Residential Investments in Germany – September 2024

Dear Readers,

Autumn is just around the corner and, in recent months, industry experts have been reassessing their forecasts and evaluating market trends. It is evident that the market is showing signs of recovery, albeit with some ambivalence. While residential property prices continue to vary across Germany, prices for investment properties have notably stabilised, particularly in major urban centres.

In this context, it is crucial to determine the precise factors influencing the development of a property’s value. The economic climate is certainly a significant factor, but other elements such as social milieu, flexibility, infrastructure, and sustainability also play pivotal roles. Although the mountain of non-performing loans (NPLs) is growing, which could also create opportunities, investors have the potential to enhance and revitalise entire districts through urban regeneration projects.

EXPO REAL, Germany’s leading real estate trade fair, is also fast approaching. Despite the ongoing shortage of new residential construction in Germany, the residential investment market is far more vibrant than is often portrayed in the media. Investors are seizing the opportunity to capitalise on attractive prospects that are arising in this market phase. We are confident that the atmosphere at EXPO REAL will mirror these positive trends and exceed expectations.

We look forward to seeing you at the EXPO REAL. In the meantime, we hope you enjoy the rest of your late summer and our latest informative newsletter!

JMS and HFR

Milieu has a major influence on value-determining factors

Given the challenges of the current economic climate, German property developers are more careful than ever before in their analysis of parameters such as construction costs, rental price trends, and yield potentials. Nonetheless, the quality of local infrastructure, including access to public transport, schools, daycare centres, nurseries, local amenities, and green spaces, also has a major influence on developers’ pricing models. The impact of these factors largely depends on the specific social milieu of the target demographic.

The situation is by no means getting easier
For the period from 2010 to 2022, the Federal Statistical Office’s construction price index registered an increase of 64 per cent – while the general inflation rate rose by just 25 per cent over the same period. Despite the current crises, these costs have not fallen significantly, while the uncertainties surrounding new ESG regulations and financing have increased.

If, despite these challenging circumstances, a property developer does decide to go ahead with a planned project, it is absolutely crucial to precisely define the target group of potential buyers from day one. All too often, developers become too focused on the property’s features and potentials, and neglect the social mix and existing infrastructure in the surrounding area.

Analysing social factors may initially seem like nothing more than common sense. For example, a developer in Hamburg is hardly likely to plan a residential project exclusively for families in the business-oriented HafenCity district. Instead, they would look at somewhere like Winterhude, Lokstedt, or Eppendorf. For the same reason, it makes no sense to rely on generic, one-size-fits-all solutions simply because they have proved successful in other locations.

The Sinus Institute’s milieus are shifting
However, as always, the true challenges lie in the details. It is becoming increasingly apparent that the wants and needs within different social milieus are rapidly evolving – especially at the very centre of society. A recent study conducted by social researchers from the Sinus Institute in Berlin and the Bertelsmann Foundation in Gütersloh has revealed that the “middle class” is experiencing a significant decline in confidence in the future. Only one in four individuals in the “nostalgic-bourgeois” milieu and just one in two in the “adaptive-pragmatic” milieu, both of which constitute the middle class, are optimistic about the future. This represents a far more pessimistic outlook compared to the same study’s findings in 2022. This shift in sentiment may lead to more frugal lifestyles and a heightened desire for security. Consequently, when assessing residential property locations, this may in turn mean that certain leisure amenities, such as having a nearby venue for cultural events, are less important than traditional social infrastructure such as schools, daycare centres, parks and green spaces, along with high-quality medical facilities. In addition, the affordability of living space is also becoming even more of an issue for residents.

In contrast, the opposite is the case for the Sinus Institute’s upper-middle-class and upper-class milieus. The “educated elite,” “performance elite,” and the more artistic milieus are all now focussing on location qualities that were not considered important just a few years ago. Environmental and social sustainability criteria are now among the most significant factors in property concepts, construction methods, as well as in the immediate surroundings. In addition, many of these households have developed a far more international mindset over the last few years. For a property developer with a focus on these more affluent demographic groups, it can be well worth checking whether the school in the neighbourhood offers language courses in Mandarin, or whether rugby is among the sports on offer at nearby clubs.

