Building law models must be made more sustainable: A possible solution
March 27, 2024
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The housing shortage is having a major impact on the current market environment in the Swiss real estate sector. Central, well-developed locations are particularly affected. Spatial planning is often singled out as one of the scapegoats, responsible for the lack of building land reserves or insufficient promotion of densification.
While inflexible zoning plans, a lack of an overarching, interdisciplinary urban planning culture, and the high complexity and lengthiness of special-use planning are rightly criticized, other factors must be taken into account. Changing investment markets – another driver of the housing shortage – are often insufficiently considered in the discussion.
The few available building land reserves in central locations are often owned by the public sector. Allocating these reserves under building rights has been gaining in popularity in recent years and is becoming increasingly important given the demand for living space. Among other issues, choosing the right model is crucial.
Current building rights models
Two models are currently used for most building rights agreements: the classic model and the Basel model, which differ mainly in how the interest rates are calculated and the adjustment mechanisms.
The classic model
In the classic building rights model, the building lease charge is determined by applying a risk-adjusted interest rate to the derived land value. Adjustment mechanisms are then agreed in advance to allow building lease charges to be modified periodically or if framework conditions (e.g. interest rate environment, construction adjustments, rent restrictions) change significantly. The advantages of this model are the transparent adjustments in regular cycles. The disadvantages, on the other hand, are as follows:
- The adjustment mechanisms are usually complex and often become outdated over longer contract terms. For example, if the index to which the building lease rate should be adjusted is discontinued.
- The building performance is only taken into account indirectly or insufficiently.
- Affordability can be jeopardized for the building leaseholder, particularly if interest rates rise sharply over the lease term.
These disadvantages can create not only conflicts but also tipping points that are detrimental to both parties.
The Basel model
This is often referred to as a partnership model, as it is characterized by an equal partnership between the lessee and the lessor. Both parties share the risks and returns according to their value contribution: land value for the building rights grantor and investment in the building for the leaseholder. The building lease interest is calculated using the following formula:
Building rights charge = net income * land value / (land value + building value)
If the parameters change, the building rights charge is adjusted every 10 years.
This model’s strength is its fairness, as both parties share the risks and returns equally. However, it is complex to apply, involves a high administrative outlay, and harbors great potential for conflict when determining the parameters.
In both models, therefore, the disadvantages prevail, either because of an imbalance between parties or the application complexity. But could there be another way?
What makes a good rights contract?
In our view, a good building rights agreement should be market-driven and balanced. To ensure that the contract is balanced over the long term of the building lease, cost-effective to implement, and has a low potential for conflict, the following five characteristics should be present:
- Simplicity
- Flexibility
- Traceability
- Fairness
- Future-proof
The balance should be maintained not only when the building lease is concluded, but throughout the entire contract term. This can be achieved by selecting suitable adjustment mechanisms that best restore the balance if market conditions change.
As we have seen, many building lease agreements based on the classic or Basel model often only fulfill part of these requirements. This is due to their complexity, potential for conflict, or lack of viability.
Is a revenue-based building rights model the future?
When attempting to design a simple, future-proof building rights model with low potential for conflict, the contractual content must therefore be fair, comprehensible, and as objective as possible. In particular, the building lease charge must be decoupled from key figures that are difficult to assess objectively in the long term (e.g. land or building value).
Under this context, one more suitable key figure is a property’s rental income. So why not link the building lease interest rate to the future development of rental income and add interest to the property income? The revenue-based model minimizes the disadvantages of all current models while retaining the most important advantages:
- Low complexity: The deduction of the building lease rate and its adjustment is very simple due to the interest on the annual income, and the principle is well-known in the real estate industry – for example, in turnover-based rental agreements for retail or restaurant spaces.
- Future viability: The majority of the Swiss population lives in rental properties. As this is unlikely to change, the model will remain valid in the long term.
- Low potential for conflict: Unlike land or building values, rental income is objectively measurable. Accordingly, the potential for conflict is low.
- Fairness: Both parties benefit equally if property income rises or falls. Downward hedging is possible.
- Intrinsic motivation: The interests of the grantor and the lessee are aligned within agreed guidelines and any restrictions on use (e.g. low-cost rent). Both intrinsically strive for the highest possible rental or building lease income.
- Versatile applicability: The income-based model is ideal for rental properties, regardless of their use. The model can also be used very easily for building leaseholders without revenue targets (e.g. cooperatives). On the other hand, the income-based model reaches its limits with owner-occupied properties. Here, the rental value must be estimated, impairing the objectivity criterion.
Wüest Partner supports landowners in granting building rights
Are you planning to grant building rights for a plot of land? Wüest Partner supports and advises public authorities and private investors in this process. Find out more here.
BWO
Study report "Building law under the microscope" on behalf of the Federal Office for Housing (BWO). Read the study here (in German or French).