Buying before ground is broken?
Property developments are becoming increasingly popular. And while demand for real estate remains so high and the supply of real estate so low, this is not at all surprising. More and more investors are accelerating their investment decisions and acquiring newbuild properties at an early stage of their development, rather than waiting for a ready-to-use property. The strategy has an undeniable charm, and means that investors are able to get ahead of the competition and secure sought-after properties for their own portfolios. It’s a tempting approach, but it can also be a tricky one.
There are two basic types of forward deal – forward purchases and forward funding. In the case of a forward purchase, an early deal is agreed to buy the development, whereby the buyer only pays once the development has been completed and handed over to its tenants. This minimises risk for the investor, who doesn’t bear any of the construction risk and only has to pay once the construction phase has been completed. This means that the investor only concludes their purchase when they are sure that they are buying a successfully completed development.
Forward funding is also becoming an increasingly popular form of real estate investment. Forward funding means that an investor not only acquires a development before completion, but also provides funding from an early stage, either before construction work commences, or once construction is already underway. While some may view this as a disadvantage or risk, institutional investors actually see it as an advantage – after all, it means they can allocate their liquid resources more efficiently and start generating returns on their investment more quickly. With interest rates so low, many investors regard this as a better option than waiting until a development has been completed.
Investors also secure a small risk premium when they agree a forward funding contract, in the form of a discounted purchase price. In fact, the risk markdowns for forward funding deals are already far lower than they used to be, especially as investors typically hedge against any extra risk. As a rule, investors do not normally acquire a development until construction permits have been issued and a specified pre-letting volume has been achieved. This shields the investor from unexpected difficulties with planning authorities and limits the extent of any letting risk. In addition, the cost risk is also normally borne by the developer. If construction costs are ultimately higher than forecast, it is the developer who has to accept lower profits, not the investor.
Despite all of this, forward funding still involves a number of risks for investors. After all, a construction site can never offer 100 percent planning security. For example, the development’s general contractor could become insolvent, causing considerable on-site delays. In order to cope with a worst-case scenario, it is therefore always better if an investor has their own experience of property development, or has a partner with the necessary expertise.
Forward deals are available to suit both large and smaller-scale investors. Institutional investors increasingly use forward deals because in this tight real estate market they don’t want to miss out on core real estate. They know that property developments offer them the chance to secure the real estate that best fits their investment profile. At the same time, the family office sector has plenty of potential buyers for smaller-scale developments.
Residential Investments 2017 – in search of the best mid-range yields
Investing today? In the face of rising prices and a shortage of available real estate assets, this is becoming more and more of a challenge. Given that the German real estate market is also highly attractive for highly capitalised and foreign investors – keyword: safe haven – you need the qualities of a bloodhound if you hope to continue investing successfully. Having said that, in a number of regions, and with the right investment strategy – keyword: alternative real estate classes – it is still possible to achieve healthy yields in 2017, you just need to know how. Here at BGP, we have analysed two trends and one potential pitfall for you.
1. Secondary locations have become more attractive
Necessity is the mother of invention, and high levels of demand have created a necessity for creativity. Investors have long since been buying real estate in less attractive macro-locations. In addition to higher yields, there’s always the chance that a secondary location in a B city could become a fashionable neighbourhood with rising property prices, replicating the trend we have seen repeatedly in Germany’s largest cities. This is where the strengths of a property’s micro-location play a decisive role. Does the object boast convenient links to public transportation? Are doctors, shops, restaurants, cafés and leisure facilities all close at hand? As many investors already know, even a prefabricated, 1970s high-rise with a stable mix of tenants and value-add potential can be well worth considering as a prospective investment. But care should be taken: No two B cities are identical and there will be significant variations in economic development from one location to the next. The right advice and market analysis are therefore essential if you hope to acquire a property with the ideal value appreciation potential.
