Which is the best property market to invest in now? It isn’t Spain, it isn’t France and it certainly isn’t Bulgaria or Hungary, says Merryn Somerset Webb. It’s Germany…
For years now the UK property market has been making investors vast fortunes. Prices have risen some 500% since 1992, meaning that those able to leverage themselves up and keep buying and selling have been able to multiply their capital many times over. But this just doesn’t work here any more. Last year, property prices stopped rising in the UK, making trading in houses pointless – particularly given how high the costs of doing so have risen, thanks to Gordon Brown’s fiddling with stamp-duty rates. So where should experienced property investors take their skills today? This is a tricky one. Britain isn’t the only European country seeing house price rises level off.
In Spain, prices rose over 15% last year (and many UK investors have made significant amounts of money by flipping properties). But oversupply – particularly along the Costas – and falling demand mean the number of transactions and prices are slowing considerably. It’s the same all over Europe, says Cheryl Taylor in The Business. In Finland, house price growth is down from 8% last year to more like 3% in the first part of this year. In Greece, prices have levelled off as infrastructure projects (many of them the legacy of the Olympics) have made new areas accessible and “softened the impact of rising demand”. And in Italy, the demand for housing loans in the first quarter was lower than expected, which “is expected to translate into lower prices”, says Taylor. Mortgage market growth is also slowing in Spain and Ireland.
Be wary of Eastern Europe
No wonder, then, that investors are turning towards the markets of eastern Europe, such as those in Bulgaria and Hungary, where prices look relatively cheap and sales people boast of the fabulous yields – 10% plus is on offer for brave buyers. But this may not be the place for those used to Western markets. The pricing systems can be opaque, there is often no established infrastructure, legal or otherwise, and there is often title risk too – how do you know and how can you prove you own a house you think you’ve paid for? The risk element is hard to quantify in emerging markets of any kind, and that is why prices are low and yields high – to compensate for the risk. These houses are cheap for a reason and they may well just stay that way.
But start buying Germany
The good news is that you can get almost the same kind of property yields as you can in Bulgaria in one of western Europe’s biggest economies – Germany. Germany, as analysts at Merrill Lynch point out, “has conspicuously failed to join in the global housing boom of the last ten years”, thanks to the dismal state of the German economy. Today, it’s one of the most depressed housing markets in the world. Germany has the lowest level of home ownership – 44%, according to Merrill Lynch – in the industrialised world and prices have stagnated or fallen for the last decade (in the year to the end of the first quarter of 2005, they fell 1.3%). The result is that they have fallen sharply relative to rents and incomes – since 1980, German housing affordability has improved more than in any other industrialised country.
Today, says Ilya Spitalnik of German Property Investors, you can buy property in Germany’s major cities and get a yield of 8% and sometimes 10% – at a time when borrowing costs in Europe are around 4%. German property is not just cheap relative to property elsewhere in Europe, it is also cheap in absolute terms.
Spitalnik is not the only person to think so. Much of Germany’s housing stock has long been owned by corporations and regional and central government. But faced with pressure to cut their costs, these groups have started to sell down their holdings. And guess who’s been buying. Not the occupants, but large-scale foreign investors “attracted by low prices and respectable yields”, says Merrill Lynch. In 2001, Nomura bought 64,000 homes from Deutsche Bahn, the German railway firm. Last year, a US private-equity firm, Fortress, bought 80,000 flats from the state pensions administrator and Morgan Stanley picked up 48,000 flats from industrial group ThyssenKrupp. In May, UK private-equity firm Terra Firma got in on the game with a e7bn purchase of 150,000 flats from German utility firm Eon. And MoneyWeek Roundtable member and Isle of Man-based investor Jim Mellon has bought 500 apartments in Berlin. The smart money from all over the world appears to be heading for Germany.
Will prices rise?
However, accepting that prices are low is one thing – finding a reason why they might rise is another altogether. What catalysts could possibly get prices moving? There are three, says Merrill Lynch. First is the passing of large amounts of the German housing stock into private institutional hands. These groups are likely to be agents of change as they try to realise the value of their portfolios by encouraging wider home ownership – Terra Firma is already linking up with mortgage providers to finance and sell properties to tenants, for example. And the tenants are willing to buy because, with interest rates this low, their mortgage payments are no lower – and sometimes higher – than their rent payments. Second is the possibility that German banks will become more focused on mortgage lending as a real single market in financial products spreads across the EU. Right now, they offer far fewer mortgage products and across a narrower range of incomes than banks in most other European countries. They also like to lend only 10% of the purchase price of a house and to see a track record of monthly savings for up to six years before they hand the cash over. Finally, and most vitally, a rise in house prices is going to need “some sort of wider recovery” in Germany’s economy.
