Who’s afraid of innovation?
Central Madrid became a car-free zone for the first time during the 2018 Christmas period. As a result, Madrid’s stationary retailers experienced a 3.3 percent increase in sales and the city’s main shopping street saw revenues boosted by 9.5 percent. Can you imagine a similar campaign in Germany? Retailers and residents would have stormed the barricades. People would have decried any such move as ecological and ideological paternalism; they would have complained of free citizens having their freedoms curtailed; and retailers would have warned of an impending sales collapse. In fact, the radical break with traditional notions of urban life in the Spanish capital has had exactly the opposite effect: People were attracted to the streets and shops; they took longer trips and in return benefited from a higher quality of life and a better shopping experience.
Innovations and, in particular, innovations in urbanisation have always been a controversial topic in Germany. This is not only because of Germany’s favourite toy, the automobile, but also because we too often think in rigid terms. Our major cities and conurbations are growing, but woe betide anyone who says we need to build more. We want our buildings to consume less energy, but everyone complains when more efficient thermal insulation drives up rental costs. We are annoyed at the large number of ‘not spots’ across Germany that do not have mobile phone coverage – even in our big cities – but there is uproar when someone suggests that we need more transmitter masts. We want everything to be delivered to our doorsteps, but we are irritated by the ubiquity of delivery vans that congest our streets as a direct result of our own behaviour. In modern Germany, progress is widely portrayed as an existential threat to traditional ways of life and an expression of the desire to constantly maximise profits. One thing is certain: we need to move away from this black-and-white thinking.
While the population is largely sceptical about digital and technological innovations, this could ultimately prove to be a blessing for our cities. Many life-changing innovations are currently being developed, although very few have so far reached full market maturity. Nevertheless, it is clear that connecting people and machines will radically change the way we deal with energy, mobility and interaction. But does this mean that we will have to follow every new trend, as was the case in the 1950s and 1960s when entire city districts were remodelled to create car-friendly cities? If we are looking for cautionary tales, we don’t have to look much further than cities like Hanover and Düsseldorf.
What about today? We are again laying thousands of kilometres of tram tracks in our cities, and China is even testing track-free trams, which travel along ‘virtual’ rails. We are building huge power lines right across Germany, and soon every household will be able to produce its own energy. Property developers are advertising a host of smart home technologies, but are at a loss when Apple changes the plugs for their devices from 30 pin to 8 pin. This list could easily be continued.
For me, two things are clear: innovations are not predictable and no innovation will be embraced by everyone. Many people imagine tomorrow’s city life as something akin to a mid-period Hieronymus Bosch painting: colourful, teeming with life and local characters. The real estate industry could certainly work towards approaches and solutions that reconcile the population’s wishes with the challenges of rapid urban population growth and an aging population. That would be a real innovation.
What investors need to consider when they buy a micro-apartment
Conventional residential construction is a growing market. And the micro-apartment subsegment is also booming in German cities, creating interesting investment opportunities for investors.
However, the “temporary housing” market has its own special characteristics, which makes it all the more important for developers and investors to understand what really counts when it comes to micro-apartments.
Target group appeal
Micro-apartments offer a welcome alternative to classic, centrally located one and two-room apartments for trainees, young professionals, commuters and business people, especially in cities that are experiencing record population growth. Understandably, one-room apartments are particularly popular with students: In the 2018/2019 winter semester alone, 2.87 million students were studying at German universities – more than ever before.1
What investors should know about fixtures, fittings and finishes
Depending on the clientele they are targeting, professionally managed micro-apartments may differ in terms of fixtures, fittings, equipment and amenities. Most tenant groups will find their needs catered for in fully furnished micro-apartments: In addition to a large bed, the living room typically features a desk, a seating group or a sofa, and hard-wearing flooring. Kitchenettes are usually equipped with a quiet refrigerator with a freezer compartment, a ceramic hob, an oven and a microwave. Each apartment will also ideally have its own bathroom with a shower. If the apartment is to be used predominantly by students, there should also be a common room or a common kitchen on each floor. This ensures that micro-apartment buildings do not immediately become classic flat-sharing communities. Nevertheless, they still foster a strong sense of living in a community, similar to a shared flat. The entire building should be equipped with high-speed wireless internet access. Floor plans should be designed for younger, less solvent tenants, offering apartments of between 20 and 25 square metres and not – as is sometimes the case with more upscale apartments – of around 35 square metres. In addition, lots of potential tenants are not interested in living in tall, anonymous residential towers. Buildings with a maximum of six storeys are far more appropriate. The more the details are designed to fit the residents, the more likely they are to opt for a micro-apartment.