Ultimately, it is the realities of the target groups’ lives that will determine which location factors are important in terms of pricing. Accordingly, property developers should adapt their concepts to the existing milieus – rather than expecting the target demographic to be drawn to their project and willingly relocate to a neighbourhood that may not suit them. The key challenge in neighbourhood development is to identify a diverse range of suitable target groups with varying economic and social backgrounds, and to create a contemporary neighbourhood concept that caters to everyone’s needs. Where infrastructure is lacking, it should be specifically developed within the neighbourhood. Neglecting or disregarding these factors – or even merely understating their importance – poses a significant risk to the long-term sustainability of any project.

Mobility is the common denominator
It therefore makes no sense to generalise about which location factors are the most value-determining – with perhaps one exception. In today’s world, modern mobility concepts and the reduction of private transport play a crucial role in nearly every new property development. Of course, locations in the suburbs are still more car-centric than those in city centres, which means more consideration needs to be given to the practicalities of parking and a host of other small (and sometimes large) details.

However, a decreasing number of people across nearly all social milieus now depend on their own personal vehicles. And the already heightened environmental awareness among younger generations is expected to further amplify this trend in the future. Convenient access to efficient public transportation systems and the availability of car-sharing services are already having an increasing impact on the achievable rental and purchase prices of residential properties. As a result, these factors are becoming increasingly important. And not only in urban centres, but in outlying areas, too.

How investors can benefit from urban regeneration

In an age marked by urban densification and a rising call for sustainable development, the optimisation of current urban structures is a key issue for the real estate industry. The concept of urban regeneration is emerging as a groundbreaking approach that goes beyond just the modernisation of buildings. This holistic process presents enticing prospects for investors by not only emphasising the upkeep of current infrastructure, but also promoting the transformation of entire neighbourhoods. The objective is to reimagine existing urban areas and render them economically, ecologically, and socially sustainable. 

Urban regeneration as a value driver
Urban regeneration, defined as the holistic enhancement of urban areas, creates a wide range of investment opportunities. This strategy seeks to not only renovate existing structures, but also to upgrade entire neighbourhoods, effectively integrating residential, commercial, and recreational spaces. For investors, this represents a chance to invest in initiatives that not only drive urban development but also appreciate in value over time. Investing in the ongoing enhancement of urban areas means utilising the potential that lies in the economic revitalisation of our cities.

Strategies for sustainable success
Investing in urban regeneration projects can be challenging. On the one hand, the complexity of the projects requires close cooperation with urban planners, local authorities, and civil society. On the other, investment decisions are now increasingly guided by Environmental, Social and Governance (ESG) criteria, which makes the evaluation of projects more even more complex. However, this complexity and the focus on sustainability also offers significant opportunities for investors. After all, the growing demand for environmentally friendly and socially responsible residential and commercial space further boosts the potential for stable returns.

By engaging in the planning process early on, investors not only have the opportunity to shape the design of individual projects, they can also ensure their economic and social viability. In addition, investing in sustainable urban development projects opens doors to attractive subsidies and tax benefits, further enhancing financial returns.

ESG as the key to resilient investments
ESG criteria are becoming increasingly important in investment decision-making. Investors who engage in urban regeneration projects can not only generate financial returns, they are also able to deliver environmental and social benefits. By conscientiously managing resources, promoting social equity, and adhering to rigorous governance standards, investors can mitigate investment risks and proactively address potential future regulatory demands.

A roadmap for the future of urban development
Urban regeneration as a comprehensive approach to redesigning urban spaces presents investors with the potential for not only lucrative returns, it also gives them the opportunity to actively contribute to the development of sustainable and livable cities. By strategically aligning economic, ecological, and social goals, investors can make a lasting impact that goes far beyond financial success and lays the foundations for long-term urban sustainability.

