August 22, 2008
In recent years residential property prices in Germany have not risen as quickly as those in Spain, the UK or the Netherlands, for example. Institutional investors have nevertheless bought extensive housing portfolios in Germany, frequently with a view to selling units individually to tenants. Such investments can only pay off if enough tenants are willing to buy their homes and if the property portfolio was actually purchased at the right price. We cannot provide a fundamental assessment in this case and would prefer to draw attention to two factors that are equally relevant for buyers of single properties and of portfolios: there are not only considerable regional differences between rental yields. This is trivial and could be justified by differing risk assessments. What is less trivial is that returns cannot always be explained by rental trends. Secondly, there are major differences between valuations in the high-priced and the low-priced segments in German towns and cities.
We shall start with the first factor. To do this we have analysed rent and purchase price data from the empirica-Institut for Q2 2008 in nearly 120 German towns and cities. This data reveals that in cities where flats command above-average rents the purchase prices of such properties are also comparatively high. This is hardly surprising as the willingness to buy an apartment should increase in line with the size of future rent payments that can thereby be saved. Since we do not know the future, we use the present as a crutch for the valuation: the prices paid for residential property are therefore regularly expressed as multiples of yearly rent. The (unweighted) multiple for all towns and cities is about 19. Then, the cities of most interest are those in which this purchase price multiplier is higher or lower than usual.
In Zwickau an average-quality home costs around 11 years’ rent, in Ingolstadt or Bamberg, by contrast, the multiple is more than 25. This is evidently consistent if rents are expected to rise sharply in Ingolstadt, whereas rents in Zwickau are expected to drop significantly. Rents for existing stock in Zwickau did indeed fall by an average of nearly half a percentage point per year between 2002 and 2007. Past performance is, however, not necessarily a good indicator for the future; in Ingolstadt rents fell by almost twice as much during the same period. There is no statistically significant correlation between the current multiples and the trend in rents over recent years. This is consistent if the valuation in many towns and cities is based on the assumption of a reversal in the rental trend, or if the differences in the relative purchase prices are at least partly attributable to the inertia of supply and demand in housing markets. Then there are attractive investment opportunities – more so in Zwickau than in Ingolstadt.
A regional perspective in forecasting market developments is therefore essential in order to separate the attractive markets from those that are unattractive. This is emphasised further by the second stated factor: relative valuations within a city do not follow a national pattern. There are significant regional differences. We measure this via the spread of rents and the prices of apartments, i.e. the respective differences between the most expensive and the cheapest dwelling. Outliers have been removed in order to rule out random effects. These spreads of rents and purchase prices provide additional information about relative scarcities in the upper and lower price segments of the residential markets. Usually one should assume that the multiple for high-quality dwellings is higher than for low-quality dwellings because rental and price risks are greater with properties of low quality than those of high quality. That is to say, rental yield is lower on high-quality properties because their prices are expected to rise faster or at least remain stable.
There are however striking deviations from this expectation: in Ulm, for example, in the low-priced segment the yearly rent multiplier was nearly 19 and thus higher than for better-quality units. For nine other cities the multiplier for the upper price segment was lower than that for average-priced properties. High-quality rental accommodation in Ulm is evidently relatively scarce or purchase prices for simple accommodation are comparatively high. It is nevertheless by no means clear what shape a correction will take in the coming years: a “normalisation” to the patterns usual in other cities could mean for Ulm, for example, a slowdown in rental growth and/or faster-rising property prices in the upper market segment. Conversely, one would presume that a city currently boasting a high multiple in the market for lower-quality property (Rosenheim or Trier) would see swift rental growth.
These observations lead to two conclusions: firstly, there are interesting investment opportunities in Germany’s residential property segment despite the negative international environment. Secondly, extensive knowledge of regional markets is required in order to tap this potential.
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