Residential Investments in Germany – December 2021

Dear Reader,

ESG is on everyone’s lips – and will soon be in our hands and under our feet. More and more companies are having to publish sustainability reports and more and more investors are actively deciding on the allocation of their investments based on sustainability criteria. This makes it all the more important for owners with older properties in their portfolios to get up to speed. At the same time, it is also worth taking a look at younger investors, whose tendency to regard real estate as one more item in their investment shopping basket should not be underestimated – even if there is always a right time to make an exit, whether in terms of future returns or in view of impending regulatory intervention, that should not be missed.

We hope you enjoy reading this latest edition of our newsletter and wish you a peaceful and healthy end to the year.

Jürgen Michael Schick und Dr. Josef Girshovich

The energy-saving potential of new construction

Sustainability and ESG (Environmental, Social, Governance) criteria are playing an increasingly central role in both private and institutional investors’ strategies in the German residential market. Among the key factors determining a growing number of investment decisions are environmental-friendliness and climate change mitigation – and, as a direct result, energy efficiency. As a recent study by the Empira Group has confirmed, it is easier to achieve this goal via new construction than by retrofitting existing buildings. Although “grey energy”, i.e. the emissions associated with the production, transport and storage of materials and during construction, is not included in the study’s analyses, this becomes increasingly irrelevant over the correspondingly long service life of the property. In addition, new construction can take advantage of the latest and most efficient technologies and processes. New residential construction thus offers the greatest potential for protecting the environment, particularly in the long term.

Energy consumption in the residential sector has hardly fallen
European climate protection targets are extremely ambitious: the EU is aiming to be as close to zero-carbon as possible by 2050. In order to achieve this goal, the real estate and construction industries will need to make a major contribution over the next few years and decades. After all, the housing sector is responsible for a significant proportion of energy consumption and CO2 emissions. In Germany alone, private households account for a quarter of total final energy consumption.

In recent years, the amount of living space per capita in Germany has increased significantly. At the same time, the average household size has been in constant decline. And single-person households consume more energy per capita for lighting and heating than multi-person households. Ultimately, such trends have meant that, in recent decades, energy consumption across the real estate segment has hardly fallen compared with other sectors, despite the implementation of more energy-efficient technologies.

Energy footprint – unrenovated buildings vs. new construction
First and foremost, if we want to substantially reduce energy consumption in the building sector in Germany, we need a more efficient approach to generating and supplying heat energy. Indoor heating and hot water are currently responsible for 87 per cent of energy consumption in the residential sector. On the one hand, we need improved technical and usage-related measures. On the other, the substance of our buildings also holds the key to improving the nation’s energy balance. In Germany, the fact of the matter is that much of our building stock is outdated.

The Empira study shows that unrenovated, pre-war buildings in Germany consume an average of 151 kilowatt hours of energy per square metre per year for heating and hot water. By comparison, the energy consumption of new buildings constructed from 2002 onwards and in compliance with current technical standards is 89 kilowatt hours per square metre, a full 59 per cent lower than that of unrenovated, pre-war buildings.

Logically, this analysis leads us to conclude that the total operating energy for the German residential sector could be significantly reduced in the long term if we can only accelerate the construction of new housing.

Private investments in the German housing market can drive the trend toward a sustainable real estate industry
Over the next few years, it will be important to act in line with EU climate targets, especially in the private sector, and to shift the focus of our efforts towards replacing new buildings rather than steadily refurbishing older buildings. To date, new residential construction activity in Germany has been far too sluggish: In 2018, only 3.47 apartments per 1,000 inhabitants were constructed, in contrast to 6.48 in Austria. Many of Germany’s other neighbours, including Belgium, France and Poland, also built considerably more apartments. The advantage of the private real estate sector lies primarily in its ability to act more flexibly and with greater speed than the comparatively cumbersome public sector. Of course, it does not make sense to replace every single pre-war apartment building with a new building. Each location and property must be assessed individually before any decision is made as to whether retrofitting or replacement makes more sense.

