Real Estate – Inflation
How is the real estate market in your jurisdiction being affected by inflation?
Developers and real estate investors had to deal with substantial supply chain problems in the aftermath of the global pandemic that not only delayed the realisation of residential building projects, but also led to massively increased costs.
The war in Ukraine and particularly its huge impact on energy prices in Germany have made matters worse. Unsurprisingly, the number of newly constructed buildings as well as the number of building permits have noticeably dropped in recent months
On the other hand, the financial leeway for potential homeowners is narrowing due to extraordinarily high inflation: the German consumer price index has exceeded a level of 10% in October 2022, a figure unseen in the past 70 years. In addition, the European Central Bank’s attempt to fight inflation resulted in a steep mortgage rate hike that has made financing substantially more expensive. While a mortgage loan with a fixed interest rate for 10 years cost less than 1% per annum a year ago, the interest rate has now risen above 4%. As residential real estate has become much less affordable, asking prices are currently stagnating and, in some areas, slightly declining for the first time in 13 years. Potential buyers seem to turn to the rental market instead
Are there opportunities that real estate investors should be aware of, particularly in the rental market?
Unlike in many other countries, the residential rental market in Germany is, compared to the owner occupier market, very sizeable. In general, more than half of German households are renters, and in Berlin, as one of the top seven German metropolitan areas, even more than 80%. Demand for housing in metropolitan areas continues to exceed the number of available homes by far. Given the increasing backlog of homes to be built and the additional pressure on the German rental market caused by refugees from Ukraine and other countries, a strong rise in apartment rents can currently be observed. In Berlin, for example, the rents for newly built apartments have increased by approximately 10% within the last year. Due to exorbitant energy costs, the operating costs for less energy efficient buildings have recently, however, risen to new heights, so that landlords of older buildings may not be able to increase the net cold rent similarly. It can be assumed that, under the current market conditions, the quality of the asset (in terms of location, building standard, energy efficiency and maintenance level) will play an increasingly important role for its valuation and the price that sellers can achieve in case of an exit.
Even though many investors who financed their property in Germany with bank loans agreed in the past years on fixed interest periods of 10 to 20 years (or even longer), those who require re-financing in the coming months and years will have to pay much higher interest rates. Particularly in cases where the purchase was highly leveraged and only small repayments were made, (re-)financing could become stressful. Taking into account the increased operating and maintenance costs, particularly for older, unrefurbished buildings, and the darkened exit prospects due to higher financing costs, it may well be that purchasing opportunities will emerge on the market that have not been available for a long time.
Equity strong investors – particularly with a value-add strategy such as energy efficient refurbishments – should therefore await buying opportunities on the German residential real estate market. That is especially true for U.S. dollar-based investors who can currently benefit from their historically strong currency. To the same extent the euro has depreciated against the U.S. dollar, German real properties have become cheaper on a U.S. dollar basis. The current strength of the U.S. dollar therefore presents an excellent window of opportunity for investments in German real estate.
Does your jurisdiction pose any significant risk of real estate prices stagnating due to rising inflation vs declining GDP? If so, how can investors protect themselves against these risks?
Unlike in many other countries, the residential rental market in Germany is, compared to the owner occupier market, very sizeable. In general, more than half of German households are renters, and in Berlin, as one of the top seven German metropolitan areas, even more than 80%. Demand for housing in metropolitan areas continues to exceed the number of available homes by far. Given the increasing backlog of homes to be built and the additional pressure on the German rental market caused by refugees from Ukraine and other countries, a strong rise in apartment rents can currently be observed. In Berlin, for example, the rents for newly built apartments have increased by approximately 10% within the last year. Due to exorbitant energy costs, the operating costs for less energy efficient buildings have recently, however, risen to new heights, so that landlords of older buildings may not be able to increase the net cold rent similarly. It can be assumed that, under the current market conditions, the quality of the asset (in terms of location, building standard, energy efficiency and maintenance level) will play an increasingly important role for its valuation and the price that sellers can achieve in case of an exit.
Even though many investors who financed their property in Germany with bank loans agreed in the past years on fixed interest periods of 10 to 20 years (or even longer), those who require re-financing in the coming months and years will have to pay much higher interest rates. Particularly in cases where the purchase was highly leveraged and only small repayments were made, (re-)financing could become stressful. Taking into account the increased operating and maintenance costs, particularly for older, unrefurbished buildings, and the darkened exit prospects due to higher financing costs, it may well be that purchasing opportunities will emerge on the market that have not been available for a long time.
Equity strong investors – particularly with a value-add strategy such as energy efficient refurbishments – should therefore await buying opportunities on the German residential real estate market. That is especially true for U.S. dollar-based investors who can currently benefit from their historically strong currency. To the same extent the euro has depreciated against the U.S. dollar, German real properties have become cheaper on a U.S. dollar basis. The current strength of the U.S. dollar therefore presents an excellent window of opportunity for investments in German real estate.
