Capital investments

Essential questions and answers

Buying real estate is a major milestone in people’s lives and therefore calls for careful consideration. Especially residential real estate is currently popular among regular and buy-to-let investors as a forward-looking investment. But ahead of such a major step, there are many questions to be sorted out – including what type of property to go for, where it is to be located, and what its intended purpose will be.

Buying an apartment involves diverse options and benefits. To brief you on a variety of aspects and scenarios, the section below will answer the most relevant questions about residential real estate as a regular or buy-to-let investment. For instance, it will provide details about the current state of the German housing market, an overview of various location factors and the possible forms of use for a residential property, insights into the costs to be expected, tax aspects as well as general tips and empirical insights you may need to know when buying a residential property.

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General information on the acquisition of a residential property

Let us start with what may well be the most important tip: There is no rush! Be sure to take your time when planning to buy a residential property. Gathering all the information you need in advance and the actual acquisition usually takes several months, and you should not be pressed for time at this stage in the process. If you have no time for this, you should perhaps hire an estate agent early on who is familiar with all the aspects of buying a property and who can take a lot of important process steps off your hands.

A residential property can serve a variety of purposes, and an incoming owner should have chosen one by the time of the acquisition. Are you planning to acquire a crisis-resistant investment as part of your pension plan but without intending to owner-occupy it now? If so, you should primarily concentrate on the type and location of the property. Properties with several residential units, for instance, offer long-term liquidity by generating rental income, and simultaneously qualify as attractive buy-to-let investment when paired with great location.

If, by contrast, you are rather seeking a more affordable alternative to renting your home and wish to make your dream of homeownership come true, your personal preferences and interests will naturally take centre stage. In this case, the location factors are bound to make a difference: The proximity to important institutions such as schools and preschools, shopping venues in the immediate vicinity of the property or the accessibility of local and long-haul transportation will play a key role for your personal feel-good parameters and for the actual and perceived value of a given property. Find out more in the section below.

Buying a residential property: important things to know

Many different factors come into play when buying a residential property. One of them is the already mentioned location of the property, and the German Economic Institute (IW) has identified the suburban districts around Germany’s metropolises as the winners when it comes to high-yield locations. At the same time, the country’s A-, B- and C-Class cities offer attractive risk-to-reward ratios as well.

The classification of German cities: classes A, B and C

When researching prime locations in Germany, you will sooner or later hit upon the so-called A-, B- or C-Class categorisation of cities. There is no official and universally accepted definition of the exact differences between A-, B- or C-Class cities. The categorisation was originally developed in the commercial real estate sector, but prospective buyers of residential real estate may use it as well to get a first rough assessment of a city’s appeal. Below, we will take you on a tour of their key characteristics:

Class A city: Germany’s most sought-after metropolises

Residential real estate in Class A cities—also called the “Big 7” cities—are characterised by very high selling prices and rent rates just as high. Most of the “Big 7” cities are international metropolises, such as Munich, Berlin, Frankfurt, Cologne or Hamburg. Demand for properties in these cities is normally extremely strong.

Other typical attributes of Class A cities include a brisk building activity, fast-paced economic growth and jobs in the most diverse industries and fields.

Class B city: major cities of national importance

Class B cities include well-known and significant but internationally less relevant cities with smaller populations, such as Leipzig, Dortmund, Hanover, Wiesbaden, Dresden or Nuremberg. Real estate prices in these cities tend to be high, and so are their rent indices. Demand for residential real estate in Class B cities, while strong, is usually less extreme than the property demand in the Class A cities.

Common characteristics of the Class B cities include a sound economic performance, functioning markets and sometimes large catchments, Leipzig being a good case in point. According to the outcome of a recent risk-return ranking, Class B cities offer the most attractive risk-to-reward ratio at the moment. Several Class B cities also benefit from their proximity to Class A cities, an example being Bonn near the metropolis of Cologne.

Class C city: smaller cities of regional importance

Class C cities are visibly smaller than the A- and B-Class cities but have regional significance. Well-known examples include Augsburg, Freiburg, Kiel, Mainz or Wuppertal. As far as selling prices and rents go, the observations made about real estate in the Class B cities apply here as well: Properties tend to be very much in demand, and the price trend is similarly sound, yet the initial selling prices are often on a slightly lower level than those in A- and B-Class cities. While demand outpaces supply even in the Class C cities, the pressure is not as high as on the Class A or Class B markets.

Location factors: things you need to know

The location of a property is almost as important as the property’s state of repair. Whether intended as buy-to-let investment or for owner-occupancy, the location often has a strong influence on the attractiveness the property. In this context, you need to differentiate between macro-environment and micro-environment, as well as between hard and soft location factors.

