On August 31, 2023, an amendment to the Real Estate Management Act and certain other acts came into force, under which perpetual usufructuaries of developed properties designated for non-residential purposes are able to convert perpetual usufruct into full ownership for a fee. This publication describes the less obvious advantages and disadvantages of this scheme and addresses the purely practical concerns regarding the application of the new regulations.
General Information
Perpetual usufruct becomes ownership title through the purchase of the used property by the perpetual usufructuary from the owner.
A perpetual usufructuary may demand conclusion of a sale agreement under the conditions specified in the amendment to the Real Estate Management Act only in relation to developed properties, and only for up to one year from the enactment of the amendment (i.e., until August 31, 2024). After this date, the property owner (municipality or State Treasury) may, but is not obligated to, agree to transformation into ownership title. Importantly, August 31 is the deadline for submitting the respective application, not for concluding a sale agreement.
The amendment applies only to properties developed and to which perpetual usufruct was granted before December 31, 1997.
The perpetual usufructuary is eligible to exercise this right provided that it is not in breach of the obligations specified in the perpetual usufruct agreement and that no proceedings are underway to dissolve that agreement.
Price for the Property
The price for the property is calculated as a percentage of the annual fee for perpetual usufruct. The amendment stipulates a strict procedure for determining the price for properties owned by the State Treasury. For land owned by municipalities, the procedure for calculating the price may differ – as in this case, this is specified in a resolution adopted by the appropriate voivodship assembly or council.
For properties owned by the State Treasury, the price is set as twenty times the product of the previous percentage rate of the annual fee for perpetual usufruct and the value of the land determined on the date of the sale agreement (for a one-time payment) or as twenty-five times that amount in the case of payment in instalments.
For properties owned by local government authorities, the property price is a minimum of twenty times the product of the previous percentage rate of the annual fee for perpetual usufruct and the value of the property determined on the date of the sale agreement, but not higher than the value of the land determined on the date of the sale agreement.
In the case of commercial real estate, the current standard annual fee is three percent of the value of the land. As there is no significant difference in the market prices of properties in perpetual usufruct compared to fully owned properties, an investment at the level of sixty percent of the land value (twenty times the standard annual fee) will yield a return at the earliest after ten or more years. This timeframe is ten or more years and not twenty, as making a one-time payment eliminates the risk that the owner of the land will revise the rate of the annual fee over time. According to current regulations, the fee can be revised no more than once every three years. Only after this time does the transformation and making a one-time payment become profitable. Hence, if the business intention of the perpetual usufructuary is development and sale of the project – it is not rational to pay the fee for conversion to ownership title. It is different if the the perpetual usufructuary plans to keep the property in their portfolio over a longer timeframe of several decades.
When considering whether this procedure will be profitable, it should be noted that the sales price is determined based on the land value on the day of transformation (conclusion of the sale agreement). This means that the perpetual usufructuary may be unpleasantly surprised in the case of properties for which the annual fee has not been updated recently. The calculated price will not be based on the most recently paid annual fee but on a new assessment conducted by an expert for the purpose of the transformation procedure. The amendment does not provide for any specific procedure to contest the valuation proposed by the expert valuer hired by the owner of the land.
This procedure may be even less profitable in the case of properties belonging to the municipality and additionally where the option of payment in instalments is chosen.
Payment in Instalments
Under the new rules, the fee may be paid in instalments, and, as indicated above, in such a case the price will be at least twenty-five times the annual fee calculated on the day of transformation.
In the case of payment in instalments, the transformation of perpetual usufruct into ownership title occurs at the moment of conclusion of the sale agreement – regardless of the fact that the perpetual usufructuary has not paid the price.
Although this issue is not addressed in the amendment, by applying per analogiam other provisions on property acquisition in the Real Estate Management Act in the case of payment in instalments, it is likely that payment for the property would have to be secured by encumbering the property with a mortgage.
Encumbering the property with a mortgage significantly complicates (if not prevents) the possibility of obtaining external (bank) financing for development of the property in the future. It is a standard expectation of the lending bank for repayment of the provided financing to be secured with a mortgage of the highest priority.
Indexation
Although the amendment does not explicitly state that a price paid in instalments is adjusted for inflation, this cannot be ruled out.
This would be done on the basis of article 70 of the act, according to which “in the case of land used for business activities, sold to its perpetual usufructuary, where payment is in instalments, the unpaid portion of the price is subject to interest according to the reference rate set in accordance with the Communication from the Commission on the revision of the method for setting the reference and discount rates (EU Official Journal C 14 of January 19, 2008, p. 6)”.
Although the amendment does not address this matter and the new regulations do not directly refer to article 70 of the act, property owners (municipalities / State Treasury) can be expected to enforce this provision, as it will allow an increase in the owner’s receivables. Given the literal wording of the regulations, in the case of a dispute the entitlement to adjust the remaining instalments for inflation would probably be confirmed by a court. At this time, there is no case law on which to rely.
