The deep worry lines of well-to-do, property owning widows
Dear investors, honoured millionaires! I am turning to you today because, over the last few weeks, several well-heeled ladies have asked me for advice on what they should do with their old, no, not men, but houses. I am talking about women, all around the age of 60, so-called property-owning widows, who might have lost their husbands, but have been left with respectable apartment buildings. The rented properties may be showing their age, but their owners are still in good shape, if you’ll permit to put it like that. Nevertheless, the ladies are tired of the rental business and don’t want anything more to do with defaulting tenants or leaking faucets. They want to be free and to enjoy their lives. So, it’s not really surprising that many of these property-owning widows are seriously considering selling their properties and “somehow” making use of the proceeds. What do you think? Would you grit your teeth and carry on? Or would you sell and invest the money in bonds and shares?
I’ll give you an example, so that you can figure it out for yourselves. The property-owning widow is 61 and, if all goes well, has another 30-plus years of life left in her. The apartment building is 40 years old and currently generates rental income of €120,000 per year. Of that, our widow has capital expenditure of roughly €20,000 on scheduled maintenance. Then there’s the tax man. He wants €22,000 per year, which leaves our widow with €6,500 per month. At first glance, that doesn’t look too shabby. But those earnings come at a price. She has to deal with 12 different tenants, the building isn’t getting any younger and, despite her regular pension, the widow doesn’t feel financially independent.
Before we consider her options, we need to examine the apartment building in more detail. Above all, we need to make a rough estimate of the property yield. It could be sold today at a price-to-rent ratio of 25. That’s €3 million. The property is debt-free, which means that the full €3 million would be available to reinvest. Our widow hopes that she can increase the €100,000 net annual cold rent by an average of 1% per year over the next 30 years. At the same time, she doesn’t think that the ageing building will gain in value. In fact, she expects the value of her property to fall to €2 million, based on her belief that the value of the building will halve, while the value of the land upon which it stands will remain stable at €1 million. These three assumptions lead her to expect an annual, post-tax yield of 2.1%. This is the benchmark for her securities portfolio. Withholding tax of 26.375% needs to be added to the 2.1% yield, which means our widow needs to generate a pre-tax yield of around 3%.
This is where it gets a bit tricky, because we need to know just what proportion of bonds or stocks our widow will need to support herself financially. If she wants a “low/no-risk” portfolio, our millionairess will have to come to terms with the fact that she won’t earn any interest. That might sound like a problem, but under closer examination it is clear that this is by no means the end of the world. She can still more than get by on the €3 million. Let’s say she withdraws €6,500 per month and increases her expenditure by 1% per year. After 30 years, she’ll still have €287,000 on her account. That might be unacceptable for many people, but I take a slightly different view, especially if there are no heirs in the picture. Even if there are greedy progeny licking their lips in anticipation, I allow myself the question, “Who says that the €3 million needs to be preserved ‘at all costs’”.
Before you start to think that I am a selfish miser, let me provide you with some figures for a portfolio split equally between bonds and stocks that would leave a residual balance of €2 million after 30 years, as was the case with the property above. The €1.5 million of bonds still fail to generate any returns. They should be used on a monthly basis to provide a sum of €3,594, rising by 1% per year.
The stocks have an initial value of €1.5 million. Over the next 30 years, they need to generate profits of €2,906, also rising by 1% per year, and need to be worth at least €2 million when all is said and done. To fulfil these conditions, the stocks would need to generate pre-tax returns of 4.5% per annum. So, do you need to ponder or do you roll the dice? Will a stock portfolio with 2,000 or 3,000 titles generate 4.5% p.a. from now until 2047? This is a question that, unsurprisingly, no one can answer, although I believe that the chances are good. In my opinion, it is far more important just how stable or unstable you are when you start to think about swapping an apartment building for a portfolio of securities, half of which is made up of stocks. It is highly unlikely that the stock portfolio will generate “stable” returns of around 4.5% percent per year. It might be 10% one year, and there’ll be other years with losses of 15-20%, and there’ll be periods when the value of the portfolio only plods along, growing by perhaps 2 or 3%. Which leads me to ask: How will you cope with these ups and downs? Will you become over-confident when stock prices skyrocket? Will you become dejected when prices take a tumble? Or will you keep your cool, living by the motto: “A well-bred lady doesn’t get rattled”. You have probably noticed, my esteemed property-owning widow, that €3 million, although nothing to be sniffed at, doesn’t exactly grant complete financial freedom. On the one hand, you depend on your tenants, on the other, the vagaries of the stock market. Ultimately, you have to decide which “freedom” is more attractive. Is it the “low-risk”, tenanted property? Or the “volatile”, faceless securities? I think the latter is more attractive, because it offers more freedom. I’d even be willing to accept that, in 30 years, my headstone bears the inscription: Here lies Volker Looman, ex-property widower, later stock market speculator!
