2.3 | The one where we are perfectly happy with second best
Your Mom, your best friend or an Insta post have probably told you to “never settle for second best” at some point or another. But what if the b-option actually was the best thing to happen to you?
It’s the week of Valentine’s Day, my lovelies, and whether you care or not, whether your day has include roses or something heart-shaped or at least an insane onslaught of the color red, no matter where you look … chances are you have not been able to escape this hellish invention of the Romans / a Christian patron saint / the card-industry. So it’s quite fitting and a bit funny that we will talk about “things that are second best” today, just days after the holiday that very loudly celebrates “the one and only” and declares that really only the best and top choice will do, at least when it comes to love. In real estate, and that’s where we find ourselves cleanly picking up where we left off last week … in real estate, it’s more and more obvious that your top choice might actually not be available (which is where real estate is still VERY similar to matters of the heart) BUT (and this is a big and important but) - the second best might be just as good, if not better. Shocking. No wonder I enjoy real estate so much more than online dating.
Because Munich, Frankfurt and Berlin have become unattainable for the average private investor, most of us are finding ourselves looking at what’s known as B-cities. Places like Leipzig (which is still pretty big at 600k inhabitants) to Gütersloh (100k) which you certainly will have never heard of. You get the idea, I am not reaching for more dating analogies to avoid the risk of writing myself deep into a rabbit hole that I can’t get out of. Most B-cities are close to the bigger metropolises (like Bonn being close to Cologne or Essen close to Düsseldorf) but are considerably more affordable because they are, well, specifically NOT the big cities. And because I think it worked well last week - we are doing the same thing again. A few headlines, two examples and, most importantly, the takeaway of what it all means for our collective dating …um .. real estate adventure. Let’s get to it.
While the top locations always never allow to generate cash flow in the short to midterm as rents typically don’t cover the huge investment, the opposite is often true for property in B-citys. If all things go well (a big if, I know) rents will cover your mortgage, interest, ongoing costs as well as reserves for the unexpected. The fact that this was true for our investments in an A-city like Hamburg is a sign that the market really has changed I guess, and that we bought great places - but we are in theory-world right now … and theory obviously does not cover the lucky exceptions. Notice my use of “typically” and “often” :) And if you want more - we covered return and how to calculate it in more depth here
I totally understand that the above makes it sound like mid-sized cities are a no-brainer and done deal, which is why I am coming at you with this as well, just to balance things out: this segment of cities, just because they are so different from each other (yet clustered together) has the biggest delta in risk categorisation. Experts basically weigh different indicators (like average rents, unemployment levels and connectivity through public transport - and score cities from 10 (the safest possible investment) to 0 (pretty risky). While A-locations for obvious reasons score consistently high, B-cities are all over the map. You’ll find places like Nürnberg, Karlsruhe and Wiesbaden at an 8 (so close to the big contenders) but also have towns like Bochum and Duisburg scoring a measly 4 (the lowest in this particular ranking). So that’s definitely key to keep in mind - having such diversity lumped together in one group, kinda like star signs, means that you can’t make assumptions that prove to be true for everything (or everyone). If anything, these risk assessments are one more piece of information to consider as you make investment decisions. If you take them for gospel, you might miss out on hidden gems that will surprise you in their return / risk-ratio - just like dating a Libra would, even though you could swear that one twelfth of the human population just isn’t suitable for you based on star signs :)
Remember how we talked about the infamous “factor” and how it gets calculated (I know, feels like a lifetime ago) - just to illustrate the difference between last week’s cities and the ones we are talking about today … In a place like Munich, you would have to calculate a return factor of about 30, in B-cities that can drop well below 20 (and we remember, the smaller the factor the better the investment as it describes how long it will take for the average yearly rent to match the purchasing price). A multiplier at 20 equals a 5% annual return, at 30 that drops down to 3.33% on average. Quite the difference indeed
Lastly, if you are looking for a resource to help you with all that risk-assessing and detail-checking as you dive deeper into the glory that is / can be b-cities … Prognos might just be your go to thing. It was founded at the University of Basel and is one of the oldest economic research centres in Europe. Together with German financial publication Handelsblatt, they have developed the Prognos Zukunftsatlas (basically translated as “a map to or for the future”) which gets published every three years als offers a very granular view at Germany’s cities and counties. If you are serious about finding the sweet spot between bearable risk and good-enough returns in places that are not as overrun (yet) - this is where I’d start
What does this all look like in real life, you wonder? Well, like lovely Freiburg im Breisgau for example. One of Germany’s southernmost cities isn’t only blessed with the most sunny hours per year (more than 1700 if you want to dazzle someone with this random fun fact once parties return) - it also sports a well known university plus adjacent nightlife and cultural happenings, is surrounded by nature and close to neighbouring Switzerland and France if that’s your vibe. Renters pay an average of 13.66 Euro a square meter (one of the most expensive of the small university cities), allowing landlords to reap a return of 3.4% on average, which is the highest in this cluster, all with low risk factors. So low in fact that Freiburg is the one place in our b-locations that sidles up to the big cities like Stuttgart for example that has the same risk/reward-ratio. Remember what I said about those second best options? Not to say “I told you so” … but settling isn’t looking so shabby this Valentine’s Day, hu?
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Kassel maybe isn’t quite as idyllic but shall function as my second example: 200.000 inhabitants, also a university city and, most importantly for real estate purposes, no contender within a 50 mile radius as far as other cities are concerned. Just 100 km away you’ll find the VW headquarters, though, which obviously also is a plus. Average rent per square meter is 8.25 Euro - a fraction of that in Freiburg - and buying a square meter in an apartment will set you back 2710 Euro on average - a plus of 12.1% compared to the first half of 2020. Free standing family homes have increased in price even more.
So my main takeaway, I believe, is amply illustrated by these two examples: with moderate purchasing prices and decent rents, b-locations are, yes, we’ve been here, much more than just second best when it comes to real estate. They are super viable options, the marriage material of property so to speak, with immediate returns instead of the vague promise of happiness down the line. You want your honeymoon now, not in a decade. Who doesn’t. What might look super rosy at the beginning does have a few pitfalls, though, and they are worth considering.
There’s less liquidity in the real estate markets of smaller cities: if you are looking to sell a property down the line, there will always be demand in place like Munich. In Kassel, though, it might take a bit longer and you might also not be able to find tenants for every apartment just as quickly as you would in Hamburg
Secondly, these markets are less transparent, simply because less data, statistics and research are available, making comparisons more difficult
And lastly: while your purchasing costs might be lower than in larger cities, that does not apply to building and maintenance costs. If the heating is broken, a repair will be similarly expensive no matter how big the city it heats in (or doesn’t anymore). Since you will have less rental income in a b- or c-location, though, that simply means that a single issue can set you back much more severely
All that to say: with higher reward comes higher risk. Per usual. It’s true for love, dating and relationships and it is true here. So choose wisely and don’t just run off with the first prospect. Happy Valentine’s Day!
Next time, on Rente aus Stein: We are finishing off our look at German geography with more details on what we have dubbed bacon cities. Yep, you’ve heard that right, vegetarian me is going to look at this last meaty slice of German cities to invest in. Make sure to subscribe to not miss this!
Disclaimer: We are not lawyers (sadly) and as such can’t give you legal and/or tax advice. We are simply telling our story in the hope that it’s inspiring to you.