Green Real Estate Investment Funds – Waiting is not a realistic option

For the good of mankind as a whole, we all need to pick up the pace when it comes to protecting the environment. Unfortunately, the real estate fund industry has so far proved itself reluctant to make binding commitments. To date, companies across the industry have declared only about one-fifth of their funds as products under Articles 8 or 9 of the EU Disclosure Regulation.

We urgently need a binding commitment from funds to prove that they are taking sustainability criteria into account. After all, the real estate sector is responsible for around one third of greenhouse gas emissions. Classifying funds as “dark green” or, at a minimum as “light green”, in the sense of the regulation, would provide investors with a valuable point of orientation, more capital would flow into ESG-compliant products, and the decarbonisation of the industry would be given a welcome boost.

Many fund companies justify their reluctance to commit themselves by pointing to the fact that the current criteria are so “fuzzy”. In my mind, that is a weak argument. It will be years before regulators have come up with water-tight definitions of sustainability for the widest possible range of economic activities. Meanwhile, technological advances will mean that previously defined criteria need to be revised. Waiting for a “finished” set of rules that will never exist would be fatal in our fight against climate change.

And the same applies to the fund companies themselves. Because while they are twiddling their thumbs, the market is creating facts. More and more investors are already demanding that investment products identify themselves as sustainable – and are allocating billions to these products. Fund companies that fail to commit are already increasingly being left out in the cold.

If you want a job done properly, do it yoursel
Fund companies should really be in the best position to develop their own criteria for the sustainability of their investments. These would involve energy efficiency standards for buildings and the use of renewable energy sources. They should also include criteria for social sustainability, which are currently less bindingly defined than their environmental counterparts. And social sustainability is what the real estate industry is all about anyway, because buildings have such a strong influence on the well-being of the people who live and work in them and have such a significant impact on the urban environment – in both positive and negative terms. It is also important to determine how ESG screening will be integrated into the real estate acquisition process and how it will be applied to property portfolios. If a fund identifies properties in its portfolio that do not meet the criteria, we need rules on how they can be made sustainable or whether they should be sold.

A well-developed ESG strategy is also the basis for meaningful ESG reporting. This not only enhances investors’ perceptions of a company, it also reduces the risk of not being able to live up to the sustainability promises the company has made.

In any case, fund companies can’t afford to wait for regulators to lead them by the hand. Change is coming one way or another – and it would be far better to help create the rules than to be overtaken by reality.

Why young investors shouldn’t forget the “one-third property” rule

You should invest one-third of your money in stocks, one-third in cash, and one-third in property. This classic, and oft-repeated wisdom was almost second nature to earlier generations, not least stock market greats like André Kostolany. Nowadays, however, the “one-third property” rule in particular seems to have been increasingly forgotten by younger investors. Why is that?

New investors take the market by storm
The robust stock market boom in the wake of 2020’s Corona Crash and the community-building of groups such as wallstreetbets have had an extremely satisfying side effect. It is almost impossible to remember a time when so many young people were so passionate and focused on the available options for investing their own money. Technology stocks and “growth stocks” have proved particularly popular – and the same can be said for cryptocurrencies, which seem to be increasingly gaining acceptance as an alternative to gold or traditional currencies.

On the back of such investment strategies, lots of investors posted solid returns over the course of 2021. But many portfolios run the risk of are not being sufficiently diversified across different asset classes. In particular, achieving the right proportion of real estate often seems like a problem. While a number of private investors already own their own homes and therefore have a substantial real estate allocation among their total assets, a large number have so far devoted little attention to the qualities of real estate as an investment product. However, several inherent features have always made real estate an attractive portfolio hedging instrument: low correlation with the overall performance of stock markets, low volatility and (similar to stocks) a high level of protection against inflation.

Different investments have different specific features
However, the above advantages do not apply equally to all forms of indirect real estate investment. Consequently, it is important to understand the potential advantages and disadvantages of individual investment vehicles. In many cases, investors include real estate stocks (or real estate ETFs) in their portfolios. However, these not only correlate fairly closely with developments on the real estate market, they also mirror the frequent ups and downs of the stock market to some extent. As a result, shares in listed real estate companies may at times trade at a discount to their book value, i.e. the fair value of the portfolio of property they own. In the case of real estate crowdfunding, which is also popular, annual returns are secure in that they take the form of a fixed interest rate – but investments are usually structured as subordinated loans or bonds. In such cases, investors do not benefit from any increases in the value of the properties they indirectly own, nor do the investment products themselves offer reliable protection against inflation. In addition, investors run the risk of losing their entire investment if the property developer has to file for bankruptcy or the project runs into difficulties.