This article appeared on 07.03.2017 in the Frankfurter Allgemeinen Zeitung
Age-appropriate apartments are still apartments
Within the German housing industry, accessible apartments have been afforded little more than a shadowy existence. The country’s housing stock boasts just 800,000 to 900,000 fully- or partially-accessible units. Anyone who has examined the market – or as many would rather describe it, the niche market – will already know: This is a sorry state of affairs and does next to nothing to cater to existing demand.
However, hardly anyone has taken the time to seriously analyse the market for barrier-free apartments. Arguments used to promote the opportunities in the market for accessible housing are often based on half-truths and a smattering of superficial knowledge. It’s no wonder that this leads to bias and erroneous conclusions. In fact, barrier-free apartments are in no way a niche market catering solely to tenants with restricted mobility – they offer levels of home comfort that appeal to all age groups. Or do you think that an amateur athlete, hobbling home with an injury, would rather torment herself with four flights of stairs, or a trip in an elevator, if there were one? Would a young father rather struggle up the steps in front of his house with an unwieldy pram, or use a ramp? Isn’t a grandson happy when his disabled grandmother is able to visit him in his new apartment? If you think about it, you already know that accessibility is a real advantage, even in such a trivial situation as carting crates of bottles up the stairs.
Very few people know what “barrier-free” actually means. In fact, the term is clearly defined by the DIN 18040-2 standard. Still, it is important not to confuse barrier-free with “wheelchair accessible” (DIN 18040-2R), which is far more expensive to implement.
Anyone who wants to provide an exact definition of barrier-free has exactly 148 criteria to incorporate. Most of these are in no way spectacular, and a majority can be implemented easily and at no extra cost. Where new-build, multi-storey housing is well-planned, barrier-free features will add little more than one percent to the total investment cost.
In most cases, though, barrier-free features are not even on the agenda when it comes to planning new housing. This is because a majority of developers mistakenly believe that barrier-free housing requires substantial additional investment. They also mistakenly believe that barrier-free housing only caters to a niche market, namely the elderly and people with restricted mobility, and that the chances of renting the property over its entire lifecycle are therefore lower.
This is simply not true, which is why our mindsets need to change. No one would immediately think of “housing for the elderly” when they enter an intelligently-designed, barrier-free apartment. Rental opportunities actually increase – especially when you consider Germany’s demographic development. Even if barrier-free apartments could only ever be used by people with restricted mobility, there is still a massive supply shortage. To create a market in which everyone who needs a barrier-free apartment could actually rent one, we wouldn’t need 800,000 apartments, we’d need 4.2 million. If the current construction upswing isn’t exploited to increase supply, this bottleneck will only increase significantly over the next few years.
The solution can only lie in the realization that age-appropriate apartments are still apartments – apartments that can be used by everyone while providing substantially more comfort, whatever the age of the tenant.
Three risks facing the residential real estate market
When the German Property Federation (ZIA) presented its Spring Review just a couple of weeks ago, the waves could be felt across the entire property industry. Empirica’s Harald Simons concluded that property prices in a number of Germany’s major cities could plummet by between 25 and 30 percent. He stated that real estate in cities such as Berlin is significantly overpriced, and warned of a bubble developing in certain localised markets. The real estate industry was almost unanimous in its dismissal of Simons’ analysis. The prospect of such massive price declines – or declines of any magnitude, for that matter – was given short shrift by a majority of experts and real estate companies. Nevertheless, there are indeed three risks that any assessment of the market needs to take into account.