Micro-apartments – opportunities and risks
Investors should be aware that micro-apartments have a higher rate of tenant churn than regular apartment buildings. As long as demand for micro-apartments remains strong, there is no downside. Still, assuming that investors don’t want to worry about every single letting or minor problem, there are two questions they need answers to from the outset. Firstly, has the developer taken the needs of future residents into account? Secondly, have they chosen an experienced operator? It is very important that the specific needs of potential tenants, such as a flexible apartment sizes or an in-house fitness room, are addressed. For investors, the right choice of operator ensures first and foremost that the risk of vacancy remains low due to rapid new letting, and the stability of the return on their investment is guaranteed.
Micro-apartments are “all inclusive” offers – tenants do not pay extra for internet, water, electricity or gas. Therefore, the average rent for a micro-apartment is higher than in other segments of the rental housing market. For investors, micro-apartments are a low-risk product: Yields of up to four percent are currently achievable.
Construction costs and location are just as important. Land on the outskirts of cities is usually much cheaper than in central districts, but requires good public transport infrastructure that links it to the university and the city centre. Savings can also be achieved by using economical, platform-based construction methods. In this case, sand-lime bricks are largely prefabricated in a factory, which also significantly reduces construction time.
As long as investors base their investment decisions on a complete range of factors, including location, letting costs and the needs of potential tenants, there is nothing to stand in the way of a successful, and very profitable, investment.
Every neighbourhood is different
Is the Berlin residential real estate market set to peak? The longer the boom persists, the more frequent this question becomes. After all, purchase prices and apartment rents have been rising at above-average rates for years now, sometimes even growing by double digits. The strong growth was driven both by a Berlin-related boom and the price gap with Germany’s A-cities – not to mention other European metropolises. This gap has now narrowed considerably. So, it is only logical that the pace of growth is now losing some momentum.
The question remains as to whether we are already seeing the end of the Berlin story and a reversal of longstanding trends. For the first quarter of 2019, the Forschung + Beratung-Wohn-Index (Research + Consultancy Residential Index) registered a decline of 1.7 percent in average asking rents on the Berlin residential market. After years of growth, this sudden decline is remarkable, but should not yet be overestimated. After all, it referred only to a comparison with the previous quarter – i.e. the fourth quarter of 2018 – and not to the same quarter of the previous year. On a twelve-month basis, the index still recorded an increase of 5.7 percent.
According to the new Berlin rent index, the average net cold rent continued to rise last year, even though the growth rate has halved. According to the index, the average rent is still below seven euros. The growth in prices for condominiums is also slowing although prices still gained a fairly impressive 13 percent according to the latest real estate market report from Berlin’s Property Valuation Committee. Berlin will remain an exciting housing market in the long term, for two main reasons:
Firstly, given its unique range of cultural and leisure activities, wide variety of educational opportunities and ever-increasing economic prospects, Berlin is and will remain a magnet for residents. Every year, 30,000 to 40,000 new Berliners start a new life in the capital. And the city is becoming even more attractive for new residents, its appeal strengthened by projects such as the German Internet Institute, a branch of Oxford University, and Siemensstadt 2.0. Secondly, we wouldn’t be doing justice to Berlin’s size and diversity if we limit our discussion to talking about “one” Berlin housing market.
Undeniably, in one or two specific submarkets – especially in neighbourhood protection areas – somewhat excessive prices are now experiencing a downward correction. At the same time, new micro-locations are stepping into the limelight and attracting interest from tenants and investors. It is these swings that keep the overall market in balance. A neighbourhood that had previously lived a low-key existence can quickly evolve into a hip hotspot. What’s more, there are lots of very attractive residential submarkets with relatively affordable rents and purchase prices where landlords can achieve comparatively adequate returns below the radar of the general public – for example outside the commuter rail ring. In order to identify the undervalued peripheral locations and fashionable districts of tomorrow, there’s one thing investors and developers need above all else: local knowledge.
This local expertise is also indispensable for successful real estate financiers. Is the borrower’s plan on track? Will they be able to pay interest from their rental income over the full term of the loan, even at different points in the market cycle, and repay the loan as agreed? In the worst case, is there a pronounced risk of vacancies and loss of rent? Will the property have maintained or increased its value by the end of the term? Or will it only be possible to sell it later at a lower price? In Berlin, the market’s traffic lights are still predominantly green. But risk management has to take a close look at all asset classes in the German capital – as it does with every loan – and assess each individual case on its own merits.
Risk for developers: proposed rent cap would also apply to newbuilds
Project developers should carefully study the Federal Ministry of Justice’s recent proposals to change German tenancy law. This is the first time that a rent cap for new buildings has ever been suggested. If the ministry gets its way, the consequences will be far-reaching. And, despite media coverage of the ministry’s other proposals, the rent cap has hardly been mentioned and remains unfamiliar to many industry players and the real estate trade press.
