Real Estate Development in Germany: Investor Tips
For over eight years, Tranio has been involved in overseas property. In the past three years, the company has focused on development projects, primarily in Germany. In this country, it is not easy to find good projects for investment: there are not enough such projects for everyone to invest, and local professional developers can afford to choose with whom and under what conditions to work.
Most of the projects – the construction of residential apartments. Such projects require an average of 3 million to 50 million euros of capital, and construction continues for 1.5–3 years. As a rule, developers do not invest their own money in a project, but receive capital from two sources: a bank loan (65–80%) and investor funds (20–35%).
Investments in Germany are protected
Many experts predict that in the coming years, in world markets, price correction can be expected, since the 10-year growth cycle is at its peak. Therefore, it makes sense to invest in the countries that are most protected from adverse market conditions, and Germany is one of those countries. I see three advantages in Germany:
educated professional population;
well-established administrative procedures, working on clear rules;
the legendary hard work of the Germans.
These factors make it possible to expect that if prices fall or other troubles occur, Germany will be among the countries where these events will affect the least and where the recovery will be faster.
Unlike the rental business, where profitability usually does not exceed 5% per annum, development projects bring customers 10-15% per annum. Much higher returns are associated with higher risks. Tranio takes care to minimize these risks. In order for investors not to make a profit, the German market must collapse in price by 20%, and such a scenario is equivalent to a collapse of the global economy and seems unlikely.
The main disadvantage of real estate in comparison with some other areas of investment (for example, securities) is low liquidity. But this disadvantage is partly compensated by the fact that development projects are quite urgent: they are usually designed for 1-3 years. If you believe that the German market will remain stable in this perspective, and if you have free capital that you can invest in this time, then investing in a development project is the product for you.
Renovation or construction?
There are several types of development. In my experience, the least risky option is the renovation of an existing facility. The developer finds an empty building that is not burdened with long-term rental agreements, and repairs it, dividing it into separate apartments if necessary. After that, tenants are settled in the building, and it is sold in whole or in cutting.
Another option is a new construction, which, in turn, is divided into two scenarios: there are plots with a building permit or without it. The first scenario is simpler, but the plots for such development are more expensive, and the profitability of projects is lower. The second scenario is more risky and long, but also more profitable. There are larger projects for the development of the site by changing the town-planning plan and obtaining permission for a substantial increase in the volume of construction and a partial change in the permitted type of construction. Such projects are a real estate junction, a fine knowledge of building and legal norms, and skillful negotiations with city authorities: officials and the city should be interested in the proposed changes. Typically, the latter type of projects are the most risky, but also the most profitable.
Rates on loans can grow
The favorable situation in the real estate market in Germany is due to the low cost of borrowed capital. Deposit interest rates remain negative, while the average mortgage rate, according to the data of the German Federal Bank, dropped from 4.42% in 2009 to 1.65% in 2018, and banks willingly finance construction and purchase of real estate.
In turn, the low rates were the result of the quantitative easing program of the European Central Bank: under this program, the ECB bought European banks’ bonds from various banks to inject money into their economies. However, on June 14, 2018, the bank announced that it intends to terminate the program by the end of the year, and now market participants expect loans to rise in price.
Therefore, investors should carefully approach projects with a large share of bank financing. The greater the leverage, the higher the potential profitability, however, this also increases the sensitivity to price correction, and the negative dynamics of the market can lead to loss of capital. The optimal ratio is 65% of borrowed capital and 35% of its own. Of course, if you want to get the maximum return on capital, and if the bank is ready to provide a large leverage (for example, up to 80% of the project cost), then you should not give up cheap bank money, but it is important to plan what you will do case of lower prices.