Buying a hotel is a good investment
Real estate as an investment: the return has to be right
Due to the lack of investment alternatives, more and more investors are entering the real estate market. The corona crisis has not stopped this trend so far. On the contrary, in many places the prices for residential property are at record levels. According to experts, the main drivers of the upward price trend are the persistently high demand for housing, the lack of building land and the properties provided, as well as the low level of interest rates.
So concrete gold is in great demand again. But you also have to consider: Anyone who invests in overnight money, fixed-term deposits, equity funds or ETFs can get their money back relatively quickly if necessary. A property, on the other hand, is immobile. You have committed yourself over the years, especially since there are one-off costs such as brokerage fees, real estate transfer tax and notary fees that have to be earned again first. A complete renovation of the old building may even be necessary first. This investment should therefore be carefully considered. Let's go through the most important things step by step.
Real estate continues to grow
As a result of the corona crisis and rising prices, properties in the surrounding area are enjoying ever greater popularity. In June 2020, the Internet portal “ImmoScout 24” recorded 51 percent more inquiries for condominiums in the outskirts of the cities compared to the previous year. The demand for homes rose 48 percent. "Because of Corona, many employees work in the home office. This saves commuting between home and work. It is quite possible that this trend will continue after the pandemic. This could make the surrounding area more attractive," explains Thomas Schroeter, Managing Director at ImmoScout 24.
Axel Guthmann, head of the federal office of the Landesbausparkassen, thinks in the same direction: "Many townspeople are just noticing how nice it would be to have a balcony or, even better, a garden. Perhaps the experience with the permanent home office will make it possible again in the future more people can live in the country or at least in the suburbs of the cities. The value an additional study can have becomes very clear, especially in the pandemic. " Out in the country, but that doesn't mean that prices in the city are going down. According to "ImmoScout 24", there has been a similar increase in the number of buyers within the cities as in the surrounding area. The demand and thus the pressure on prices will therefore also remain high within the cities.
Note: Working in the home office has become permanent for a large number of employees and self-employed during the corona pandemic. The home office can be deducted in the tax return with the new home office flat rate. This includes a tax bonus of up to 600 euros.
Which properties are suitable as a capital investment?
House or condo
Commercial real estate
Please consider: If you fall for a tenant and they don't pay rent for months, that can get you into trouble yourself. On the other hand, B-locations in medium-sized cities are more attractive. The purchase prices there have also risen, but not so enormously. And the rents are also at a good level - from an investor's point of view.
"In view of falling savings interest rates, vacation properties represent an attractive form of capital investment and retirement provision," emphasizes Kai Enders, member of the Engel & Völkers Management Board. In addition, they increase the diversification of wealth, open up tax advantages and offer a certain protection against inflation. "In addition to the financial aspect, many owners naturally also appreciate the intangible return in the form of personal use," adds Enders.
If you are the owner of a shop and a discounter like Lidl or Aldi concludes a long-term rental agreement with you, you can count on secure income at least for this period and calculate your return. If, on the other hand, you are the proud owner of a restaurant, a lot depends on how the tenant runs it, how he treats his staff, what the cook is like, if he even finds someone who wants to do the job.
Anyone who wants to invest here should definitely seek advice from local experts such as brokers, etc. Because compared to renting out private real estate, renting out commercial real estate is much more cyclical. If the economy is bad, private individuals will not give up their apartment because of this. If people go out to eat less because of this, the restaurant tenant will feel it and therefore may no longer be able to pay the rent.
The main advantages of investment properties
There are many reasons for investing in home ownership: stable value, inflation protection, social security and independence from the stock market. Investors also enjoy tax advantages and mostly attractive rental returns.
Capital gainRental properties pay off in the short and long term. In the short term, landlords achieve a return on their capital employed; in the long term, the value of land and property increases.
Stable valueOwning real estate improves the stability of the value of private assets because the assets are distributed across different asset classes. The targeted allocation protects against default risks and persistent crises with individual types of assets. This stabilizes the total assets.
