on a larger scale.

In Copenhagen, municipal planning is motivated by a desire to increase the number of family dwellings in the city. However, that does not alter the fact that the average household size has been shrinking for years on end, with a sharp increase in the number of single-person households.

Municipal planning should be designed to safeguard an attractive and varied housing supply, not to drive single people out of the city where they want to reside, which happens to be the case today. In fact, the number of single-person households is shrinking, and so is the per capita housing area, while the supply of small flats, in particular in the 50-74 sq m range, has levelled off. In other words, only few singles can afford to maintain a residence in the city unless they opt for co-habitation. An oversupply of expensive flats of 100+ sq m does little to alleviate this.

 

 

 

 

Thinking that we will see the emergence of more affordable dwellings for ordinary families by restricting landlords’ possibilities of achieving a fair return on investments in an upgrade of their properties is illusory. Better and more affordable dwellings are created by constructing more dwellings, by constructing more small-sized dwellings and by constructing more social housing.

 

A BRIEF INTRODUCTION TO SECTION 5(2) MODERNISATION
In Denmark, old-stock residential rental properties are typically comprised by the Danish Residential Rent Regulation Act’s provisions on cost-regulated rent control, ensuring that the rent cannot exceed the given operating costs plus a minor return. However, if a landlord is able to provide documentation that a lease unit has been comprehensively modernised in the span of two consecutive years, section 5(2) of the Residential Rent Regulation Act allows for the lease unit to be let at utility value, which typically means a rent greatly exceeding cost-regulated rent.
 
Section 5(2) modernisation is defined as improvements that increase the utility value of the lease unit, such as installing bathroom facilities, insulation, entry phones or aerial equipment, but not replacements and repairs of existing building parts and installations. For a series of improvements, including new kitchens and modernisation of existing building parts and installations, a part of the investment is classified as maintenance.

Legislation stipulates a minimum cost in order for the modernisation scheme to be regarded as comprehensive. In 2019, the threshold amount is DKK 2,255 per sq m and DKK 257,894 per lease unit (minimum).

 

 


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Peter Winther

CEO | Partner | MRICS

Copenhagen

Peter is CEO of Colliers International in Denmark. In cooperation with the Investment & Capital Markets team, he also facilitates the sale of commercial and investment properties, including hotels and shopping centres, as well as property portfolios and companies.

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