2. Student residences as an alternative investment
Students need somewhere to call home just as much as anyone else. Many of us will know this from our own personal experience. And as the number of students at Germany’s universities continues to increase, so does demand for small, compact apartments and rooms in convenient locations. The numbers speak for themselves: There are currently more than 2.8 million students in Germany, and roughly 12 percent are overseas students. Investing in one of Germany’s university towns or cities should therefore be on your agenda for 2017. And don’t forget: You can significantly boost real estate yields by tailoring your concept specifically to students, for example by letting rooms on an individual basis, which doesn’t require more than a minor additional investment. In this respect, it is well worth investigating whether it makes sense to work with a facility management partner. It’s important to bear in mind that the unusually high number of students right now is due to the temporary boost delivered by double intakes – so don’t be dazzled by current figures and make sure you analyse the long-term trends. Tip: A mid-price strategy will deliver more sustainable lettings than those available in the premium segment, which is currently benefiting most from the short-term student boom.
Eastern Germany’s flourishing landscapes 2.0
Last but not least, a warning: Wherever you turn, talk is dominated by claims of a real estate boom in eastern Germany, and that the region’s B cities, in particular, are hitting peak popularity. But caution is advised: Eastern Germany’s real estate markets are profiting less from the region’s individual economic development and far more from a reaction to the enormous price increases seen in western Germany. There are very good reasons why we everyone is currently talking about “swarm cities”. The swarm may well be circling eastern Germany right now, but only because so many young and highly flexible people simply can’t afford to live in an apartment in one of western Germany’s major cities. But what will happen when the real estate market in western Germany corrects? As soon as automatic rental price increases are no longer possible for new tenants, the swarm will move on. And many investors will be left holding their relatively expensive real estate – bought as the market was rising – waiting for affluent tenants to appear in cities that lack strong economies in their own right.
No two B cities are identical, no two university towns are the same, and the east doesn’t function like the west. Investors who want to invest successfully in the medium and long term should make sure they are not dazzled by short-term developments. At the same time, domestic and international investors are targeting secondary, mid-range locations and alternative real estate classes, such as student residences. Overall, Germany remains a solid investment location for investors who fully understand the unique characteristics of each of the country’s regions.
Ms Reiter, more and more people are moving to Germany’s major cities, but housing is and will remain scarce. What makes it so difficult to develop property in these locations?
The strongest demand in Germany’s major cities is of course in the districts with the best living conditions – culture, leisure amenities, proximity to work and infrastructure. It is not just a question of increasing the density of housing in these neighbourhoods – even converting commercial spaces, no matter how much you speed up zoning and planning procedures, won’t deliver the additional housing we need. It’s about more than just good property developments. We also need neighbourhood and district developments which, in the best cases, prioritise the creation of new residential space. This is a realisation that some municipalities have arrived at quicker than others. In most cases, this means that property developers – together with a property’s end-user – often have to get the ball rolling, and hope that the infrastructure will follow.
What does this mean for the regions around our largest cities?
The key importance of the areas around our metropolitan regions has become one of the major topics for the housing sector. With good universities, continual population growth and high employment rates, an enormous housing shortage has developed in many regions. This has driven rental and property prices up to unaffordable levels. The market’s problems can only be solved if people can be persuaded to move to neighbouring towns and cities. Given the economic upswing, commuter belts around metropolitan regions are going to remain attractive propositions in the long-term. This means that we urgently need to create more housing in secondary locations.
You are currently developing a new residential quarter with roughly 450 apartments in Wesseling, between Cologne and Bonn. Has demand in major metropolitan regions reached such a high level that large-scale developments can be profitable, even in medium-sized cities?
Wesseling is not a traditional medium-sized city. After all, Cologne pretty much transitions directly into Wesseling. If anything, you could compare Cologne-Wesseling-Bonn to the Rhine-Ruhr metropolitan region. The demand from would-be buyers for affordable homes in the area is enormous, and many potential homeowners are simply not being served right now. We see this in the low levels of homeownership in Wesseling, which confirms how huge the untapped market is and demonstrates the potential of Wesseling as a residential location.
Who are the potential buyers in these areas around large cities? Young families, commuters?
There is not only a shortage of apartments for students and commuters in our city centres, but also classic two- to five-room apartments and detached houses for couples and families. Demand is strong across a wide range of different buyer and tenant groups. And people have also become more willing to commute, as long as the right infrastructure is readily available.
What do you need to offer if you hope to attract people to your residential development?