The term hard location factors is used for quantifiable or measurable values that lend themselves to an objective assessment – for example, the accessibility of local infrastructure or the economic situation of an area. By contrast, soft location factors are of emotional nature, and their assessment is subject to personal preferences. They include, for instance, cultural amenities, shopping venues or the general reputation of a region, a city or a locality.

The section below will give you an overview of the key factors defining the macro- and micro-environment of a given property.

Which location factors define the macro-environment?

The assessment of the macro-environment of a residential property focuses primarily on the city, district or region, and less on the actual site the property occupies. What is the general quality of the local infrastructure access like? What is the demographic structure like? Is the economic and political situation sound and stable? All these are important question that need to be considered when evaluating the macro-environment.

Concrete location factors of the macro-environment:

  • Infrastructure: Accessibility of rail-bound transport, highway network and airports

  • Regional purchasing power and economic growth

  • Demographic structure

  • Historic incoming migration

  • Unemployment

  • Political situation

  • Leisure benefits (cultural amenities)

  • Recreational value of the region

  • Rent index

  • Price Trend

Which location factors define the micro-environment?

In turn, the micro-environment focuses on the direct surroundings of the property or of the site. Infrastructure-related aspects here include every-day amenities such as, for example, the actual distances to schools, day nurseries, doctors’ offices, pharmacies or to public transportation stops and shopping venues in the area.

Which concrete location factors decide over the micro-environment?

  • Shopping venues in the vicinity

  • Proximity to day nurseries, preschools, and schools as well as to physicians and pharmacies

  • Distances to restaurants, bars, and leisure attractions such as theatres, cinemas or museums

  • Proximity to recreational spots like parks, green spaces, or lakes

  • Building density and structure of the immediately surrounding area

  • Neighbourhood structure

  • Street noise

  • General reputation of the area

Condition and fabric of residential real estate

In addition to city and location of a given residential property, its current state of repair is one of the decisive factors. If the property needs to be fully refurbished after its acquisition, this will obviously imply a significant expenditure of time and money. Although the capital expenditure will ideally be reflected in a discounted purchase price to compensate for the poor condition of the building fabric, the refurbishment work will nevertheless delay the time when your property starts generating income from rent payments, for example.

Whether in need of work or still in mint condition: In view of the steadily intensifying climate crisis, the energy efficiency of the property represents another important factor that investors and owners should take into account when choosing or possibly refurbishing a residential property – especially with regard to its possible long-term returns, because energy-efficiency will significantly boost the property’s attractiveness, both for potential buyers and for tenants, if any.

Especially in the case of older properties, the current condition of the property should always be taken into account with a view to maintenance because it can become a major cost factor over the years. Whenever homeowners associations, or HOAs for short, are involved, a helpful and important aspect in this context is the so-calledspecial assessment. It works like a maintenance reserve and is earmarked for non-budgeted expenses of the HOA toward the common property, meaning it is not spent on a privately owned apartment, the so-called individual freehold property.

To help you remember the key factors concerning the building condition and fabric when viewing a potentially interesting residential property, we listed them in an overview below for your convenience

Important questions concerning the condition of a residential property

  • In what state of repair are roof and façade of the property?

  • Are there any known issues with the building’s energy efficiency?

  • Is the property poorly soundproofed and thus susceptible to impact noise or street noise?

  • In what condition are windows and doors?

  • Are there any moisture issues in the house?

  • What is the general atmosphere like in terms of living ambience and health aspects?

Important notes on the tax aspects of residential real estate

Property buyers of any kind should also find out well ahead of time about tax-related issues, because these are bound to play a major role over the years. For example, it is important to know for buy-to-let investors in this context which exact tax allowances they can claim if they decide to let their property in order to generate liquidity from rental income.

This makes sense insofar as residential rentals imply tax benefits in the owner’s income tax assessment. In addition to the purchase price, homeowners may also claim the incidental acquisition costs as deduction from their taxable income, which includes, among other things, the real estate transfer tax, but also the land register fee and the notarial costs.

Whenever investors decide to re-sell their property they are also well advised to familiarise themselves with the calculation basis for theproperty speculation tax. This tax will be levied if a given residential property that has been continuously let is resold before the end of a ten-year speculation period. But even if the speculation tax kicks in, it is not the entire selling price that will be taxed, as the owner may deduct the historical cost and the costs incurred in conjunction with the sale from his or her tax base. The rate of the property speculation tax is ultimately based on the seller’s personal income tax rate, which means that the profit earned is declared in the seller’s personal income tax return and in this manner filed with the competent inland revenue office.

Things you need to know about the current housing market

A decisive question that will always present itself to prospective buyers ahead of such a major investment is this: Is it sensible and sustainable to invest in the housing market at this time? How are selling prices in the market trending? What role does the rental index play when you let residential real estate?