Non-Performing Loans: The Worst Is Yet To Come

Finally some good news! The European Central Bank (ECB) has lowered its key interest rates for the first time in almost five years, following ten consecutive rate hikes. At least that’s probably what many in the property sector are thinking. However, it is still too early to sound the all-clear on the real estate market. Construction costs remain high. Transaction activity is sluggish, with few deals being closed. Achievable price-to-rent ratios have also taken a bit of a tumble and are no longer always above 20 –in some cases they can now be as slow as 10 or 15, even for perfectly appealing, easily marketable properties.

Furthermore, financial institutions continue to be cautious in providing financing for real estate ventures. This reluctance from banks suggests that a return to pre-crisis “business as usual” is improbable. In fact, it looks as if lenders are more likely to step on the brakes in the near future and make their lending criteria even more stringent.

Banks are having to act slowly
One significant factor is the increasing number of non-performing loans (NPLs) on banks’ balance sheets. Then there’s the pressure regulatory authorities are exerting on banks in relation to property financing, which is also steadily increasing.

In response, the ECB has launched a programme of Targeted Reviews und On-Site Inspections. Similarly, the German Federal Financial Supervisory Authority (BaFin) is conducting special audits under the German Banking Act. Of particular importance is the strict monitoring of risk management requirements (MaRisk) and Loan-to-Value (LTV) risk, which involves an analysis of loan collateral in relation to the value of any loans. As property market values decline, banks are gradually seeing these impacts reflected in their loan portfolios, and they are being forced to take defensive action.

Non-performing commercial property loans up by 129 per cent
Regarding NPLs, the latest data from the European Banking Authority (EBA) indicates a clear upward trend. At the end of the first quarter of 2024, the total volume of non-performing commercial property loans in Germany amounted to 14.2 billion euros, marking a significant 129 per cent increase compared to the previous year. The overall volume of NPLs in Germany also rose by 25 per cent to 39.8 billion euros during the same period.

And this trend is not expected to end anytime soon. This is because refinancing has become far more expensive, despite recent interest rate reductions. Particularly affected are loans acquired approximately seven to ten years ago, many of which are set to mature between 2024 and 2026. The challenging refinancing landscape means we are likely to see even more property companies experiencing financial difficulties. According to our estimates, there should be around 60 billion euros in NPLs in the German market as a whole by the end of the year, representing a more than 50 per cent increase compared to the end of the first quarter. And this number may continue to climb as a significant volume of loans from the previous economic boom phase reach maturity over the next couple of years.

To some participants in the property market, the outlook may be bleak. For others, however, there are also opportunities on the horizon. The increasing volume of non-performing loans is expected to result in an uptick in real estate asset sales. Currently, many sales are still taking place below the 100-million-euro threshold. It is only really above this threshold that Anglo-Saxon private equity and hedge funds become interested.

Ongoing reluctance to buy NPLs
Offers for these “smaller” NPL sales are currently being very closely examined by single and multi-family offices – and sales are being conducted with maximum discretion and confidentiality. Despite this interest from family offices, German institutional investors have been holding back on NPL purchases, potentially missing out on a favourable entry point, as they did in the years around 2003, and again in the wake of the global financial crisis.

Successful NPL sales require robust restructuring concepts and consistent workout strategies, expertise that is no longer available in many banks. As a result, market participants, whether investors or credit institutions, are reliant on partners who can provide the necessary expertise and management support.

Ahead of EXPO REAL: An industry between crisis and a new beginning

At first glance, the headlines about the state of the real estate market and, above all, the crisis in new construction, always convey the same negative messages. Auch das The standard of political proposals for solutions has also reached a new low. However, upon closer examination, a sense of stability and optimism emerges, particularly in the residential property investment sector. Where is the real estate market heading this year?

When the key players in the property industry convene at this year’s EXPO REAL in Munich a few weeks from now, one thing is already clear: sentiment among delegates from the various asset classes could not be any more varied.