The new draft bill would modify Section 5 of the German Economic Offences Act (WiStG), which regulates rent increases, and introduce a provision which would no longer allow landlords the honest practice of taking advantage of restricted supply. In future, all rents will be limited to exceeding the local comparative rent by less than 20 percent, as long as there is a small supply of comparable apartments in an area, which is bound to be the case in almost all attractive larger cities. And it will be sufficient if there is a small supply in a single district, rather than the whole municipality.
One exception is made for new buildings. During the first five years after first occupancy, there is no rent increase limit. But here comes the crucial point: For any re-lettings after this period, the landlord will have to comply with the new rent cap. The landlord can cite the fact that the apartment is in a new building and is therefore exempted from Germany’s rental price brake legislation, the Mietpreisbremse (Section 556f of the German Civil Code). However, this is of no use to the landlord if the rent is deemed excessive by the parallel regulation. Even if the previous rent was higher, this would no longer protect the property as a going concern. There is an exception: a higher rent would be permissible if the rent is necessary to cover current expenses. However, the burden of proof lies with the landlord. In effect, if the Ministry of Justice’s proposals are implemented, the 120 percent limit for newly built real estate would apply after five years.
Every developer knows that as land prices and construction costs continue to rise, it makes no financial sense to let at 120 percent of the local comparative rent, even with a grace period of five years. As a result, developers will have to pull out of the rental housing construction market, putting an end to the short boom, and will inevitably redirect their efforts to building condominiums and commercial properties.
While experts and rational politicians all over the country are thinking about how to boost the construction of rental housing, the ideologically left-wing Ministry of Justice is not impressed. Instead, it is planning to apply its new rent cap to new buildings as well. Since 2015, the Greens, the Left Party and the SPD, together with tenant activists, have been calling for the “exemptions” to the rental price brake to be abolished. Outgoing Justice Minister Katharina Barley has now delivered a draft bill of such far-reaching scope and many have not yet recognised the impact it could have. For reasons of space, I cannot go into more detail about the new tenancy law’s other harmful effects (including the manipulation of the rent index by extending the reference period from four to six years). We can only hope that the right of centre Union puts a stop to this nonsense.
Hatred of real estate owners
Given the housing crisis and spiralling rents, people need a scapegoat. And they’ve found one: real estate owners. Recently, during massive demonstrations against the “rental market madness” in Germany’s big cities, “predatory landlords” were singled out as hate figures. Now activists are calling for the expropriation of private landlords in Berlin and other cities. The protestors were clear on what should happen to “predatory landlords”: “Turn the predators into prey”. In a national poster campaign, the Left Party (Die Linke) also proclaimed “Now we are biting back”. Next to the text, the left-wing party’s posters featured an image of a knife and fork. In calling for “predators” to become prey, they are effectively advocating murder. The Left Party’s supporters include large numbers of animal welfare activists, vegans and staunch defenders of other minorities, but they seem to have no problem in aligning themselves with such hate speech.
In the run up to this year’s revolutionary first of May demo in Berlin, posters were put up all over the city. The text read “Against a City for the Rich” and an image of a guillotine featured prominently. As we all know, the guillotine was used to execute scores of people in the French Revolution, including the French King, Louis XVI. On the eve of the 2017 demonstrations, activists paraded through Berlin waving signs exhorting people to “Kill Your Landlord”.
Indignation was rightly raised when far-right Pegida demonstrators carried a gallows intended for Angela Merkel and Sigmar Gabriel, Germany’s Chancellor and then leader of the junior coalition partner. This was widely reported and attracted pointed criticism on the nightly news and all across the German media. In contrast to the gallows at the Pegida demo, however, I have not heard a single politician condemn the guillotine posters used to advertise the anti-rich First of May demonstration.
The vitriol now being directed at property owners does not appear to raise media eyebrows either. In fact, the opposite seems to be true. A few weeks ago, a “joke” appeared in one of Germany’s leading weekly news magazines, Stern: A cartoon depicted two middle-aged ladies in a café. One turns proudly to the other and says, “My son is on the board of a Berlin housing company”. The other replies, “It’s a pity there were no prenatal tests for things like that when we were pregnant”. The German Real Estate Association has lodged the following complaint with the German Press Council against the magazine:
“The reference to prenatal testing of amniotic fluid would seem to imply that some lives are worth living and others should be terminated. Stern’s ‘joke’ makes it clear that the son, the board member of a real estate company, is not worthy of life. As a consequence – and the author clearly encourages this interpretation – abortion would have been the preferable solution …. We’ve already seen death threats against the directors of housing companies, who have been forced to surround themselves with private personal protection as their cars are set on fire. With this vicious caricature, the perpetrators will feel that such violence is justified”.