Funds – analogue or digital?
A traditional real estate mutual fund, in comparison, offers the opportunity to benefit from rising asset values, combined with a lower correlation with developments on the stock market – plus annual distributions. Nevertheless, it is largely Gen Xers and Baby Boomers who invest in property funds. Among younger investors in particular, funds frequently have a somewhat fusty image, triggering associations with bank counters and stuffy investment advisors in suits and ties.

Nowadays, however, it is also technically possible to tokenize fund investments (and loans). Real estate assets can be deposited in digital form as security tokens, which are subsequently stored in an investor’s wallet and – at least in theory – can be transferred as freely and in as decentralised manner as cryptocurrencies. Unlike Bitcoin, though, the token always has an intrinsic value, which is why it is likely to be much less volatile. Currently, a legal framework is being developed in Germany to make this form of “virtual” real estate investment freely tradable. If successful, this will allow the real estate fund industry to reinvent itself and become more attractive to a new generation of investors.

ESG moves to the top of the agenda
Another aspect that is gaining in importantance, especially among younger investors, is ESG (Environment, Social, Governance). Accordingly, investments should not have a negative environmental or social impact. Then there is “impact investing”, which goes even further and focuses on the positive impact and added value of an investment. In the real estate sector, too, a growing number of fund managers are choosing to develop sustainable products and include them in their portfolios. And this is about more than merely ensuring that new properties are built to the highest KfW energy-efficiency standards and are more environmentally-friendly in day-to-day operation. There is also the question of how densification projects in already built-up areas can be delivered as efficiently as possible. Social aspects are equally important. After all, the issue of affordable housing is one of the most pressing issues of our time and is of major relevance to society as a whole. And that is precisely why some fund managers have already started to include subsidised housing units in their portfolios, with very tangible economic benefits: rent-capped and subsidised rental housing is almost always guaranteed to be fully leased – which in turn guarantees stable cash flows for investors.

Prices for multi-family apartment buildings continue to rise

New report on the German multi-family investment market:
B and C cities gain momentum
Multi-family properties hold their value despite the pandemic and the new regulations on the horizon

The good news is that the volume of transactions involving apartment buildings in Germany remains stable. At EUR 22.8 billion, the transaction volume in 2020 was around 1.1 per cent down on the previous year’s figure, compared to an 8.4 per cent rise in 2019. Shrugging off the impact of pandemic-related restrictions, 2020 scored the second-highest transaction volume on record. This is one of the key findings in the recently published second edition of SCHICK IMMOBILIEN’s residential investment market report. This comprehensive study analyses the latest developments on the multi-family investment market in Germany’s 50 largest cities and is based on data for transactions involving multi-family and mixed-use residential and commercial buildings – apartment buildings – from municipal appraisal committees.

Berlin remains by far the biggest apartment building market
According to the SCHICK IMMOBILIEN research, the number of transactions concluded in 2020 declined by about 5.9 per cent compared with the record figure for 2019. The study’s analysis of data on 12,666 transactions concludes that the largest declines were registered in Germany’s Top 7 cities, where the number of transactions dipped by 8.7 per cent to 3,074. Berlin registered by far the most apartment building transactions in 2020. The German capital successfully bucked the national trend. Despite new regulations, rent caps and the expropriation debate, the volume of transactions rose by 6.7 per cent to EUR 5.15 billion. In Munich, Hamburg, Frankfurt, Cologne and Düsseldorf, transaction volumes were down, in some cases by double digits. Only Stuttgart recorded a significant increase of 35 per cent.

Transaction volumes in Germany’s Top 7 cities in 2020 (in EUR bn)

Growth in B and C cities
Germany’s B cities enjoyed a 2020 that will live long in the memory. The number of transactions increased by 0.7 per cent, while transaction volumes rose by 18.5 per cent to EUR 6.3 billion. Above-average demand for multi-family properties was registered in Wiesbaden, Nuremberg, and Bremen. Of the 14 surveyed B cities, Bochum, Essen, and Duisburg recorded declines. These figures illustrate that the focus of multi-family investment has shifted from Germany’s Top 7 cities to its B cities.