On one hand, there are companies striving to promote new construction. In this field, however, they are operating against an incessant tide of negative headlines. One of the most striking recent stories reveals that only 175,000 new dwellings are expected to be built in 2026. According to the Ifo Institute, this figure starkly contrasts with the nearly 300,000 new apartments built in 2022, and falls far short of the German government’s target of 400,000 new-build apartments. The new-build crisis is manifesting itself above all in cities, where living space is already in such short supply. There is also an acute shortage in terms of the quality of the political proposals on how to tackle the crisis. One of the latest quick-fix proposals comes from Federal Building Minister Klara Geywitz, who has suggested that house-hunters turn to vacant properties in the exurbs and rural areas – a superficial solution that fails to address the root of the issue.

Stabilisation of the residential investment market
On the flip side, as the latest figures prove, the residential investment market has been becoming consistently more stable over recent months. This trend is confirmed by data from Schick Immobilien’s Berlin Residential Investment Market Report for the second quarter of 2024, which reveals that average prices and the number of transactions are both on the rise, indicating a surge in market activity. Currently, the average cost of a mixed-use, residential and commercial building in the German capital is EUR 2,401 per square metre. This marks a notable increase from the average purchase price of EUR 2,377 per square metre for multi-family and mixed-use, residential and commercial buildings in 2023.

The transaction volume in this market has also developed positively and is now up on the same quarter of the previous year for the third consecutive quarter. The transaction volume in Q2 2024 was around 18 percent higher than the same quarter of the previous year. In total, residential and commercial properties worth EUR 863.9 million changed hands on the Berlin market – another indication of the continued stabilisation of this submarket.

Private investors particularly active
As important and dominant as the Berlin property market may be for the German market as a whole – after all, it accounts for a good 20 percent of the national market – it is also important to have broader horizons. At Schick Immobilien, we have extended our reach as real estate agents well beyond Berlin to encompass a total of 75 locations. Our focus now includes top-tier cities such as Munich, Hamburg, Frankfurt, Düsseldorf, Stuttgart, Cologne, and Leipzig. At the same time, we recognise the potential in smaller city markets and remain open to exploring opportunities in those areas as well.

This all goes to show that the current state of the residential investment market in Germany is robust, despite the prevalence of negative news. Two groups of investors in particular are currently showing a keen interest in real estate as an investment opportunity: The first group, private investors, family offices, and foundations are interpreting the current market situation as an opportunity to actively engage in expanding and enhancing their portfolios to secure stable returns over the long term. The second group is commercial investors, who are strategically focusing on value-add opportunities in response to increasingly stringent climate protection regulations.

The reasons for the success of this asset class are obvious. Firstly, this development is the result of demographic trends in the capital. Berlin’s population grew from around 3.67 million to around 3.78 million in the short period from the beginning of 2020 to the end of 2023, an increase of more than 3 percent. This had and continues to have an impact on rental prices. In fact, rental prices for existing apartments have seen a substantial increase of around 20 percent compared to the same quarter of the previous year, while new-builds have experienced an 11 percent increase. This continuous rise in asking rents for both existing and new-build apartments is expected to persist, with the existing property segment showing particularly strong growth.

Outlook: Finding solutions, together
Looking ahead to EXPO REAL in Munich, it is evident that the residential investment sector is not facing the same crisis as many other asset classes within the property industry. Optimism prevails. This highlights the importance of collaboration between all stakeholders, whether politicians or industry figures, to develop tangible solutions. These solutions must not only address immediate challenges but also contribute to a comprehensive political framework with lasting impacts beyond today and the current legislative period.