Two criteria are crucial for any successful concept:
The mix of housing – the right mix of different types and sizes of apartments that will create a rich neighbourhood diversity – along with affordable rents and property prices at a level that is no longer available in our inner cities.
In the Rheintal Quartier in Wesseling we have developed apartments specifically tailored to the needs of different age and target groups. From modular apartments and classic two- to five-room apartments, to multi-generation concepts and townhouses. The green and open spaces, along with the quarter’s central square and water playground, all combine to guarantee a high quality of life − and create an urban and structural unity, or social homogeneity, that truly make the quarter a place well worth living in.
Planning a property development to make a contribution to urban development, to the spatial, structural and economic development of the city, also makes a great deal of sense. We incorporated the planning objectives of the city of Wesseling into all of our plans.
Still, even in major cities, not every location is suitable for such a large-scale investment. What factors do you consider when you choose a location?
With any location, the key factor is local infrastructure. We want to guarantee rapid access to the city centre, whether by subway or suburban train, or via convenient motorway access. Shops, children’s daycare, schools and leisure facilities should also be close by.
What’s more attractive for real estate investors in suburban areas – existing properties or newbuild developments?
We are definitely seeing a shift among investors – following strong price growth for existing properties over the last 18 months, newbuilds, including those in suburban areas, are in strong demand again, as long as the ratio between rents and purchase prices is right.
Everybody is talking about “swarm cities”. Do you see potential in cities beyond the traditional conurbations?
The term “swarm city” has been used to describe new migration patterns within Germany. The research institute Empirica coined the term when it demonstrated that 18-35-year olds rise up like a swarm of bees from many of Germany’s regions and descend on a small number of “swarm cities”, thereby creating housing shortages, while the regions they leave become progressively deserted. The “swarm” is no longer just heading to Germany’s major cities, it is also spreading out into their surrounding areas.
The result is that a new university student no longer automatically looks to live in their university’s home town. Thanks to current market conditions (massive housing shortage, extremely high rental and property prices, increased willingness to commute), more and more students are choosing to live in peripheral areas. I can well imagine that cities beyond the traditional metropolitan areas, those with good transport links and infrastructure, could easily become the new “swarm cities”.
The intelligent alternative
2017 is not long underway and already many investors, having have only ever invested in apartment buildings and residential complexes, are facing the challenge of identifying suitable investment objects at reasonable prices from the extremely limited supply of properties on offer.
Newbuild apartment buildings are an intelligent alternative for investors who have previously only invested in existing residential real estate. Institutional investors and funds, who until recently tended to restrict their acquisitions to existing residential properties, have continuously increased their investments in new apartment developments. And the sector provides significant opportunities for private investors too.
Good apartment buildings have become a rarity. Demand far outstrips supply in most major markets. As a result, prices in Germany’s largest cities have increased to such an extent that the prices for newbuilds and existing buildings have steadily converged. This has massively boosted the relative attractiveness of newbuild rental housing. The potential for rental increases in the existing housing stock has also been limited by the introduction of the Mietpreisbremse rental price brake. But the rental price brake does not apply to newbuild residential buildings, as legislators wanted to boost the construction of new housing. In contrast to existing buildings, rents in privately financed new rental apartments can be freely agreed by landlords and tenants. The newbuild sector’s modern energy efficiency standards also ensure that operating costs are kept low. As tenants only really care about their gross rent, this actually improves a landlord’s chances of achieving attractive rents. Although more and more new housing is being built across Germany, this will still not be enough to satisfy the housing demands of rapidly growing populations in the country’s largest cities. Increased property prices and rents reflect this growing housing shortage, and many real estate experts are forecasting that rents and prices will keep on rising. Unlike existing apartment buildings, buyers of newbuilds don’t have to worry about maintenance backlogs or − in the case of extensive modernisations − statutory energy-efficiency retrofits.