If this provision is applied per analogiam, the property owner cannot divide payment into instalments payable over a period exceeding ten years. If the price due to transformation of the property is 25 times the annual fee, this means that the annual liability due to the transformation will amount to 250% of the annual fee to be paid over the next ten years.
Obligation to Pay the Price applicable to a Specific Entity
Based on general legal norms, as the amendment does not specifically state otherwise, the obligation to pay the price rests with a specific buyer, not each successive (including future) owner of the purchased property. The obligation to pay the price is binding upon a specific person and is not transferred automatically with the transfer of the property. To ensure that liability for payment of the price is associated with the land, this would have to be stipulated in a specific provision of the law.
This means that any arrangements concerning payment of the price (remaining instalments payable due to transformation) with the future buyer of the property must be made contractually between the seller (the previous perpetual usufructuary that has the obligation to pay the price for the change of the nature of title to the property) and the buyer. If this issue is not regulated, the only obligated party will be the seller, regardless of the mortgage established on the property to secure payment.
As there is no significant difference between the market price of properties given in perpetual usufruct and properties in full ownership, selling the property with remaining payments due for the change of the nature of title isa significant burden for the seller. It is difficult to expect that a new buyer of the property would be willing to pay the instalments remaining on the day of the sale on top of the market price. The price for the property after transformation would have to be significantly higher than the market price of a similar property if the transformation had not taken place. Therefore, the cost of transformation could be expected to be largely borne by the seller, without the possibility of obtaining from the buyer any surplus over the market price. This is a further argument for making a decision to change the nature of title to the land only if there is certainty that the property will not be transferred over the next several decades.
De minimis aid
Under article 1981 of the Real Estate Management Act, the provisions introduced by the amendment apply subject to regulations on state aid. Similarly to article 69a(1) of the Real Estate Management Act, this means that where land used for business activities is sold to the perpetual usufructuary:
- the difference between the value [market price] of the land and the price of the property constitutes state aid;
- the day of granting of state aid is considered to be the day on which the sale agreement is concluded.
For most entrepreneurs, the permissible state aid is EUR 200,000 gross over three consecutive years. Where the value of the state aid (the difference between the market price and the sale price set according to the guidelines described above) exceeds the permissible limit of de minimis aid, aid is granted up to this limit and the perpetual usufructuary has an obligation to make a payment covering the difference between the market price of the property (determined by an expert in the valuation prepared for the transaction) and the price due to the transformation. This is determined in accordance with the amendment, where this difference exceeds the permissible amount of de minimis aid. This also applies when the perpetual usufructuary has made use of the permissible amount of de minimis aid previously in whole or in part. The amount of the additional payment is determined in the agreement for sale of the land.
Charging Tenants with the Cost of Transformation
The standard in the case of triple net lease is that all fees and costs associated with the operation of the property leased are actually borne by the tenants, usually within the operational (service) fee. Similarly, the standard in the market is that the annual fee for the perpetual usufruct of the property leased is also borne by the tenant/tenants. This is usually stated explicitly in the terms of the lease agreement.
Where perpetual usufruct is transformed into ownership, the transformation fee effectively constitutes the purchase price of the property. A situation in which a tenant pays a share of the purchase price of the property without simultaneously becoming the owner (such as in BTS projects) is misaligned with the market standard.
This issue certainly requires case-by-case analysis in relation to a specific agreement, but the broad market standard / generally established catalogue of service fee components is that the cost of transformation, unlike the annual fee, cannot be included in the service fee and tenants can be expected to contest any grounds given for charging them with such a fee, unless otherwise directly stated in the lease agreement. The above bears no relation to the fact that this payment will be made instead of the annual fee for perpetual usufruct.
Even if the tenant does not object to (or does not notice) this new cost, when a professional legal audit is conducted as part of the future acquisition of the property, the inability to legally (in accordance with the agreement) transfer liability for the payments due to the transformation (purchase price) will be flagged as a high risk.
If article 70 of the Real Estate Management Act were to be applied, if the price for the property were divided into instalments, the amount of the instalment at the time of transformation will correspond to at least 250% of the annual fee. This constitutes twenty-five times the annual fee (the lowest possible price where payment is made in instalments) spread over a period of ten years (the longest permissible instalment period under the Real Estate Management Act). It is difficult to expect tenants not to protest against such additional costs, especially in a situation where the permissibility of charging them is at least questionable.
Summary
Considering the above, it is not surprising that the option of payment for transformation of title to properties given in perpetual usufruct is not particularly popular. This solution seems profitable only in very specific cases. It definitely will not apply to properties acquired for investment purposes (redevelopment and sale) or to properties given in lease.