OPPORTUNITIES IN GERMANY
Calls for tighter rent controls on multi-family housing threaten value growth, writes Alex Catalano
German residential rents have been in the political spotlight this election year, with all major parties except the Free Democratic Party proposing new legal caps on rent rises. While rent controls are nothing new in Germany, the prospect of price controls on new lettings, which until now have been unfettered, is unsettling investors in the booming multi-family housing sector.
The German Civil Code already caps rents on existing tenancies at 20% over the Mietspiegel – the local market average – over a three-year period and they can only be increased once every 15 months.
Moreover, last December, the German parliament voted to allow state governments to limit rent rises to 15% in cities with tight housing markets. Berlin and Hamburg have both already introduced this lower cap.
There is little clarity about the further controls politicians propose, as they are not written into party election manifestos. But if verbal proposals become regulations, they would restrict rents on new lettings to 10% over the Mietspiegel in areas with “strained housing markets”. Initial rents in new buildings, however, would be excluded, so that new development is not jeopardised.
“This could potentially mean a decline in market rents and reduce the potential for portfolio valuation growth,” say Bart Gysens, head of property research and analyst Bianca Riemer of Morgan Stanley.
Andreas Matter, president of the German property federation, ZIA, adds: “These measures will restrict investment in existing buildings and block urgently needed housebuilding. Interfering with prices is always a misguided policy.”
Even new buildings’ exemption for initial rents will not help, the ZIA says. While the initial
letting can be at a free-market level, above the Mietspiegel, subsequent tenancies must conform to the Mietspielgel, raising the potential for rents to drop. This is unlikely to encourage investment in new building.
However, landlords can boost rents by modernising Germany’s outdated housing stock, in particular, improving energy efficiency and making it suitable for the elderly. The law allows them to pass on up to 11% of modernisation costs as rent rises, but the Mietspiegel rent cap still applies.
Gysens and Riemer say the combination of potential for rent hikes and availability of subsidised long-term financing at 1% make upgrading more profitable than acquisitions: “Modernisation can result in a 15% levered return on equity invested before potential valuation uplift, versus 9% for acquisitions.”
Deutsche Annington, for example, plans to spend €800m in the next five years upgrading its stock. But, as Morgan Stanley points out, improving properties is more complicated than acquisitions.
Investors chase rental growth
While funds piled into private rented hous- ing earlier this decade, seeing it as a play on rising values and owner-occupation, today’s investor enthusiasm for the sector is partly fuelled by its steady, if modest, income growth. Tighter rent controls risk jeopardising this and dampening values.
Forum Partners’ third private equity fund invested €40m in German housing firm Kompass. Forum co-founder Andrew Walker says: “There is a risk, and that’s one reason why we sold quite a lot; although it’s also best to take a profit, as we all learned in 2006-07.”
Kompass has bought and sold three portfolios in the past two years. The first involved gaining legal control of properties backing loans the company acquired before selling them to a public company.
The second was €39m of housing in Berlin and east Germany, acquired – unusually, he says – by buying a German bank’s loan. The third buy was a Düsseldorf portfolio, which Kompass bought from a Danish company.
Forum has doubled its initial investment in Kompass and continues to back the business. It recently paid €29m for a large refurbishment project that needs a further €20m of investment.
“In the long term, given the absolute price of German residential and strength of Germany’s economy vis-a-vis the Eurozone, the sector is still a good place to invest,” says Walker.
Local authorities’ rental mirror reflects going rate for housing
The Mietspiegel, produced by major German local authorities, documents average rent levels on existing tenancies in a city. The location, age, size and usually the quality of the property are taken into account; Berlin’s Mietspiegel, for example, shows about 100 different possibilities.
The data is compiled through surveys of tenants and landlords. The latest Berlin Mietspiegel, released this May, showed an average 3.1% rise in 2012, a slowdown from the previous year’s increases.
However, rent rises for new lettings have outpaced the Mietspiegel. A recent study by DIW-Berlin of asking rents on new lettings in 25 German cities found average growth of 1.5% annually between 2007 and 2012.
But this masks wide variations; in Berlin and Hamburg, rents have been powering ahead, at 4.3% and 3.7% annual rises respectively, while in Leipzig they rose at 0.5% annually.