When it comes to property investment, should you opt for the rental market or consider backing development projects? While Germany is a good bet for both, rental yields are unlikely to reach more than their average of 5%. Property development project yields can reach between 10 and 15% annually. And Germany is one of the safest countries in Europe to take this investment step.
As high calibre investment projects aren’t flooding the country, local professionals can afford to be picky with the investors they choose. But for the right kind of investor, it can be an excellent choice.
Many development projects in Germany revolve around apartment constructions, and generally cost between €3 million and €50 million on average. Projects tend to last between 18 and 36 months and developers usually obtain backing from two places:
- Bank loans account for between 65 and 80%
- Investor capital makes up the 20-35%
The key takeaway from investing in German property development projects is the relative security of your investment. We can expect to see a certain price adjustment in markets globally as we reach the peak of a decade-long growth cycle, and investors should be turning towards protects in countries that are safest in terms of withstanding changing market conditions.
Germany is one of the safest countries to invest in thanks to key factors, including its history of workable administrative procedures, concise and fair regulation, and a population comprising well-educated professionals. If prices do fall, or other market fluctuations occur, Germany is one of the places that will be least affected and will recover more quickly.
Development projects bring the bonus of higher yields, but of course that does mean higher risk. As it currently stands, however, to become unprofitable, the market in Germany would need to drop by about 20%. This kind of scenario is equivalent to the repercussions of a global economic crash and appears unlikely.
The disadvantage of low liquidity is a factor in real estate investment compared with other asset classes. However, this is at least partly offset by the urgency of the development project. Out of necessity, they have a time span of up to three years. If we assume that the property market in Germany will remain stable for the next few years, then investing in these kinds of projects can be extremely beneficial.
Types of development
There are different types of development project available, including renovating and converting an existing property and new developments. With new developments, there are different options too as the project can start with a plot of land with or without a construction permit already in place.
If there is a permit already in place, it can seem a simpler choice, but land plots for these kinds of developments are more expensive and tend to have lower yields. A scenario without a construction permit is a higher risk option, and will be a longer-term project, but can be more profitable.
Larger projects include developing land by changing the urban developing plan. This means getting permission for a significant increase in construction volume and modifying the type of construction. These are much bigger projects that need a high level of understanding of legal and building regulations, real estate expertise and sometimes tricky negotiations with officials. This is the riskiest kind of development project, but also the most profitable for the investor.
Low borrowing costs
Relatively low borrowing costs are another attraction for German development projects. According to Deutsche Bundesbank, the average mortgage rate dropped to 1.65% in 2018 from 4.42% in 2009. Banks are ready, willing and able to finance property development projects and purchasing.
However, due to the upcoming termination of the European Central Bank’s quantitative easing programme, which will stop at the end of 2018, we can expect to see loans becoming more expensive. This means that investors should be cautious when it comes to projects with a high ratio of bank financing. A good ratio to go for is 65% loan capital and 35% personal funding. Of course, the shorter the development project is likely to last, then the lower the risks are in terms of potential rate growths.
Where should you invest?
Lower risk projects in areas with an increasing population are a good idea. Look for regions with a strong economy and high capacity for buying. In Germany, strong areas for investment traditionally are Stuttgart, Munich, Hamburg, Frankfurt, Dusseldorf, Cologne and Berlin, also known as the ‘Big Seven’. In 2018, however, prices are high, and the markets are overheated. A comparative example is decent building land costs in Munich (€3,000 /m²) and in other Bavarian cities (roughly 1,000/m²).
Instead, turn towards the suburban areas of large cities. The suburbs of Stuttgart, Hamburg, Berlin and Munich are all developing fast due to the young families relocating there from metropolitan areas where residential property prices are just too high. Also, consider B-locations with a population of over 60,000. These include areas like Augsburg, Regensburg and Ingolstadt in Bavaria.
Bear in mind that the economy is weaker the further east you go, with a smaller and comparatively less wealthy population. This inevitably means a lower potential for growth and less demand for residential property.