Pay as you grow

Germany is not the first country that springs to mind for British investors seeking an opportunity to make money from overseas property. The UK’s poor perception of Germany may have softened a little, but there is still some reluctance to regard the place as a holiday destination or, for that matter, a place to invest in property.

That country seems to have been overlooked as an investment destination in favour of others further afield such as Bulgaria, Croatia or Cyprus. But while Germany’s economy has been floundering for the best part of the past decade, there is now a widespread belief that, with long-awaited economic reforms beginning to take effect, it is about to turn the corner.

Since reunification in 1990, the country has struggled with the burden of assimilation. Economic growth has been slow, consumer confidence low and house-price growth non-existent. With around 70 per cent of people in the UK owning their own homes, you might expect something similar in Germany.

But most Brits will be surprised to learn that fewer than half of Germans have bought theirs. Since 2000, property prices across Europe have soared – in Italy and France they have grown at ten per cent per annum, in Italy 15 per cent and in the UK 17 per cent. Yet in Germany, house prices have stagnated.

Don’t bank on it
Unique economic factors lie behind this anomaly. Since 1990 the country has seen slow population growth. To say the German economy has underperformed is to oversimplify. Germany has suffered from high unemployment of 11 per cent, mainly due to restrictive labour laws discouraging investment in jobs. This has forced the economy to look to technology; as a result, it remains the fifth largest globally and is the world’s biggest exporter.

In East Germany, there was a culture of renting statesubsidised property and this was also the case in the West. Indeed, former Chancellor Gerhard Schröder rented a flat in the capital, Berlin. This reluctant attitude spread to the financial institutions, and German banks appeared unwilling to lend money. Obtaining a German mortgage can be lengthy and complicated. German banks offer a smaller range of financial products than other European banks and prefer to lend only 60 to 80 per cent of the purchase price. Borrowers also have to be in regular full-time employment with proof of a savings record dating back six years. Little incentive for or tradition of home ownership has fed a vicious circle that has kept house prices flat.

The flipside to this apparently gloomy situation is that, for the investor looking for rental yields, German property is exceptionally good value. The stable, mature rental market offers the investor net yields on new-builds of up to ten per cent. Long-term tenancies also offer security of income. Interest rates are currently low, around 3.2 per cent, although they are on the rise.

The winds of change
What would add greater impact is a significant rise in German home ownership – but for that to happen the economic situation and prevailing attitude of the population has to change.

Low prices are one thing, but finding a reason why they might rise is another altogether. There are three catalysts that could get prices moving. First is the passing of large amounts of the German housing stock into private institutional hands; these are likely to be agents of change as they try to realise the value of their portfolios. 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.

The third is economic reform. A year ago in November, Angela Merkel was sworn in not just as Germany’s first woman Chancellor, but as the first Chancellor from the former East Germany. Merkel was only too aware of the necessity of reforms to the welfare and labour laws, which are now widely believed to have begun to take effect, and has promised to accelerate the pace of change.

Tony McKay, chief operating officer of Instant Access Properties, predicts price rises: “The German property market has underperformed for a long time, but there’s been a lot of interest recently, led by major institutions and banks that can sniff a profit. It’s a fantastic place to invest – 18 months ago, the market had bottomed out, but it has now increased by at least 15 per cent.”

Institutional push
Foreign property investment has flowed into Germany this year. Private equity groups Terra Firma and Blackstone have kick-started the buying with multi-billion euro investments. Nearly £10 billion of global funds has flowed into German property on the back of the country’s economic recovery. Around 80 per cent of investment in German property last year was from foreign investors, compared to just 20 per cent in previous years. In August, Germany overtook France as the second biggest market for property deals in Europe. Germany accounted for 21 per cent of transactions in the first half, up from 13 per cent of total transactions in 2005, while France accounted for 16 per cent.