Inflation protectionOwning real estate also acts as a buffer against inflation. As the Institut der deutschen Wirtschaft Köln (IW) found out, investments in German residential buildings achieved an average return of 48 percent between 1998 and 2007. However, consumer prices rose by only 13 percent over the same period. The bottom line was a real profit of 35 percent.
Rental incomeLandlords benefit from regular rental income. If there is excess demand on the tenant side, landlords can push through rent increases and thus increase their return on investment.
Tax benefitsAttractive tax advantages are an essential aspect of purchasing a rental property. Landlords can compare the financing interest paid to the rental income. Since there is usually a negative balance in connection with building depreciation, maintenance costs as well as repair and administration costs, owners achieve income tax relief.
Supplementary pensionIn old age, homeowners kill two birds with one stone. You own the property's asset and also benefit from the rent saved (owner-occupier) or from regular rental income (landlord). According to expert estimates, homeowners have around 30 percent more financial leeway in retirement than seniors living for rent.
The most serious disadvantages of investment property
However, investing in a property is also associated with risks that you should know and assess before making a decision:
Tenant-friendly legislationIt is not uncommon that a tenant does not transfer any or only part of the rent. The tenant-friendly legislation and case law makes it difficult for landlords to get rid of rental nomads quickly.
Repair costsAnyone who opts for a residential unit in a large complex has little influence on repairs and their amount, which is decided by a majority in the owners' meeting. Affected social environment
Rent amountIf the social environment changes over the years, this can lead to falling rents and falling income.
Fixed interest rates and amount influence the returnIf you do not secure the loans for a very long time when buying the property, i.e. at least 15 years, you run the risk that the investment will no longer pay off after the fixed interest period has expired due to higher interest rates.
Capital is not available for a long timeIf the entire savings flow into the purchase of a property, you will not be able to dispose of it for many years. If the house or apartment has to be sold before ten years because you urgently need money, there is a risk of speculation tax and early repayment penalties for the prematurely terminated financing loan.
Little risk diversificationA lot of money has to be invested in purchasing a property, so that there is usually not much capital left for other investments. If the purchase turns out to be a bad investment - for whatever reason - it means total failure.
Administrative burdenWhen buying a single-family house or an apartment that is not part of a community of owners, you usually not only have to look for a tenant, but also to deal with repairs, complaints and the annual ancillary rental bill.
Loss of rentYou fell for a rental nomad who did not pay the rent for months and who also littered the apartment. However, you can protect yourself against this with a relatively cheap rental loss insurance.
What factors make a good investment property?
Bottlenecks in large cities cause prices to rise Apartment and rental prices have been on the rise for years, especially in large cities. The reasons for this are large numbers of people moving in and the low number of apartments available. Price drivers are not only the well-known real estate markets in southern Germany. In addition to Munich, where condominiums rose by more than ten percent within a year, prices in Hamburg, Dresden and Dortmund also climbed in double digits. Anyone who decides to rent an apartment in a prosperous city has good long-term prospects for asset growth and high rental yields.
University cities are convincingStudent cities are almost always economic winners and are therefore particularly suitable for capital investors. In a study, Deutsche Bank describes the advantages primarily in terms of overarching location factors. The operation of universities and colleges is independent of the economic cycle. The employees do not need to fear for their jobs and many students look for a job in the cherished environment after completing their training. The incomes of these graduates are usually higher than those of people without a university degree, so the income level in such cities is often above average. "The positive effect on the overall market is particularly evident in smaller cities where the university plays an important role," explains Eva Grundwald from Deutsche Bank. From this point of view, the DB study particularly highlights Marburg, Heidelberg, Trier, Würzburg and Münster. These five cities are characterized by a very high proportion of students in the resident population. Overall, according to the study, the real estate value development in typical German student cities (student share over 15 percent) is better than in cities without a significant student share. Over the past decade, the mean increase in value of new condominiums in such cities was more than 1.5 percentage points per year higher than the increase in value in cities with very few or no students. This applies to both East and West Germany.