This is how it works:
When you buy a property development, you are buying an apartment building before it has been built. The developer benefits from secure financing and the investor benefits from lower acquisition costs. Payments are either made once the entire development has been completed and fully let, or in instalments linked to construction progress. Within the industry, this is known as a forward deal. This has increasingly become the typical strategy used by insurers and pension schemes to invest in residential real estate. There are already forward deals starting at €3 million, and banks are more than happy to provide financing, which means that even smaller-scale residential real estate investors can enter the property development market. Most institutional investors only consider developments of €15 million and more. This means that private investors have great opportunities in the market segment between €3 million and €14 million.
You have two alternatives:
Those who want to invest in central locations – depending on the city – can expect gross yields of between 2.5 percent (Munich) and 3.7 percent (Berlin, Hamburg, Düsseldorf, Cologne, Frankfurt). Those who want higher yields (4 to 4.5 percent) will need to invest in attractive, up-and-coming areas in more peripheral districts, or in metropolitan suburbs and commuter belts. Investors who use debt to finance a large proportion of the purchase price will significantly increase their yields, and can achieve up to double-digit returns on their equity. As in other real estate sectors, the relationship between interest rates and gross yields for new residential construction has rarely been as favourable as it is right now.
So, if you have only ever invested in apartment buildings or housing schemes, and are only receiving a trickle of offers at reasonable prices, then newbuild developments could be exactly the intelligent alternative you are looking for in 2017.
The Rhine-Main region is booming
It was clear from the “Frankfurt Real Estate Roundtable” on February 21 that the boom in the Rhine-Main region is showing no signs of slowing. And this assessment is in no way only true for Frankfurt. The latest figures from bulwiengesa, for example, show that condominium prices in Mainz have doubled since 2007. Demand has surged in cities such as Offenbach, Darmstadt and Wiesbaden – and prices have risen accordingly. As Wolfgang Ries from Bien Ries AG said: “I’ve been developing apartments for more than three decades, and I’ve never experienced a boom like this one.”
Skyrocketing prices – and not just in Frankfurt
According to bulwiengesa, average purchase prices for condominiums (first-time occupancy) have now reached almost €5,000/sqm in Frankfurt, €4,200 in Darmstadt and €4,000 in Mainz and Wiesbaden. In comparison: In 2007, the average price for a condominium (first-time oc-cupancy) stood at €3,000 in Frankfurt. Over the same period, prices at the top end of the market have climbed from €4,500 to €8,500 per square metre. Rental prices have also risen significantly – although not at quite the same pace as purchase prices. For example, setting the price index for 2007 at 100, the index would now register 170 for condominiums in Frank-furt and 140 for rental prices. The average rent in Frankfurt has risen to €14.80/sqm per month, while the peak rent has climbed to €21.00/sqm (bulwiengesa excludes exceptionally high values from its figures).
40 new inhabitants per day, but only 11 new apartments
The development of new apartments is still failing to keep pace with the region’s population growth. The number of households in Frankfurt has grown by more than 51,000 since 2006, which contrasts with just 26,000 apartment completions. Eleven new apartments are currently being completed in the Main Metropolis each day, but the population is growing by 40 in-habitants per day, which is equivalent to 22 new households. A comparison of the number of rental housing developments with the number of newbuild condominiums reveals that con-dominium developments are in the clear majority. In absolute terms, two-thirds of the apart-ments being developed are condominiums – the proportion is slightly lower in terms of total floorspace, but still amounts to 59 percent.
Strong demand from foreign buyers
The residential tower boom also remains unbroken. Bulwiengesa lists a total of 23 such de-velopments since 2012. The tallest residential tower in Germany so far, GSP Städtebau’s “Grand Tower”, boasts 51 storeys and soars 172 metres above the city. Construction started in Q2 2016 and is scheduled for completion by the end of 2019. The pace of sales has been incredible – 305 of the 401 apartments sold in just ten months. The development’s sales partner, Zabel, has secured large numbers of foreign buyers – from a total of 21 different countries.
In general, Asian buyers have been registering a great deal of interest in Frankfurt. Iris Dilger from Die Wohnkompanie Rhein-Main recently presented her company’s development Sophie in Solmsstraße in Bockenheim. Of 124 apartments, 100 have already been sold, and two-thirds of the buyers come from Frankfurt. Still, these Frankfurt-based buyers include a sub-stantial number of Asian buyers – more than one in four has Asian ancestry.