In London in the early-1990s, foreign investment flooded in and signalled the start of house-price rises. Does this mean the same for Germany? Iain Keys, the director of real estate at fund manager London & Capital, estimates the market will see a good five years of growth: “The UK market is seen as quite hot. Yield compression is going to slow as money goes elsewhere. This is a once-in-a-lifetime opportunity for buying prime German real estate at discounted prices.”

The new Germany
The summer’s football World Cup gave Germany something of a makeover, certainly in British
eyes. Commentators and fans alike were so won over by the country and their hosts that after
England’s untimely departure, somewhat im-probably Germany became the team of choice for many. But it would be a little rash to buy property on the back of a five-week sporting festival.

Germany was already seeing a tourism boost – in the year to May, the month before the competition began, tourism was up 6.4 per cent year on year. Petra Hedorfer, chief executive officer of the German National Tourist Board (GNTB), explains: “International travellers are increasingly recognising and appreciating Germany as an attractive and multi-faceted destination. We’ve seen a significant rise in numbers from almost all our top markets.”

Weekend city breaks and cultural visits have been the key areas the GNTB have been marketing, and at the same time there has been an increase in the number of German cities connected by cheap flights. EasyJet fly to Berlin, Dortmund, Cologne, Hamburg and Munich; Ryanair to Bremen, Berlin, Düsseldorf, Frankfurt and Karlsruhe; Air Berlin to Berlin,  Düsseldorf, Hamburg, Hannover, Leipzig, Münster and Nuremberg; and Lufthansa flies to all major cities.

Regional variations
Hamburg, Germany’s second largest city, is the country’s principal port. Known as the Venice of the North, the city lies at the junction of the Elbe, Alster and Bille rivers and its centre is beautifully situated around the Binnenalster and the Aussenalster lakes. The city’s Christmas market is a huge draw for tourists.

Munich is often referred to as Germany’s “secret capital”. Its parks, museums, palaces and architecture are the main draw for tourists – if you discount the Hofbräuhaus, the world’s most famous beer-cellar. The two-week long Oktoberfest is the busiest time of year.

Germany’s real capital is Berlin. Since the fall of the Berlin Wall in 1990 and reunification, the city has been transformed. It is as famed now for its avant-garde architecture and art scene as it has always been for its nightlife. Artists, musicians and designers that have been priced out of London, Paris, Rome and Barcelona flock to Berlin to live.

Cologne is renowned for its unique Gothic cathedral and many relaxing restaurants along the banks of the Rhine, while Frankfurt is Germany’s financial centre, the home of the European Central Bank and a transportation hub for rail and air travellers. The city’s book fair attracts over 100,000 visitors every year. Germany may not have the weather or the wholly comforting ex-pat style of the Spanish coastline, but it has a plethora of attractions and scenery, all garnished with the finest beer and sausages.

The number of new-builds in Germany has historically been low, leading to a shortage of housing in some parts, so these will be the areas of greatest price rises. “Since reunification, the number of new-builds has stalled along with house prices,” says McKay. “Increasing house prices go hand-in-hand with increasing new-builds. With all the indicators pointing towards increasing property prices, there will inevitably be more opportunities to invest in new-builds. The key is choosing the right new-build in the right city. To do that, you need to make sure you have good local knowledge, and are not just acting on a whim.”

An emerging market
To say the German market comes without problems would be naive. It is an immature market. Volumes of transactions are low compared with markets such as those in the UK and pricing can be erratic, with similar properties selling for wildly different prices. Brokerage fees are very high, ranging from three to six per cent. This makes the costs of buying pretty high – once you’ve added up brokerage fees, stamp duty of 3.5 per cent, notary fees at 1.5 per cent and legal fees, you can expect to pay at least seven per cent.

This should change as money floods into the market and volumes push brokerage prices down, but for now it can look off-putting. 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.

McKay has confidence in German property: “Initially, with high rental yields there is room for capital growth without a ground shift in German attitude to owning property, but in the longer term a change in attitude would be needed. Once property prices begin moving up, attitudes will change. Experience in the UK and Spain has proved that. The odds are that five years from now investors will look back on those pre-election days of September 2005 and wish they’d had more faith in Germany.”