The German Market

The credit boom of the last decade in the developed world is well-document, along with the repercussions of the binge that we are all now paying for. Quite a party, for those that put the easy credit to useful work, a painful and perhaps catastrophic ending for those who invested the money flowing from the banks in a less than useful manner. With the near-zero interest rate policy we now live in, perhaps the true effects are yet to be felt. As the story unfolds, the number of keys being handed in from over-priced holiday homes, exotic cars and the like could well increase. Oh well, I am sure it won’t be the same next time….

As a team of English property consultants and investors, our perception of the German mortgage market and financial conditions are very interesting to reflect upon. It is true to say that a freshly re-unified Germany was somewhat out of sync with the rest of the world in terms of financing policy and the mortgage market. Whilst the former West had an economy and housing market broadly in line with other mature market, the unique event of re-unification in 1990 brought about changes which make the conditions completely out of phase with the rest of the developed world to this day.

Between 1990 – 1996, when interest rate policy was restrictive for investment across most markets, a wave of speculation of the real value of property in the former East took hold. With the market in the East effectively held under a social regime and property ownership was not possible, the value of the property was unknown. A common-held view that the re-unified country would equalise in prices to a great extent as the East caught up with the successful development of the West during the period of separation. Investments flowed into the East from domestic and foreign sources and the appetite for investment was increased by high bank lending values and government-backed grants for development of historical property.

What happened as a result is a familiar story of over-exuberance, albeit based on a unique event of the fall of the Berlin Wall. As investments were made through the period to 1996 or so, the performance of those investments became unsupportable. The expectation of rent levels being similar to those in the developed West were unrealistic, population fell in many cities and towns due to the pull of the more affluent West and the ability for free travel and high interest payments of the time began to bite. Many investments failed, or needed to be supported from external income to prevent foreclosure. Think about it, just as the developed world was gearing up for a decade in which property values increased by 200-300% on the back on low inflation and low interest rates, so Germany dropped like a stone. It is not uncommon to hear of over-exuberant investments to fall by 50-70% during this period. Despite the prevailing low interest conditions, particularly after joining the Euro, the incentive or abilty to support these failed investments waned. Only the very toughest survived the markets of the East.

What happened next? Germany went through a programme of fiscal reform and set a course for low-inflation and increased productivity. Wage bargaining was tough, and output of the prized high-value German goods increased. All parts of Germany stabilised and began the process of reform. In terms of the property market, equilibrium was found in most areas between 2000-2005.

Only the smaller towns of the East, with still dwindling populations, failed to recover to some extent. The landscape of low prevailing interest rates and double-digit net yields was lade before keen investors. Initially, large institutions were making most of the hay. Firms such as Goldmann Sachs bought up huge portfolios, from repossession or direct from the state. Berlin became the buzz in terms of the place to invest. Private investors joined the fray, and Berlin in 2006 saw investment from international sources reach 70% of all property transactions. Was another bubble about to be created, as in the rest of the world? To some extent, things were overdone. Propert yields in the West and in the capital dropped to 3-6%, only supportable through low interest rates or demand from owner-occupiers where that demand existed.

So what’s the position now? Well, Banks still have memories of the losses made post-reunification but appetite is returning. Well structured investments are attracting good financing today, albeit restricted to some extent by bank’s over-leveraging in the international markets and the associated credit drought. Whilst many areas are offering quality investments in the 4-7% net yield range, and therefore in borad equilibrium in terms of cashflow, some pockets have emerged as oddities and very interesting for investors. These are the areas in which we operate, namely Leipzig, parts of Berlin, Halle (Saale), Dresden and perhaps Chemnitz. Over the last 2 years, we have been delivering investments which average 11.2% net yield on delivery and attract finance at an average of 76%. For the cashflow investor, times are good. Currently we are helping mainly private investors secure deals with the yield range of 9-12% net, with finance up to 80% loan to value, with fix rate mortages from 4%. As long as the due diligence is carefully conducted to ensure a rental yield is sustainable, and the investment property does not require significant maintenance, a good regular cashflow is assured.

What’s the outlook? From a capital value perspective, yields in the 9-12% range (double the financing rate or more) tend to be unstable. Interest from the full range of investors is increasing as cash held on deposit returns next to nothing and alternatives are sought. As confidence builds, these yields should tend towards a level that should be considered in equilibrium, 5-7% net yield should be expected on this basis although markets tend to over correct and yields may fall below this level depending on financing policy. The capital value prospects for investments made now are therefore very favourable. The effect of a falling yield / rise in capital values can only be exaggerated as the appetite for owner-occupation increases in the East, from a level or around 15% today to nearer the German norm of 45%. In terms of rental values, you could argue tenants have never had it so good in many cities, including the capital. It will astound investors unfamiliar with the German market to hear of the very low rents paid for high-quality property. Taking Berlin for example, it is common place for a tenant to pay between 250-300 Euro per month for the net rent of a 50 sqm apartment which leaves the affordabilty on the average household purchasing power [in Berlin 2,500 Euro per month] very high. Net rents consume only 20% of household income on average in many cities.

Around Europe this is typically 35-55%, leaving a very good upside to rents in areas which are in demand. Indeed rent levels are so low, even in some great quality property, that they still languish at or just above the amount paid by the government to those in receipt of income support. Rent reviews have been resisted in part by investors that are fearful of losing tenants if they exercise their ability to increase rents to the market rate, and in parts over supply has suppressed the levels achievable. It is interesting to predict where the rental market will go, and how fast any changes will occur. In Berlin this story is unfolding already and the gap between existing rent levels and new rent levels has widened so far that pressure is being felt in all but the lowest grade areas which are over supplied.

We work with investors from all over the world is are now part of the story in Germany as the market develops. Do get in touch with one of the ProVenture team if you want to find out if Germany could be a place for you to invest in the coming years.