Important factors to consider when purchasing a rental property

Especially for first-time investors, choosing the first investment property can be difficult, especially when comparing two properties with similar prices, locations, and returns on investment. So, what should be the decisive factor when deciding which offer to buy? Our expert team has compiled some important points that every investor should consider when buying a rental property in Germany.

Location

As a rule of thumb: When an investor looks at different locations, the most common phenomenon we observe is that they often follow their gut feeling. Most international investors are typically inclined to buy a property in a city they’ve at least heard of, and this is an impulse that we find difficult to combat. In comparison, for German investors, personal knowledge of the area or its fame does not play such a significant role.

Germany is vast, and its regions are very diverse. Saying that western Germany is economically more advanced and therefore a better investment than eastern Germany is not correct. It is much more important to look for meaningful investments, because even in North Rhine-Westphalia, an economically very strong region, one can make the wrong choice when selecting a city or a building. In contrast, you might make the right choice in Saxony and buy a property that will be 30% more expensive in a few years.

It is very insightful to analyze the population of a city and area to see where most people work, where they buy their food, and what transportation they use. Another priority should be searching for properties in green environments, where parking is not an issue and public transport is available. Moreover, priority locations should not be those where people can go to work, but rather those where the living climate is right. Because you have to think of your property as a long-term investment. And no one can guarantee that the employment situation in this area will remain the same after 5 years. What’s more important is that employees can reach their desired workplace with various public transportation options.

But let’s assume that for two properties, the micro-location that the investor focuses on is quite similar. Then you need to think further and compare other factors.

Condition of the Building

Please note: You can also look at investment projects that do not require major renovations. But even in these cases, there will be situations where some of the apartments will eventually need renovation. This happens, for example, when tenants who have lived there for a long time decide to move out. In order to attract new tenants and rent at current market prices, the property must be in good condition and renovated.

What happens if the renovation costs for both properties are also comparable? In this case, you should look at the average size of the apartments in the building.

Apartment Sizes

An example would be two buildings with similar price and size, one with apartments of 60-70 m² and the other with 34-40 m². Smaller apartments can sometimes be rented at a higher price per square meter, and you will achieve a higher return on investment. However, if the condition of the apartment is average or even poor, higher renovation costs will arise. And the more apartments you have, the higher the renovation costs can be.

It’s important to know that renovation costs for smaller and larger apartments are similar. The highest costs are for renovating the kitchen and bathroom, but these exist in every apartment, regardless of size. Even if you generate a bit more capital at the beginning of the rental, you might lose money as an investor in the long term due to renovation costs. That’s why it is also important to analyze the tenant list before finalizing your property purchase.

Tenant Sheet

You need to check how long the tenants have been living in the building. This will help you better understand the perspectives for increasing rental income and also calculate the approximate renovation costs. If tenants have moved in relatively recently, it means the apartments are most likely rented at market prices. According to German law, you are only allowed to rent to new tenants at current market prices. Your options for increasing rent for long-term tenants are limited. Therefore, your current rental income is most likely below market value. On the other hand, if your tenants move out frequently, there is a reason for this, and you should find out what it is.

Current Rent Prices

If your tenants have been living in the building for a long time, this is a good indicator that the location is good and generally everything is fine. However, the current rent for tenants who have lived there for more than 10 years is most likely significantly lower than current market prices. This is also why they are probably not interested in moving out and will likely stay there for many more years. For this reason, the investor might miss the chance to bring rent prices up to market levels. However, for those investors who prefer stability in the building, it is more likely that this will be achieved through long-term tenants.

Liquidity

Even if the investor wants to buy a rental property with their own funds, the fact that the bank is willing to grant financing guarantees that the building is in excellent condition. For example, if your monthly payments account for about 50% of the rental income, the bank considers the earnings from this property to be stable and substantial enough to cover the financing. Of course, the bank is interested in earning profits, just as an investor is, and does not want problematic assets in its portfolio.

Profitability

Let’s compare two rental properties. The first one is located in Saxony-Anhalt and generates a rental yield of 7.4%. This property consists of 16 rental apartments in two separate buildings near downtown Dessau. The second property consists of 9 apartments, located 15 minutes from downtown Dresden, and has a rental yield of 5.8%.

Both locations cannot be compared directly. Despite the fact that Dessau is a fairly large city with over 100,000 inhabitants, it is still much smaller than the capital of Saxony, with more than half a million inhabitants. However, the rental yield in Dessau is 1.6% higher. The fact is that Dresden is currently one of the most important hotspots for the German real estate market, and prices are expected to continue rising. Therefore, any tenant movement in the future will bring a price increase for your rental income. So, which property should you choose? The property with the lower rental yield brings fewer risks and more stability. Although vacancies will occur during the investment cycle, they will burden you less.

For the property with the higher rental yield, the fluctuation in your target income is quite possible. For example, tenants may move out more frequently, it may take more time to find new tenants, or you may need to renovate more often. Therefore, the real question is: What are your investment goals as an investor? If you want to buy and relax, you should buy properties with slightly lower rental yields. If you prefer to maximize profitability as much as possible and exit the investment in the medium term, you should probably go for the property with the higher rental yield at the beginning.

Every good investment starts with the right questions that define long-term strategy and personal goals. No investment is the same and should not be treated as such. Contact Investix if you would like a free consultation.