Risk 1: Interest rates. Historically low interest rates have been a key property price driver over the last few years. On the one hand, because financing has seldom been cheaper, and on the other, because investment alternatives have dried up. We all know that the European Central Bank will, at some point, follow the US Federal Reserve and start to tighten monetary policy again. All real estate investors know that this will happen eventually. Which is why I believe that the risk of rising interest rates has already been factored into prices.
Risk 2: Immigration. Many of Germany’s largest cities have been growing as a result of strong international immigration. As far as domestic migration is concerned, both Munich and Berlin actually have negative net migration rates. This is a point I am unfortunately forced to make in response to Harald Simons. Investors and property owners should therefore not assume that the high-volume immigration figures we have seen over the last few years will continue indefinitely.
Risk 3: Tenancy law. The most significant risk, and it is one that is often underestimated by many within the industry, is the impact of legislation on prices and asset values. Plans to tighten up the rental price brake have been on the agenda for some time now. In order to give the rental price brake “sharper teeth”, legislators are set to require landlords to inform new tenants how much the a previous tenant was paying. I believe that the next German government will at least attempt to introduce this measure – irrespective of which party actually wins the upcoming election. On top of this, there are also plans to extend the reference period for municipal rent indexes from four to eight years. These figures are important as they are the basis for local comparable rents, which are used to determine the level of permissible rents under rental price brake legislation. In my eyes, this would be nothing short of a “rental price manipulation” law. Rent indexes will be manipulated for as long as it takes for politicians to achieve their socio-political objectives. The end result will be significant cuts to rents in Germany’s official rent indexes. In many cities, and across a range of property age categories, this will mean reductions of up to €1.00/m² per month.
Then there are the plans to limit property owners’ freedoms to raise rents after modernisations, including the introduction of a tenant hardship provision and an extension of the rental increase cap from three years to four.
This is not an improbable scenario, whether under a grand coalition or a R2G coalition (SPD-die Linke-Green). It would have a dramatic impact on the development of rental prices which would, in turn, have a significant influence on property price growth. After all, if rents do not continue to rise, the prices paid for existing properties will no longer be justified.
It is already clear that the wind has been taken out of the sails of rental price growth in Germany’s major metropolises. In cities with populations of over 500,000, rents in new-build housing rose by 5.4 percent in 2015; in 2016 this had dropped to 1.8 percent. In Cologne and Düsseldorf, market analysts are already reporting year-on-year growth of 0 percent for rents in newly built housing.
Let’s turn our attention to Berlin for just a moment. Since 1996, rents across the city’s housing stock have risen by 84 percent. But can Berliners afford to pay ever increasing rents? At over 9.4 percent, Berlin is the federal state with the third highest unemployment rate. In terms of purchasing power, Berlin lags behind every single western German state, while almost 20 percent of the capital’s households receive some form of welfare payments – an unfortunate national record. This is a striking combination of facts and figures, which is why I firmly believe that investments in fair and standard locations make a great deal of long-term sense. These are the locations that are set to experience the greatest, continuous demand.
As you can clearly see, there are a number of risks that could well cause property prices to fall in specific localised markets. At the same time, it’s important to remember that these remain risks – none of the scenarios described above will necessarily materialise. But they could.
Residential investments: New-build, existing stock or…?
The opinions of leading German residential real estate investors at the “Berlin Real Estate Roundtable” on May 4 couldn’t have been more divided. Some are almost exclusively investing in new-builds, others almost exclusively in existing stock – and others complained that both are overpriced.
