Germany’s robust economic strength makes even its secondary cities look extremely attractive in economic terms, or so this essay argues. Especially the country’s decentralised structure with numerous economically dynamic high- and middle-order centres beyond the “Big Seven” cities creates attractive conditions for real estate investors. On top of that, the author argues, it pays to take a closer look at the often scorned cities of the Ruhr. Among these, Dortmund has made a name for itself as a fast-growing economic centre. “Motor towns” like Ingolstadt, Wolfsburg and Erfurt also offer great opportunities at the moment. Then again: Each location still requires in-depth analysis. Ed.

Residential real estate in Germany is sought by domestic and foreign investors alike. In analogy to the commercial real estate segment, the housing markets of cities beyond the metropolises offer investment opportunities with attractive risk-and-reward profiles, too. This is true even and especially in face of the historically high price level. Low interest rates, capital inflows and the extreme investment pressure this generates, on the one hand, coincide with Germany’s economic stability, attractive terms of financing, as well as the high and growing demand for housing in the country’s cities, on the other hand. The reasons that have caused the transaction volume on the German housing market to ascend to a record high are analogous to those in the commercial real estate segment.

The price trend for residential real estate is indeed impressive. And sometimes a point is best illustrated by taking a closer look at the figures: Over the past seven years, the ImmobilienScout 24 real estate portal identified an average price increase of around 70 percent for residential real estate in Germany. Prices were quickest to rise in the country’s “Big Seven” cities, these being Hamburg, Berlin, Munich, Düsseldorf, Cologne, Frankfurt am Main and Stuttgart. The square-metre price of a 3-bedroom new-build flat with medium-quality interior fit-out in Berlin, for instance, was just over 2,000 euros in 2007. Ten years on, buyers pay nearly twice as much for a comparable flat, the going rate being 3,900 euros.

The strong growth inevitably raises the question whether or not prices have grown faster than would seem reasonable, and whether or not we are looking at a speculative bubble on the German housing market. Observers keep comparing the situation with the US real estate market of the years 2006 and 2007 that triggered the global financial crisis.

Sustained Incoming Migration to the Cities

However, a look at the fundamentals on the German market reveals nothing that would qualify as serious cause for concern. For one thing, the price growth mirrors the strong and persistently growing demand for housing in the conurbations, which in turn is generated by the sustained incoming migration to the cities. Secondly, property investments are backed by much more equity capital today than used to be the case during the boom years before the onset of the financial crisis. And thirdly, the boom on the residential property market in Germany is supported by the dynamics of the national economy. For the past ten years, the German economy has been following an upward trend that was checked by a temporary dip in the wake of the financial crisis, if only for a short period of time.

The country’s economic clout and its diversified economic structure, which includes a robust mid-market sector, ensure stability even on the real estate market. Especially the country’s decentralised structure with numerous economically dynamic high- and middle-order centres beyond the “Big Seven” cities has proven a boon for real estate investors: After all, it presents the opportunity to reap attractive returns even in markets beyond the “Big Seven” whose risk position is at least as sound.

Yields Rates of over Eight Percent in Some Places

Yield rates on residential real estate investments are now down to 3.7 percent or even less in the “Big Seven” cities. By contrast, yields are nearly twice as high in cities like Duisburg, Halle, Magdeburg, Essen or Mönchengladbach at 6.8 percent, and are more than twice as high in Wuppertal (7.2 percent) and Chemnitz (8.2 percent).

It could, of course, be argued that the figures reflect the elevated risk – not least because names like Duisburg, Halle or similar evoke the spectre of shrinking cities combined with growing vacancies and difficult social structures. Which means more or less the opposite of what investors generally consider a stable and attractive investment location. But here, too, it pays to take a hard look. Because the idea of an ailing central region in Germany or of decaying steel and coal metropolises on Rhine and Ruhr is simply incorrect in its one-dimensionality. Dortmund, for one, a city in the Ruhr, has long established itself as a fast-growing economic centre. The city has an excellent infrastructure, lies at the heart of a conurbation of roughly ten million people, and attracts businesses.

Cities with a strong economic structure like Ingolstadt or Wolfsburg score even higher because they have benefited specifically from their position as automobile production centres in recent years. While the upheavals in the automobile sector or in any case the uncertain outlook of the German industry give rise to the question whether the advantages of these cities will turn into liabilities in the future, cities like Hanover maintain a clearly more diversified position.

Automotive and mechanical engineering counts among the industrial sectors traditionally strong in Hanover. As far as services go, the sectors of transportation, logistics, communication, tourism as well as convention and event management are registering tremendous growth. It is complemented by the city’s central location and sound transportation infrastructure, which enhance the local livability while boosting the economy.

Investors have become aware of Hanover’s potential, and prices are going up as a result. Depending on the fit-out and location, the going rate for residential real estate is anywhere between 2,080 and 2,690 euros per square metre. But property is still far more affordable here in the state capital of Lower Saxony than it is in Cologne or Stuttgart, for example.

Economic Structure as Decisive Factor

Another case in point would be Erfurt. While being the largest city and the state capital of Thuringia, it is also located in the German heartland, and developing rather handsomely. The economic focus is on mechanical and plant engineering, the media and creative industries, horticulture and the food industry. At the same time, Erfurt has established itself in a variety of technological fields. This December, the new ICE hub in Erfurt will commence operation. The high-speed railway service will cause travel times to Berlin, Munich, Frankfurt and Dresden to drop to less than two hours on average.

The improvement of infrastructure has encouraged plans and projects that seek to exploit the new opportunities and potential for Erfurt and Thuringia as a whole. This development is reflected even in the demographics: Beating forecasts that predicted a drop in population to 180,000 as recently as the turn of the millennium, Erfurt is now home to more than 210,000 residents, and the upward trend continues. For the time being, investors in residential real estate pay an average rate of 1,820 euros per square metre here, while the yield rate is currently at 4.3 percent.

Each City Calls for a Comprehensive Analysis

To sum up: There is no shortage in upside potential on Germany’s residential property market, even and especially outside the metropolises. That being said, even the currently fast-growing cities won’t be able to stave off indefinitely the demographic challenge Germany is facing. The demographic shift will radically change the country. In the long term, the BIB Federal Institute for Population Research expects the German population to drop by as many as 17 million before 2060. By contrast, forecasts that factor in an increase in incoming migration assume that the population total will drop by around eight million residents only.

According to a survey conducted by the Bertelsmann Foundation, regional demographics will differ starkly from one region to the next over the 15 years to come. There will be winners and losers, making it all the more important from an investor’s point of view to make the right investment decision on the basis of a thorough analysis of the long-term outlook. Meanwhile, it has become unlikely for investors to find a hidden gem among the ranks of Germany’s B and C Class cities that is still completely untapped. Properties in sought locations are in short supply and pricey even in these places. Unless the interest environment experiences a dramatic shift, the trend of recent years will continue. But if you are willing to go off the beaten track at least to some extent, and if you combine this approach with the indispensable know-how of the local conditions, you will be able to undertake investments in these places that are both attractive in the current market environment and will prove sustainably profitable in the long run.

The author

Nikolai Dëus-von Homeyer

Managing Partner, N A S Invest GmbH, Berlin