The rent cap was introduced in February 2020 by Berlin's ruling coalition, which argued it was necessary to keep rent affordable in the German capital.
Germany's highest court ruled on Thursday that a rent cap introduced by the authorities in Berlin last year is unconstitutional.
The Federal Constitutional Court in Karlsruhe said that German states do not have the authority to implement legislation on the issue. The legislative power residing exclusively with the federal government, it added.
The rent cap was introduced in February 2020 by Berlin's ruling coalition comprising the Social Democratic, Greens and Left parties, which argued it was necessary to keep rent affordable in the German capital.
The regulation meant that rents for some 90 per cent of Berlin apartments were frozen at June 2019 rates for five years and that new rents could not be above that level, while existing rents needed to be reduced to conform.
It immediately came under heavy criticism with 284 federal lawmakers from the ruling CDU/CSU parties and centre-right Free Democratic Party launching a legal challenge. Two Berlin civil courts had also referred the case to judges in Karlsruhe.
Interior Minister Horst Seehofer welcomed the ruling, saying that the Berlin rent cap had been "the wrong way to go in terms of building policy".
"It has created uncertainty in the housing markets, slowed down investments and not created a single new flat," he added.
The ruling means tenants will now have their rents reverted to what had previously been agreed with their landlords. They may also have to pay the difference between the capped rent and the contractual rent in arrears.
Housing group Vonovia has already announced that it does not intend to make any back-rent demands. The company, which owns around 42,000 flats in Berlin, estimated it lost up to €10 million because of the rent cap.
But Sebastian Scheel, a Left party senator for urban development and housing of the state of Berlin, criticised the ruling.
"We had broken new grounds with the rent cap and expected a different decision," he said. "Social peace is in danger due to rising rents and the displacement associated with them.
"It is now the federal government's task either to create an effective rent law that ensures social mix in the cities or to transfer the competencies for this to the Lander [German states]," he added.
Euronews reporter Kate Brady said the ruling could present major problems for tenants who now face demands for back-dated payment on their capped rents.
“Some tenants may now face huge back-payments,” she says. “Landlords are able effectively to demand months-worth of back-payments and a recent poll suggested that only around a half of people who have been affected by these lower rents have actually saved the money for the eventuality that this rent cap was overthrown.”
_Watch Kate's report in the video player above. _