This may well be on its way, says Sven Lorenz in The Zurich Club Communiqué. Remember Britain in the 1970s? It was mired in high unemployment, falling property prices and political gridlock, and was lagging far behind other European economies. Then along came Margaret Thatcher to generate an economic revival “that no one would have ever deemed possible”. Central London houses that could have been picked up for a mere £10,000 in the 1980s now go for £1m plus. The same could be about to happen in Germany: after 12 years of “continued economic crisis”, Germans are worn out. Their per capita income is below that of the UK and the European Union average and 11% of the population is on the dole – a rate last seen in the 1930s. They know something has to change and that’s why, at the next election, they may vote not for Chancellor Gerhard Schröder and his Social Democrats, but for the opposition, the more free market Christian Democratic Union party (CDU), led by Angela Merkel.
This would put Germany in a very interesting position. Right now, the lower house of the Bundestag is controlled by the Social Democrats and the upper house by the CDU, with the result that the two spend most of their time blocking each other’s decisions and creating a kind of administrative gridlock. If Merkel were to win in September, this would put both houses in the hands of the CDU, which could allow them to implement “a strong dose of reform”, something that could, in turn, kick off a German economic revival.
Spitalnik, who says he is seeing a huge amount of interest in German property from both UK and Irish investors, is convinced that the property market in Germany has bottomed and will soon be turning up. After all these years of falling prices, he says, there are few people left to sell their houses, so prices are unlikely to fall further. Come in now, he says, and you’ll catch the bottom. You could make the same amount of money in the German market as you would have made if you’d started investing in UK property back in 1992/1993. It is “a major turnaround play”.
Which cities are the best bets?
Spitalnik’s favourite investment city is Berlin, which is not only creative (it’s well known that artists, musicians and designers priced out of London, Paris, Rome and Barcelona have been flocking to Berlin to live), but is at the centre of the reunification effort. As such, it offers a huge variety of investment opportunities and such high yields that investors should make their costs back and a reasonable profit even without the expected capital appreciation coming through. Other cities, such as Frankfurt, Stuttgart and Hamburg, also look good. Rents and prices are currently stable, but the number of new properties being built has been decreasing over the last seven years and supply is restricted, suggesting that a small rise in demand could push prices up disproportionately.
None of this is to say that the German property market comes without problems. It is, points out Spitalnik, immature. As the volumes of transactions are low compared with markets such as those in the UK, pricing can be erratic, with similar properties selling for wildly different prices and brokerage fees very high. They range between 3% and 6% and are usually 6% in Berlin, although these are ordinarily split between the buyer and the seller. This makes the costs of buying pretty high: once you’ve added up the brokerage fees, stamp duty of 3.5%, notary fees at 1.5% (you must use a notary in Germany) and legal fees, you can expect to pay a minimum of 7% and usually a great deal more (the average is 10%-12%) of the value of a property just to get into the market.
This should change as money floods into the market and volumes push brokerage prices down to more reasonable levels, but for now it can look offputting. On the plus side, there appears to be a reasonably favourable tax regime in place for non-resident investors. If you hold a property for ten years, for example, it can be sold free of capital gains tax, and rental income is not subject to a withholding tax.
But if the bulls are right and the current German property market is akin to that in the UK in 1992, the amount you’ve paid out in fees and the level of taxation you’re hit with will fade into irrelevance next to the profits to be made in the market. It won’t happen over night, says Lorenz, but “the odds are that in five years investors will look back on those pre-election days of September 2005 and wish they’d had more faith in Germany”.
Where to put your money in Germany – Jack Dyson
At least three quarters of German houses have been built since World War II, but there are still traditional village homes available in rural areas such as the Rhine and Mosel valleys. Property in former east German states is generally cheaper than in more affluent areas of the country and a keen eye should find plenty to modernise, particularly as various states in Germany offer grants of up to e250,000 as an incentive for buyers to rebuild/renovate historic properties. But overall, the most sought-after rental homes are “‘Zinshaeuser”(which have eight to 20 flats) – especially modernised “Altbau”. These were built between 80 and 120 years ago, have high ceilings and lots of character. They are virtually impossible to get in Frankfurt, but there is still a market in Dusseldorf, Hanover and Berlin. The return rate, according to www.invest-in-germany.de, ranges from 6%-8% a year.
German Property Investors can help investors with e600,000 or more to invest to get into the market. The firm finds properties, helps investors through the German business process, and guides them through legal and bureaucratic processes. It can also help with financing. More information for those with any amount to invest directly can be found at www.bundesregierung.de and www.invest-in-germany.de. Those seeking exposure to the market via equities might look at Berlin-listed Eurocastle Investment Limited (EZG.GR), an investment firm with a diverse portfolio of real-estate assets, including substantial amounts of recently purchased German property. The shares are on a p/e of around 13 times and offer a yield of 7.6%. And those with delusions of grandeur can buy a castle in east Germany. After the fall of the Berlin Wall, the state found itself in possession of hundreds of them and is now keen to flog them off at anyprice to private investors rich enough to renovate and maintain them. See www.poshjourneys.com for more information.