Germany: Unaffordable housing

Urban migration and a resurgence in institutional investment are pushing up the prices of housing construction, leading to a vicious circle. Barbara Ottawa reports

Property investments are high in demand among German institutions and already this year major portfolios have changed hands. In February, Industria bought 800 apartments, mainly in Hamburg, for €51m from Bouwfonds Investment. At the end of March, 5,750 residential units in Berlin changed hands, from Deutsche Wohnen to ADO properties for €375m. But the major part of transactions in the first quarter (all of 78%) can be attributed to Deutsche Annington taking over Gagfah.

Property consultancy Dr Lübke & Kelber expects turnover of residential deals this year to “probably surpass the 2007 record with approximately €15bn”. The prediction is based on a “strong start to the year with €10.6bn invested in the first quarter alone into the German multi-family market” – 80% more than in Q1 2014.

The forecast does not include the planned takeovers of Berliner Westgrund by Adler Real Estate or Conwert by Deutsche Wohnen. Ulrich Jacke, managing partner of Dr Lübke & Kelber, says this further consolidation, together with high prices and ongoing low interest rates, “supports his opinion” on the new record transaction level.

Go back 10 years and institutional investors often steered clear of residential properties because yields were too low. This perception was revised for today’s more moderate average levels of return. Stephan Schanz, senior analyst in Aberdeen Germany’s continental European property research team, says yields have compressed considerably in the office space with initial yields on Frankfurt office space having dropped around 100bps over the past 10 years to 4.5%.

“Investors’ understanding of the risk profile of residential investments has changed,” Schanz says. Investors are now seeing the “more bond-like character” of residential investments compared to other sectors with stable – albeit rather low – initial yields and a diversification of tenants buffering risks of major vacancies. Schanz sees “a considerable increase in institutional investment products” covering the residential segment.

But demand is not only being driven by investors. It is also being fuelled by a strong, ongoing migration to major cities – “not only the big seven”, Schanz stresses, “but any larger city with good economic development”. In total, Germany has over 80 major cities, most of which have strong population growth.

According to Aberdeen research, 32% of all immigration between 2010 and 2014 from German rural areas went into metropolises in the country. “New construction is not catching up with demand in many cities,” Schanz says. He gives Frankfurt as an example where over the past 10 years demand exceeded supply by around 8,500 apartments per year. The situation is similar in Berlin, followed by Munich with a 5,400 units shortage each year and less strained in Hamburg where there is a 2,100 units shortage.

New constructions are hindered mostly by a lack of space in urban areas or by too-high redevelopment costs. “Conversion of often vacant office spaces into flats is being discussed frequently,” says Schanz. “But the question is whether the property is suitable and also how high a price the owner wants for it in spite of not being able to find new tenants”.

As construction costs increase, the price for buildings and development plots has become an important factor in the feasibility of projects. “Very often developers can only plan luxury housing to make up for the initial costs,” Schanz says. “But what most cities need are flats in the mid-price range.” 

Applying the rental brake
Recent government efforts to slow runaway rents in Germany cities could also be compounding the situation. At the time of writing, the Mietpreisbremse, or ‘rental price brake’, had been passed by the government and was likely to come into effect as soon as 1 June. In a next step, the provinces then have to decide which regions or which areas in cities actually have a “strained rental market” to which the rental price cap would be applied.

But the new law is likely to limit the growth in affordable rented multi-family housing, while increasing the proportion of owner-occupiers, according to Scope Ratings (Germany has one of the lowest owner-occupancy ratios in the EU, at 52.6% compared with an average of 70%, according to Hypostat).

Scope expects investors to instead concentrate on refurbrishing and renovating existing multi-family properties because rental increases are not affected by the new law.

Schanz does not believe Mietpreisbremse “will have a major impact on investments” in the residential segment – or indeed on many tenants – because of the various exemptions.

However, even within those regions rents can still be increased up to 10% above the local average rent and up to 15% over a three-year period. New constructions as well as extensively refurbished buildings are exempt. 

Further exemptions were made for indexed rental agreements and contracts in which certain increases are already set down upon signing. Additionally, rents that are already higher do not have to be lowered. Even tenant associations only expect a very limited impact for the majority of tenants. German research institute Pestel has actually pointed out what the country really needed was a cap on price increases in building plots rather than rental prices.

Research by German real estate company Patrizia looking at the impact of rental restrictions in various countries found a “minor negative impact” on both the net cash flow yield and the total return. Patrizia warned investors not to overestimate the influence of the new rental regulation and be put off by it. Even in countries where the regulatory measures affected rental price growth, rents still increased by 2.6% to 3.6%, well above inflation.

“For investors this shows that rental price regulations alone are not hindering rental price increases,” Patrizia said. In fact, for the first time, rental markets in many European countries offer opportunities at the same time allowing investors to build a pan-European residential portfolio.