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25 10 2018

Class B Cities Show Best Risk-to-Reward Ratio

For residential real estate investors with focus on robust returns on equity, it generally recommends itself still to opt for the so-called “ABBA” strategy, which encourages investments in the Grade B locations of Class A cities, and inversely in Grade A locations of Class B cities. This is the outcome of the latest Risk-Return Ranking by Dr. Lübke & Kelber GmbH, an asset management consultancy firm specialising in residential real estate.1 The survey found positive risk-return ratios in all of Germany’s “Big Seven” cities, especially in the Grade B locations. The same is true for most of the other major German cities, and here includes both Grade A and Grade B locations.

The findings reaffirm a trend that has emerged in recent years. While the selling prices—and with them the returns—are flatlining in the Big Seven cities except for modest gains, the Class B cities are catching up, some of them very quickly. Thus, the ranking also permits the conclusion that the rental upside potential for existing properties in the metropolises continues to decline because of the high rent load ratios.

Munich and Potsdam the Cities with the Lowest Risk

For the purposes of their ranking, Dr. Lübke & Kelber gathered data on demographics, socio-economic conditions, the housing market and the current rents and selling prices in 111 German cities. The survey uses this data basis to determine, for each city, the difference between the potentially achievable return on equity and a recommended minimum rate of return. This in turn is determined by adding the risk mark-up, which factors in local conditions, to the level of the risk-free interest rate that can be earned with German ten-year government bonds.

Fürth in Franconia is one of the most attractive and safest residential investment destinations in Germany. It made the Top 3 in no less than three categories of the Risk-Return Ranking. Located in the prospering metro area of Nuremberg, the city took the top spot in regard to existing, well-located properties, ahead of Lüneburg and Osnabrück. As far as new buildings go, Kempten in the alpine foothills offers the best conditions, followed by the cities of Fürth and Dresden.

The lowest risk was registered in the Bavarian state capital, which remains Germany’s most expensive city. Aside from Munich, the risk associated with residential investments is also very low in Potsdam at just 0.28 percentage points, compared to 0.1 percentage point in Munich.

Leipzig and Dresden Present Great Yield Opportunities in the New-Build Segment

Even some of the East German cities report sound risk-return ratios, particularly in their new-build segments. Two cities in Saxony, Dresden and Leipzig, kept returning stable growth in sales prices in recent years and made it into the Top 6 of the ranking. A synopsis of the rankings reveals opportunities for tidy returns on equity in almost all of the examined cities, in some of them actually well above three percent.

Since the interest environment is unlikely to change in the near future, investments in the wider German housing market remain a paying proposition. The high number of Bavarian cities in the top spots of the rankings is also explained by the low real estate transfer tax rate of 3.5 percent, a fact that highlights the influence of policy decisions on the attractiveness of investments. By converse argument, some of the measures planned by the governing Grand Coalition—such as the tightening of the rent freeze, the extension of the reference period for rent index surveys and the historic district protection—harbour the risk of diminishing the return potential across Germany in the future.

1 www.spiegel.de/wirtschaft/unternehmen/kaufen-oder-mieten-was-ist-wo-guenstiger-a-1231213.html