Rural regions are falling behindReal estate in rural areas attracts with low purchase prices, but rarely brings high rental income. The rental yields are correspondingly below average. Aging and rural exodus prevail in many areas. Due to the declining population, the demand for living space and with it the rental prices are falling.
Low ancillary rental and administration costs
Little or no renovation costs
What else to look out for when buying investment property
The right purchase price
In addition to the careful selection of location and property, the construction financing must be optimally matched to your own finances. Regardless of whether buyers use the property themselves or want to generate rental income, the financing should be sustainable in the long term. Experts recommend at least 20 percent equity when buying real estate. More is definitely better, because many banks only offer top conditions from 40 percent equity. The additional costs are not to be forgotten. Because the fees for brokers, real estate transfer tax and entry in the land register can increase the acquisition costs by up to 15 percent of the property price.
In addition to the requirement for at least 20 percent equity, experts recommend 20 years cold rents as the maximum justifiable purchase price for a residential property. With a monthly rent of 800 euros, this corresponds to 192,000 euros. The same rule of thumb applies to owner-occupied properties. These should also be paid off after 20 years through the - theoretically paid - 20 annual cold rents. A few years ago, 15 times the net rent excluding heating was considered a realistic upper limit, but nowadays it is no longer possible to get apartments in good locations at such prices.
The additional purchase costs
Only in rare cases does the bank finance the entire purchase price and, even more rarely, the ancillary costs. At least this is what an investor should find. These are primarily:
- Broker's commission of up to six percent of the purchase price plus 19 percent VAT
- Real estate transfer tax between 3.5 (Saxony) and 6.5 percent (Thuringia) depending on the federal state
- Notary and court costs of around two percent of the purchase price
Investing in real estate is especially interesting for people who earn a lot of money and pay high taxes. Because you can deduct many of the costs you incur in this context from tax. Here are the most important:
- Interest they pay on the home loan
- Broker's commission when purchasing
- Notary and court costs
- Two percent of the acquisition costs per year
- Property tax
- Repair and renovation costs.
These one-time and ongoing costs are compared with the rental income. If the costs are higher than the income, there will be losses from renting and leasing. The investor can then deduct this from the positive results of another type of income, for example from employment (employee relationship), and thus reduce the tax burden.
Determine the value of the property
The best property is of course the one that costs little, is well located and brings in a lot of rent. But of course you will not find this ideal property. The better the location, the more consumers want to buy the property and therefore drive up the price. On the other hand, good properties in great locations can also be rented out much better, i.e. more expensively. What can a property cost now?
The rent multiplier is an important key figure.Experts say that a residential property should not cost more than 25 to 30 annual cold rents. If a condominium brings in 1,500 euros a month net rent, this is 18,000 euros a year and thus 450,000 euros in 25 or 540,000 euros in 30 years.
This calculation does not take into account the ancillary purchase costs and ongoing management costs. Therefore, it only gives a rough indication of whether an offered property is rather expensive or cheap.
Calculate the possible return
This sample calculation is intended to illustrate that expensive properties with a high rental multiple only bring a low return. You are being offered a two-family house for a price of one million euros. The rental income from both parties amounts to 25,000 euros net. That gives a rent multiplier of 40.
However, you also have to take into account that there are annual management costs of 2,500 euros. That means: The net rental income is only 22,500 euros. Since you also have to pay eight percent incidental purchase costs, the total investment is 1.08 million euros. That results in an annual net return of only 2.1 percent.
Conclusion: The return is far too low. Because if a tenant does not pay the rent for a while, the return continues to decrease.
Warning: yields can also decrease
There are many reasons why there is much more to be said for real estate than against it, and that will not change anytime soon. At one point we are experiencing a strong influx of EU citizens and refugees who have to be provided with housing. Today's citizens tend to prefer larger rather than smaller apartments, even when they are single. Older people do not want to give up their much too large apartments from which the children have long since moved out.
Nevertheless, we must not hide the fact that in individual cases the returns on apartments can also fall. The social environment can develop negatively because the population structure is no longer right. Surprising and expensive repairs can hit the office. You fall for wrong tenants several times who refuse rent payments and cannot be sued from the apartment so quickly. In addition, after 15 or 20 years, if you want to sell the property, you may not find the buyer who will give you the proposed purchase price.