Naturally, these questions have complex answers, but the long and the short of it is without a doubt: Yes, real estate is still considered a safe investment. Then, as now, the most compelling aspect of real estate remains its combination of robust returns with long-term security and comparatively moderate risks. Above all, demand for residential real estate is as high as ever, both among investors or buy-to-let investors and homeowners or owner-occupiers

Germany’s housing market during the coronavirus crisis

The buoyant sentiment is perfectly plausible. Since the outbreak of the coronavirus pandemic, it has become obvious that the assumed resilience and long-term prospects of many established economic sectors is dubious after all, a case in point being the tourist industry. Several industries suffered massive setbacks and sustained losses, chiefly among them the hospitality, retail and cultural sectors.

By contrast, the housing market has remained robust, showing a strong and stable performance throughout. Even during the crisis, buyers and investors continued to embrace real estate as a safe-haven investment target, and prices have kept going up, albeit at a slower pace.

A look at the general market development therefore returns a positive assessment, with inside experts and valuers agreeing that no dips are to be expected in the medium and long term. For more information on the state of the housing market during and after the coronavirus pandemic, see our article on the subject.

Great interest rate situation favours apartment acquisition

For prospects currently toying with the idea of buying a home, another attractive aspect comes into play: the current interest rate level for mortgage loans. The interest rate situation may soon permit lenders such as the federal KfW development bank to pass negative interest, at which the bank itself borrows due to monetary policy of central banks, on to private buyer and investors. By converse argument, this would imply that borrowers may actually be paid to take out a government-sponsored loan from the KfW bank, for instance.

For more information on the current interest rate situation and possibly negative interest on mortgage loans, keep reading this article on the subject.

Is a real estate bubble looming in Germany?

The unchecked upward trend of residential property prices as well as the clearly favourable interest rate situation for buyers and borrowers has prompted the frequent question whether or not a bubble may be forming on the real estate market. So, is there a real estate bubble in Germany? While a few reasons may suggest as much, market insiders agree: Even though residential property prices are rising steadily, their growth pace differs. Nor are prices for residential real estate in Germany particularly high when compared to price levels in other European countries, so that the formation of a bubble does not pose a serious threat for property investors.

The risk is further reduced by the fact that the available supply in properties lags far behind demand, which is explained by strict building regulations as well as by the currently low capacities in the construction industry. Moreover, the risk of non-performing loans is defused by the then-as-now strict lending guidelines in Germany.

To sum up, it is safe to say: There is no reason to lose any sleep over the risk of a possible real estate bubble on Germany’s housing market.

Buying an apartment: key benefits at a glance

Investing in a residential property as buy-to-let investment or for owner-occupancy comes with numerous benefits for the buyer. In addition to the long-term growth potential of the housing market, which makes an investment equally attractive for both private and professional investors, there are also the lower costs of owner-occupying a given property, which can save you large sums of money in the long term.

Owning versus renting: which is cheaper?

A common error in judgement results from comparisons of tenancies with owner-occupancy. It is often assumed that buying a home is by far the more expensive variant of the two – the opposite being the case. Naturally, buying a residential property involves a substantial initial investment which many people can undertake only with the help of borrowed funds. But over the many years that the owner-occupier spends repaying the loan, it turns out to be a very rewarding step to take.

The latest statistics on the subject suggest as much: When considering Germany as a whole, homeownership is 56 percent more affordable on average than renting a comparable home. When considering the rate paid per square metre, it turns out that tenants pay an average of 9.89 euros per square metre whereas owner-occupiers pay only 4.32 euros. And this is true even in the highly popular and therefore pricey metropolises and major cities. To find out more on the comparison of renting versus owner-occupying, including how to calculate the owner-occupiers’ housing costs, take a look at this article.

Residential property to bolster your pension plan

Especially for private individuals who are looking for a safe asset to invest in for the sake of their own or their family’s future, residential real estate represents an ideal investment. The positive price trends on a market that is considered safe make the ratio of risk to return highly attractive while also making it reasonable to expect high returns on investment when reselling the property later on, assuming that key factors like location as discussed above are duly taken into account. The development of rents also presents little cause for concern, despite the significantly weaker form curve compared to the development of selling prices – this being, in any case, relevant only if the acquired property is supposed to be let. For more details on the rent growth trend, see this article.

Homeowners are far less vulnerable to old-age poverty than people who rent their homes. The fact has just been documented once more by recent survey of the Pestel Institute. After all, housing costs become more of a burden for people in retirement age, who often spent more than 30 percent of their income on rent. As a result, old-age poverty often ties in with difficulties to pay the rent, or so the survey suggests.

Moreover, forecasts predict further price increases for residential real estate in the years ahead.

Conclusion: residential real estate retains its long-term appeal

Buying residential real estate has been and remains a popular investment format. Be it as an alternative to renting your home and paying less for housing in the long term, or as asset to bolster your retirement plan, or as buy-to-let investment for wealth-building – there are still sound reasons and incentives for a residential property investment.

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