It is very common, especially for first-time investors, to struggle when choosing their first investment building and even more difficult, when they need to compare two objects with a similar price, location, and ROI. So, what should be the defining argument when deciding which one is better to buy? Our expert team has compiled a few important things every investor needs to be aware of when purchasing a Multi-family home in Germany.
As a rule of thumb, when the investor is looking at various locations, the most common thing we see is that it’s often based their emotions. Most international investors are mentally inclined to purchase a building in the city which they know at least something about and it is an impulse we find hard to fight against. In comparison, for German investor, the personal knowledge of the area or lack of it – doesn’t really matter that much.
Germany is huge and its regions very diverse. Saying that West Germany is more economically advanced and therefore is better to invest than East, is not correct. It is way more important to check for investments micro-location, because also in North Rhine Westphalia, which is economically very strong region, you can make a wrong choice when choosing a city or with the building itself. In comparison, you could make the right choice in Saxony and buy a building which would grow in price by 30% in just a few years time.
It is very important to analyze a population of this particular city and area, to see where the majority of people are working, where are they buying their groceries, what transportation they use. What should also be a priority – to look for buildings in green surrounding areas, where parking a car is not an issue and where public transport is available. Also, the priority locations shouldn’t be the ones where people can walk to work, but those where it is comfortable to live. Because you need to think about your property as a long term investment. And nobody can guarantee that after 5 years the situation with jobs will be the same in this particular area. It is much more important that employees can reach their desired workplace with various public transport options.
But let’s say, that for these two objects the microlocation the investor is looking at is quite similar. Then you need to think further and compare other factors.
…condition of the building
Please be aware: you can also look at the investment projects which doesn’t need major refurbishment. But even in these cases, there will be situations when some of the apartments will need to be refurbished at some point. That happens, for example, when tenants who have lived there for a long time decides to move out. For you to be able to find new tenants and rent it out for current market rates it needs to be in good condition and refurbished.
What to do if the renovation expenses for both properties are also comparable? Then you need to look at the average size of apartments in the building.
Let’s look at the two buildings which have similar price and size but one of them has apartments sized 60-70 sqm and second 34-40 sqm. From one point of view, renting out smaller apartments can be done for a higher price per sqm and you will get higher ROI. But, if the apartment condition is average or even bad, then you can have higher renovation expenses. The more apartments you have, the higher renovation costs might be.
It is worth to know that the costs for renovating smaller apartments and bigger apartments are quite similar. The highest costs will be for the kitchen and bathroom renovation but those exist in every apartment regardless of the size. Therefore, even if you gain a bit more money at the start from the rent, in a longer period of time as an investor you can even lose money on renovation costs. That’s why it is also important to analyze the tenant sheet before completing your property purchase.
You need to check how long the tenants have been living in the house. It will allow you to understand better what perspectives you have for increasing rental income and also to see what would be the approximate costs for the renovation in the future. If the tenants have a tendency to move in for a relatively short period of time, it means that apartments most likely are rented out for market prices. The thing is, that German legislation allows you to rent out for current market prices only to the new tenants. Your options of increasing current rental income for long term tenants are limited. That’s why your current rental income most likely is below market value. From the other side, if your tenants are moving out often, there is a reason for it and you should find out what it is.
Current rental rate
If your tenants have been living in the building for a long period of time it is a great indicator that location is good and in general, everything is good. However, most likely the current rental rate for the tenants who are living there for more than 10 years is much lower than the current rates on the market. That’s also the reason why they probably aren’t interested to move out and probably will live there for many more years. Because of this, the investor might miss a chance to bring rental rates to market level. However, for those investors who prefer stability in the building, it is more likely to be achieved by having long term tenants.
Even if the investor is planning to purchase a multi-family home with his own funds, the fact that the bank is willing to mortgage it gives a guarantee that the building is good. For example, if your annuity payment is approximately 50% of rental income the bank will values income from this building as a stable and substantial to cover mortgage payments. Of course, the bank is interested in receiving income as much as an investor does and do not want a troubled asset in its portfolio.
Let’s compare two multi-family homes. First is based in Saxony Anhalt and has 7.4% rental yield. This investment portfolio consists of 16 tenanted apartments in two separate buildings, located nearby city center of Dessau. The second is an investment portfolio of 9 apartments, located 15 minutes from Dresden city center with a rental yield of 5.8%.
Both locations can not be compared. Despite the fact that Dessau is quite a big city with a population over 100 thousand, it is still much smaller than the capital city of Saxony, with more than half of million population. However, the rental yield in Dessay is higher by 1.6%. The thing is, that Dresden is one of the main hot spots for German real estate market at the moment and it is highly expected that prices will continue to rise. That’s why every tenant movement will bring a price increase for your rental income in the future. So, which property should you choose? Fewer risks and more stability will be achieved with the property with a less rental yield. However, within the cycle of your investment period, the vacancies will happen but it might affect you a little less.
For the building with a higher rental yield, the fluctuation of your target income could be more possible. For example, tenants could move out more often, it may take more time to find new tenants or you may need to do refurbishment more often. That’s why the real question is – what are the investment objectives for the investor? If they want to buy and forget – they should purchase building with little less rental yield. If they prefer to maximize profitability as much as possible and exit in the mid-term, then they probably should choose the building with the higher rental yield at the start.
Every good investment starts with the right questions to define the long term strategy and personal objectives. No investment is the same and it should not be treated as one. Contact Investix if you would like to have a free consultation.