News

New census data provide insights into Berlin’s vacancy rate and rent burden

Data from the 2022 census have now been published. The data were collected during a random survey of 12 percent of the population. The Federal Statistical Office (Destatis) also gathered information from 23 million property owners and 8,000 property companies as part of its building and housing census. One key finding is the national vacancy rate, which stood at approximately 1.9 million apartments on the census date of 15 May 2022. According to calculations from Destatis, Germany as a whole therefore has a vacancy rate of 4.3 percent. Despite the housing shortage, which is particularly prevalent in urban centres, there are thousands of empty apartments in several major German cities. On the census date, there were more than 40,000 unoccupied apartments in Berlin, more than 20,000 in Munich, and slightly less than 20,000 in each of Hamburg and Leipzig. At a national level, 55 percent of vacant apartments had been unoccupied for over a year, while 38 percent were expected to be available for occupancy within the next three months. The city states of Berlin, Hamburg, and Bremen had higher rates of quickly available flats (between 52 and 61 percent) compared to the national average. Among vacant apartments, 24 percent were due to be modernised or refurbished, 7 percent were vacant for sale or owner-occupation, and only 4 percent were slated for demolition. In Berlin, the vacancy rate has decreased since the last census in 2011, when around 66,000 apartments were empty. The average price per square metre for in-place rents in Berlin in 2022 was EUR 7.67, lower than in Munich, Stuttgart, and Frankfurt am Main. Moreover, Berlin’s rent burden, at 27.2 percent, was also lower than the national average of 27.8 percent.

Purchase prices fall in Berlin in Q2, new-build rents continue to rise

According to data from the real estate platform Immowelt, prices for existing flats in Germany increased by 0.3 percent in the second quarter of 2024. Immowelt Managing Director Piet Derriks explained that property prices have now returned to pre-crisis levels: “We are seeing that the property market has recovered noticeably since the beginning of this year after two years in crisis mode, largely because access to financing has improved compared to the previous year”. With further interest rate cuts by the European Central Bank on the cards, Derriks expects prices to continue to rise throughout the year. However, he observed, price trends for existing apartments in individual German cities have been quite mixed. For instance, while Frankfurt am Main saw a 5.5 percent increase in prices in Q1, there was a 0.6 percent decline in Q2. Conversely, Stuttgart experienced a 0.8 percent drop in prices in Q1, followed by a 3.6 percent increase in Q2. Berlin, on the other hand, witnessed price decreases for two consecutive quarters, most recently by 0.2 percent. The reason for this is that the high price level fell much later and less sharply and is now more in line with the rest of the market. In contrast, rental prices for new-build apartments tell a different story. According to data from Immoscout24, Berlin has surpassed Hamburg and Frankfurt am Main to become the second most expensive city after Munich in terms of average rent, at EUR 19.62 per square metre.

New rent regulations are being planned for Berlin

Berlin is a city that has long been a battleground for tenants, with a long history of efforts to regulate the rental market. Various political initiatives, such as the rent cap, price brake, and housing alliance, have been implemented to provide relief, especially on the price front, on the sought-after housing market. Christian Gaebler (SPD), Berlin’s Senator for Urban Development and Building, told the Berliner Morgenpost newspaper about the Berlin Senate’s latest plans: a new inspectorate to combat exorbitant rents is to be launched in November. “After the summer break, we will introduce the necessary bill. I assume that this will be passed relatively quickly”, commented the senator. Berlin’s Senator for Economic Affairs Franziska Giffey (SPD) has additional proposals: “In a light of budget constraints, we also have to talk about the revenue side”, she commented to the German Press Agency. “Another lever is the population register”, she noted, especially as the 2022 census has revealed fewer residents in Berlin than assumed: “More and more people want to live in Berlin. But the question is, do they all register here? For every person who is not registered in Berlin, the city loses over EUR 3,000 in national financial allocations.” She also wants to tackle residents’ parking and has proposed increasing the cost of permits from EUR 20.40 for two years, to EUR 20.40 per year. Independently of the plans of the Senate and the SPD, the Berlin Greens are preparing to introduce a new legislative proposal known as the Housing Industry Act, which they say they will present in the autumn. The Greens’ proposal will call for the introduction of a “landlords’ licensing” system, requiring larger landlords to adhere to specific criteria and social standards.