The topic for an event in early May at which several leading German investors spoke was: “Investors’ criteria for acquisitions of new-build residential developments (forward deals)”. The opinions they expressed couldn’t have been further apart:
Arguments in favour of existing housing
Florian Mundt from the Deutsche Investment Kapitalanlagegesellschaft took a very firm view: Any comparison of the yields generated by existing housing and new-builds can only find in favour of existing housing. This is the reasoning behind his company’s decision to rule out investments in new housing developments. Nevertheless, he did concede that existing housing only comes out clearly on top when you choose to ignore the impact of the Mietpreisbremse (rental price brake). The same caveat applies to the distribution yield. In IRR calculations, however, new-build housing is the clear loser – owing to the greater potential for rental increases in the existing housing sector. His company mainly buys existing residential real estate in Berlin and Hamburg. I have my doubts regarding his calculations, especially as Mundt claimed that it is possible to buy new-builds and existing housing at similar price-to-rent ratios. But from what I have observed, existing housing – and in particular investment properties – are currently changing hands at far higher price-to-rent ratios than new-builds.
Lots of investment in forward deals
In contrast to Mundt, Lutz Wiemer from HanseMerkur Grundvermögen AG takes a very different view: “We would also love to invest in existing housing, but there are simply no opportunities at reasonable prices”. Wiemer is clearly a proponent of forward deals for housing developments. The same is true for Fabian Klingler from Aberdeen and Nikolaus Jorzick from Hamburg Team.
Wertgrund’s Thomas Meyer, who in the past has only ever invested in existing housing, is also looking to increase his company’s investments in new housing developments, and is already planning to steer between 30 and 50 percent of his investments into forward deals: “My heart still beats strongly for existing housing, but when you calculate dispassionately, which means you including the Mietpreisbremse in your calculations, there’s simply no way you can conclude that these are economically viable investments, not at today’s asking prices.”
Most of the investors are not willing to pay price-to-rent ratios in excess of 25 for new-build housing. And they continue to focus on central locations in Germany’s major cities. In my opinion, investors are devoting nowhere near enough attention to the “commuter belts”, where it is still possible to buy at price-to-rent ratios of 22. In cities like Berlin and Munich, an exodus to the suburbs is already underway, although investors have yet to appreciate the significance of this trend.
Flight from Germany
Bouwfonds is one of Germany’s major investors in residential property, although the company has long invested in other European countries too. Martin Eberhardt believes that there are currently more profitable opportunities in countries like Holland or Polen – the German market has, in his opinion, become too expensive. “Right now, the focus of our residential real estate investments is primarily outside Germany,” said Eberhardt. The Bayerische Versorgungskammer, one of the biggest players on Germany’s real estate market, with investments of €78 billion, has stopped investing in German housing altogether. Or, more accurately: They continue to monitor the market but are unable to find any investments that fulfil their investment criteria.
“Never heard of it, count me out”
Whether these overseas investments prove to be more profitable than investments in Germany – based on the previous experiences of open-ended funds – I have my doubts. Of course, professionals like Patrizia and Bouwfonds are masters of the international investment business, a claim that very few can make. From what I have seen, the criteria used by many investors simply don’t tally with current market conditions. Some investors are still using acquisition criteria that have been out of step with the market for years. Almost everyone wants to buy new-builds in one of Germany’s Top Seven cities, but no one is prepared to pay price-to-rent ratios higher than 25. Property developers would rather sell condominiums individually, or sell entire developments to one of the many family offices who are prepared to buy at higher ratios. The opportunities available in the commuter belts of Germany’s largest cities are largely being ignored by a majority of investors, who often justify this by pointing out that such locations, without the cachet of a recognisable name, are difficult to sell to insurers and other major investors. “Never heard of it, count me out” is clearly the motto of a large proportion of investors.
I am convinced that there are significant problems in store for those who are still investing in existing housing. When ten investors bid for an existing property and eight of them don’t include the Mietpreisbremse in their calculations, the two investors who do take the Mietpriesbremse seriously stand little chance of lodging the winning bid. I see big risks for investors who base their calculations on levels of rental growth that are not legally permitted by the Mietpreisbremse. In many cases, an investment in a new-build makes far more sense, particularly as new-builds are exempt from the Mietpreisbremse. I am also at a loss to explain how fund companies manage to convince insurers and other investors when their sums only add up by breaking the law with impermissible rent increases. One of the Berlin Real Estate Roundtable’s participants aptly compared this with the cheating software and defeat devices used by VW to manipulate emissions tests.