Real estate as an investment: choosing the right financing
As a property buyer, you currently benefit from low interest rates and consumer-friendly framework conditions. According to statistics from Deutsche Bank, an average German household only has to spend around a third of the financial expenditure on buying a house today than it did in 2000.
Secure favorable interest rates
A construction loan with a fixed interest rate of ten years is already available in times of low interest for significantly less than two percent effective interest. This low interest rate enables high repayments to be made. This allows you to determine very precisely how many years you would like to invest your mortgage loan.
With the help of a corresponding repayment amount, you can control whether the property should be paid off in ten, twelve or fifteen years. If the loan is repaid in full within the fixed interest rate, the bank distributes an interest discount in some cases.
Current construction rates from selected providers
Nominal interest p.a.
Effective interest p.a.
PSD Bank Munich
PSD Bank Nuremberg
Fixed interest 10 years, loan 300,000 euros, 3.5 percent initial repayment, 80% loan / Source: Biallo building finance comparison; As of December 22, 2020; Information provided without guarantee.
Complete loan - the full repayment loan
If you already live in your own four walls and only want to buy a second property as an investment, you should choose complete financing - in the form of a full repayment loan. This financing variant offers you absolute calculation security, because at the end of the credit period you are completely debt-free. In the current phase of low interest rates, the rates for full repayment loans are significantly more affordable than in phases of high interest rates. Depending on the loan amount and financial strength, full financing with terms of less than 20 years is currently easily possible.
Disadvantage: So that the property is completely debt-free at the end of the term, you have to accept a high repayment installment, usually three to four percent of the loan amount. Despite the current level of interest rates, you should carefully consider whether you can cope with these high repayment installments in the long term. If that is the case, a full repayment loan is a very useful instrument to get the apartment or house free of debt quickly and in a plannable manner.
Financing does not sew on edge
The purchase of a rental property usually means a long-term burden. As the owner, you may earn regular rental income, but unplanned costs for maintenance or repairs can upset the calculation.
A financial cushion for incalculable additional costs is a must. Building finance experts recommend putting around 20 percent of the total investment cost on the high edge as asset retention.
Alternative: real estate funds or real estate crowdinvesting
Real estate funds
For those who shy away from the risk of a high investment and a financial commitment over 15 years or more, a real estate fund could be an interesting alternative. A basic distinction is made between closed and open real estate funds. Closed funds are so called because they usually collect very large amounts of money from a limited number of investors, then invest this money in hotels, shopping centers or office towers and close the fund as soon as all the shares have been sold.
In this sector there are many crooks and representatives of the gray capital market who have destroyed many millions in investor money in the past. Laypeople can hardly judge whether the information in sales prospectuses is realistic. You'd better keep your hands off it. Open-ended real estate funds are less risky, but not without it either. Here, too, the purpose of the fund is to put the collected money into real estate. If a lot of money is raised, the fund will not be closed, but will buy more real estate.
The large number of properties also means a certain diversification of risk. If things don't go so well with a rental property, the others can make up for it. The fund company manages the property for the investors. Rental income minus costs is the income that is distributed to the owners.
But: Anyone who purchases shares in a real estate fund usually pays an issue surcharge of five percent. In addition, there are administrative costs of between 0.5 and two percent per year, which reduce the return. If you want to find a good fund, you should choose one that has received a good rating from the rating agency Feri Euro Rating.
Real estate crowdinvesting
Real estate crowdinvesting is a relatively new form of investment. Similar to crowdfunding, in which many investors invest in a business idea, social or ecological projects, many investors come together via internet platforms to jointly finance larger real estate projects. In this context, projects in sustainable construction such as green buildings can also be mentioned.
In contrast to real estate funds, here you have the option of deciding on a specific property. The big advantage: You can invest smaller amounts in different properties with different terms, so that you both minimize the risk and remain financially flexible. In addition, you do not have to worry about administration or the search for tenants, which, however, also reduces the return.
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