Transaction volumes in Germany’s B cities in 2020 and year-on-year change

Prices continue to rise
Strong demand for apartment buildings caused prices to rise again in 2020. The median purchase price for an apartment building in 2020 was EUR 2,104 per square metre of living space, an increase of 10.5 per cent. Nevertheless, the range of purchase prices is particularly broad with buyers in Dessau, Gera and Gelsenkirchen paying around EUR 750.00 per square metre, while properties in Munich (EUR 7,300/sqm), Frankfurt (EUR 4,395/sqm) and Wiesbaden (EUR 4,005) sold for the highest prices.

Depending on the city, location and condition of an apartment building, achievable gross initial yields ranged from 8.6 per cent to 2.3 per cent, with price-to-rent ratios anywhere between 11.67 and 43.0. Rents for existing apartments increased by an average of 2.9 per cent across the study area. It is notable that rents in the Top 7 cities (+2.7 per cent) rose at a slower pace than rents in the B cities (+2.9 per cent). Buyers of multi-family properties can expect the greatest potential for rent increases in Lübeck and Karlsruhe, where existing rents rose by 5.9 and 5.3 per cent respectively. The peak rent for a newly built apartment averaged EUR 15.36/sqm. This represents a 2.9 per cent increase over 2019. Vacancy rates of 0.2 per cent in Munich and Frankfurt, 0.3 per cent in Freiburg and 0.4 per cent in Münster confirm the particularly strong demand for rental housing in these cities.

The research also confirms that the pandemic has had a minimal impact on the multi-family investment market, which has proven extremely robust. And the trend toward higher prices has continued in recent months with initial nationwide data for 2021 indicating that the number of transactions in the multi-family property market is again set to climb slightly this year as transaction volumes increase due to rising prices.

Prices for multi-family properties in the ten most expensive cities in 2020 (in EUR/sqm)

Would you like more information? Then drop us a line to info@schick-immobilien.de and we will send you a copy of the hot-off-the-presses “Zinshausmarktbericht Deutschland”.

News

Pre-emptive purchase rights ruled illegal

In a sensational ruling, the Federal Administrative Court has quashed Berlin’s policy of pre-emptive purchase. According to the Court, the assumption that the sale of an multi-family property in a designated neighbourhood protection area after the stipulated seven-year period could lead to the displacement of tenants does not provide sufficient justification for Berlin’s building authorities to exercise their pre-emptive purchase rights. The new judgement is a clear victory for many property owners in Berlin. In addition, many of the Abwendungsvereinbarungen (“aversion agreements”) concluded between district authorities and property owners will now also be subject to scrutiny. The ruling will have two consequences: In the short term, authorities will make less frequent use of their pre-emptive purchase rights. In the long term, federal lawmakers are likely to revise the existing legislation and will probably even strengthen municipalities’ rights of first refusal.

Tax on inhabited housing under discussion

The debate surrounding proposals to levy a tax on inhabited housing is intensifying. The tax, levied on rental income, would be payable on capital gains from rental real estate. The tax has history and was previously in force between 1923 and 1944. Now, Berlin’s politicians are calling for it the tax to be reinstated as an alternative to the expropriation of housing companies owning more than 3,000 rental units in the city. A tax on inhabited housing would impact all owners and landlords, irrespective of the number of housing units they own, and would also have a significant impact on loan-to-value ratios and current mortgage financing practices.

Berlin aims to build more

The three potential coalition partners in Berlin are still haggling over the political details of the new Senate, but they are already sending out clear signals about residential construction and look likely to introduce a percentage cap on the construction of new condominiums. Accordingly, at least two-thirds of all new apartments will have to be built for the rental market. The Green Party and left-wing Die Linke have even called for a rental housing quota of 80 percent. In addition, they want 50 percent of all new apartments to be rent-controlled and subsidized. Combined with ongoing discussions about new construction in Tegel,