The Italian residential lease market: A potential gold mine?

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Italy is currently experiencing an economic recovery, in the real estate residential market as elsewhere. This is due to a turnaround in consumer spending after the massive crisis of 2008 as well as an influx of foreign purchasers - particularly from Australia and New Zealand, wishing to buy homes in Florence and Rome especially - attracted by the “Italian lifestyle” and by a tax regime beneficial to foreigners looking to purchase a permanent residence in the country.

This renewed interest in the Italian residential market comes not only from individuals who usually intend to purchase a residential property for their own use, but also from institutional investors, both Italian and foreign. For example, we are seeing a growing and significant number of joint venture agreements, which enlist a non - Italian financial partner on the one hand, and a local industrial (developer) partner, on the other hand, aimed at the construction of new residential properties or the refurbishment/conversion of pre-existing urban areas, particularly in the Milan area.

It should be noted though that whilst the residential market is growing in respect of sale and purchase agreements, the same progress has not been seen in the residential letting market.

There are various reasons for this. Historically, it has been extremely difficult for institutional investors to invest in the Italian residential letting market. In 1978, the first law governing lease agreements (both residential and commercial) was issued (Law no. 392 dated 27 July 1978), and this is, for the most part, still in force. In respect of residential leases, the Law introduced the “fair fee” (equo canone), which is a mechanism ensuring fixed fees, and which cannot be excluded. This provision, combined with a national inclination towards home ownership (due to a chronic lack of employee mobility), meant that for almost 30 years, only a very small number of investors invested in residential properties to let. Consequently, Italy has one of the highest percentages of homeowners in the EU (unlike, say, Germany).

Despite major revisions of the law governing residential leases by Law no. 431 of 9 December 1998 (the Residential Tenancy Law), there remain many hurdles for investors in this market to overcome. Indeed, it may be argued that the Residential Tenancy Law is excessively strict, being beneficial for the tenant at the expense of the landlord. For example, the Residential Tenancy Law includes many mandatory provisions applicable to standard residential lease agreements. It establishes that the “standard” lease agreements (ie lease agreements not subject to additional constraints other than those provided by the Residential Tenancy Law) cannot be for a term longer than four years and, broadly speaking, the lease will be automatically renewed for an additional period of at least four years unless the landlord notifies the tenant of its intention not to renew the contract, giving the tenant six months’ notice. Additionally, at the end of the first four-year period, the landlord is only entitled to terminate the lease in certain specific circumstances.

"Historically, it has been extremely difficult for institutional investors to invest in the Italian residential letting market."

The tenant may exercise their right to withdraw in two scenarios: (i) when established by the contract; and (ii) upon the occurrence of a “serious reason” (see below). The landlord, however, is not entitled to withdraw from the residential agreement before the expiration date in any circumstance.

What would constitute a “serious reason”, allowing the tenant to withdraw? The Italian Supreme Court (Corte di Cassazione) has held that “serious reasons” may be defined as “those facts which are unrelated to the tenant’s will, are unforeseeable and which have occurred after the execution of the lease agreement and which would make the continuation of the agreement extremely burdensome”. It is difficult to see why a similar right has not been granted to the landlord.

Furthermore, eviction procedures against a defaulting tenant are very slow, making it difficult for a landlord to regain possession of the property and get it back on the market.

There are additional limitations on other types of residential lease agreements. Generally speaking, the parties to a residential lease agreement may agree a term shorter than four years: in particular they may enter into what is known as a “3+2” lease agreement, provided that the rent is not higher than that fixed in local agreements made by associations of homeowners and tenants; or they may agree upon an initial term shorter than three years, provided that the reasons justifying a temporary lease agreement are among those specified in the local agreements and they appear as an express term of the lease agreement.

In summary, there are still many restrictions on residential leases. Additionally, apart from very special cases, residential leases are normally exempt from VAT and subject to registration tax equal to 2 percent of the annual rent, payable by the parties 50 percent each (and the portion due by the landlord is a cost which is not recoverable from the tenant). Given all the above, is there any leeway in this mandatory system to encourage investor-landlords to enter the Italian residential letting market? The answer is yes: contractual models - very different from the traditional ones - may be adopted which could rebalance the respective positions of landlord and tenant.

The most interesting model is the lease agreement for tourism use. Usually known as short term rentals (STR), these are a particular sub-category of lease agreements, they are very short term and aimed at satisfying temporary housing requirements. They are contracts by which the landlord grants the tenant/ tourist the personal enjoyment of real estate for tourism purposes in exchange for rent and, unlike traditional leases, the applicable law provides that a landlord of a STR can legitimately provide complementary services (such as changing linen, cleaning services, wifi, etc), without altering the nature of the contract. It should be noted though, that, in order to qualify as an STR, the tourism purpose must be specified in the contract.

This type of contract is a real opportunity for investor-landlords because it benefits from a liberal regime under the Civil Code provisions only (save for section 1, paragraph 4 of the Residential Tenancy Law, which requires that the contract be in written form). This means that the parties are free to agree on the duration of their agreement, making reference only to their respective interests.

In a residential lease agreement for tourism purposes, the parties are also free to agree on the rent and the means of payment. The current market practice, given the short duration of the contract, is to exclude any reassessment of rent during the contract. In addition, often the ancillary costs (such as the utilities) are included in the rent and are quantified on a lump-sum basis. Additionally, the minimum requirements to sign such contracts are considerably less than those required for the signing of a traditional lease agreement.

For all these reasons, investors may be encouraged to enter this market, particularly given the high tourism potential of Italy. It is to be hoped that the Italian Parliament, in the wake of the STRs, will finally initiate a more general process of relaxing legal requirements on residential leases, removing the constraints included in the Residential Tenancy Law and providing rules and regulations more suited to today’s market.

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