15/10/2019 - Investment Themes: Real estate


From rent caps to low interest rates: opportunities and risks of the real estate market

Interest rates are lower than ever, the shortage of housing continues nevertheless German residential real estate came under more pressure recently as the increasing regulation of the market becomes noticeable. The so-called B cities, on the other hand, offer opportunities.

Written by Hagen Ernst, Deputy Head of Research & Portfolio Management

Despite record lows of interest rates and persistent housing shortages German residential property stocks came under greater pressure because of increasing regulation. At the federal level, for example, it was decided to extend the rent index for a period of five years until 2025. In addition the calculation period has been extended from four to six years. The rent index is therefore now more in line with the historical rent average than reflecting the local comparative rent.

The situation is extreme in Berlin where the Senate wants to introduce a rent cap that by the will of the Left Party would have turned out to be a radical "forced rent reduction". According to a first draft by the Left Party responsible for urban development and housing, for example, an apartment in an old building may be let for a maximum of six euros per square meter - regardless of its location. This lies clearly under the current rent mirror of 6.72 euro per square meter. The draft envisaged a simple differentiation according to age of construction. Understandably, a clear classification is needed so that every tenant can see what rent he has to pay and the flood of rent reduction applications can be processed as quickly as possible - after all the Berlin authorities are already hopelessly overburdened.

On the other hand, it is also not in the sense of justice that a lawyer pays the same rent in the stucco old building in Prenzlauer Berg as a low-income earner in the simple old building, for example in the workers' quarter Reinickendorf. The coalition partners SPD and Grüne seem to have recognized this as well. It seems that the rent index has been reduced to a more moderate form. Upper limits with corresponding rent reductions will only apply to low-income earners whose rent payment exceeds 30 percent of their monthly income. In addition rents under certain upper limits may be adjusted upwards in line with wages or inflation.

In addition, modernization measures should at least be rewarded to a certain extent. For modernizations within the last 15 years rents may be 1.40 euros per square meter above the rent index. In the case of new investments the rent may be increased by one euro per square metre. This means that energy modernization is virtually no longer feasible. Climate protection is therefore not a top priority, at least not in Berlin, and nobody wants to pay for it. However the rent cap remains constitutionally questionable - and it remains to be seen how the Bundesverfassungsgericht (Federal Constitutional Court) will assess such an intervention.

Stricter regulation endangers new construction activity

In view of constantly rising rents in the conurbations it is understandable that politicians are now taking a more radical approach and want to regulate rents more strongly or freeze them completely. Such interventions, however, are risky. According to the Federal Statistical Office, 285,900 apartments were completed in 2018, the highest number since 2002 - but this is still far from enough to ease the situation on the housing market. The political target is 375,000 new apartments per year. In view of increasing regulatory intervention, building permits have already fallen by 2.3 percent in the first half of the year. As a result the housing shortage is likely to become even more acute which should affect low-income earners in particular if tenants continue to be freely selected.

In Berlin the uncertainty of investors is now so great that the transaction market collapsed completely after the rent cap went public. It is to be feared that the already insufficient new construction activity will be significantly reduced. As a logical consequence Berlin therefore has only the choice of increasingly creating new living space itself. However, the target of 30,000 additional municipal apartments in five years by 2021 will be missed anyway - 26,000 new apartments are realistic. Both financial resources and manpower are lacking.

Berlin housing development companies offer interesting entry opportunities

Nevertheless the municipal housing company Gewobag  acquired 5,800 units from Ado Properties for almost one billion euros recently. This was the first major transaction after the rent cap. With a gross yield of 2.7 percent and a price per square meter of 2,600 euros Gewobag paid a high price - despite the rent cover. Listed housing companies with a Berlin focus are currently quoting a gross yield of a good four percent and an implicit price per square meter of less than 2,000 euros. In 2004 the Senat of Berlin privatised the Gemeinnützige Siedlungs- und Wohnungsbaugesellschaft (GSW) with 65,700 units for 405 million euros. Now almost 10 percent of the original portfolio is being repurchased with below-average quality because of primarily prefabricated buildings. Sustainable management is called into question - and it shows that the state or local authorities do not necessarily have to be the best alternative. Perhaps in the end it would be cheaper to support low-income earners with adequate housing subsidies.

Berlin as an excellent example - with potential for investors

The situation remains very unclear. Is the rent cover coming for Berlin? Is it constitutional? Will other cities follow? Much is unclear. However there could be interesting entry opportunities for investors. In particular housing companies with a focus on Berlin are trading well below their asset values. The market has already virtually anticipated a price correction of 20 percent. However prices have even risen further up to the rent ceiling and at least the municipal companies seem willing to pay any price in order to increase their portfolio. In view of the housing shortage and the extremely low interest rates, however, it is by no means certain whether such a price correction will really take place. The law on the rent cap should actually be passed on 15.10.2019. However, due to disagreements within the Berlin Senate about the exact structure this deadline may not be met.

Housing shortage intensified, regulation as biggest risk factor

In any case the housing shortage will be further exacerbated by the interventions. Instruments such as the rent cap could even add value to real estate in the long term as the already scarce commodity of housing becomes even scarcer. Although interest rates are currently at an unhealthy low level a significant rise in interest rates is unlikely in view of the looming recession. This means that the two biggest risks oversupply and rising interest rates are actually averted for the near future. Thus the greatest danger for a price correction is likely to come from regulatory intervention. A positive aspect here is that the SPD and Grüne do obviously not share the radical plans of the Left Party in Berlin.

Those who are afraid of the political risk but are looking for a solid dividend share in view of the zero interest rate policy are interested in portfolio holders with a focus on B-cities or in locations with residential markets not quite as tense as Berlin, Frankfurt or Munich. Properties in B-cities with good or at least stable demographic development such as Dortmund, Magdeburg or Chemnitz, for example, appear promising. Rents are significantly lower there - and there is still potential for rent increases. Prices have not yet risen as strongly and the achievable yields are correspondingly higher.

Conclusion: B-cities with a view of more

In view of increasing regulation, the visibility of German residential real estate is low. The housing shortage is likely to become even more acute because of the currently planned interventions. In addition interest rates appear to remain at a low level for the foreseeable future. The current discounts to the net asset value of listed portfolio holders imply a price correction of 10 to 20 percent for real estate. Due to the continuing tense housing situation and the persistently low interest rates, however, it is questionable whether such a price correction will really take place. Companies that focus on Berlin have the highest valuation discounts but also have the highest regulatory risks, such as the rent cap. Portfolio holders with a focus on B cities are likely to have the lowest regulatory risk. Here, price increases and rents are not yet so high. In addition, real estate in such locations still generates relatively high returns. Therefore a dividend yield of three to four percent can be distributed.


Note: All information published is for your information only and does not constitute investment advice or other recommendation. Long-term experience and awards do not guarantee investment success. Securities are subject to market-related price fluctuations which may not be compensated for by the active management of the asset manager or investment advisor. This information cannot replace a consultation. All information has been provided with care and to the best of our knowledge at the time of preparation. Despite all due care, the data may have changed in the meantime. Further information on opportunities and risks can be found on the website www.dje.de. The sales prospectus and further information are available free of charge in German from DJE Investment S.A. or at www.dje.de The fund management company is DJE Investment S.A. DJE Kapital AG is the distribution agent.