The one in which we get pretty technical on the financials of "Mietenrendite"
Clearly, we are all looking for good investments. To understand the basics, we threw ourselves at the research and wrote it up nicely.
You know that feeling of quiet dread when you nod along to someone talking about something - while actually having no clue what is being discussed? It often goes hand in hand with the assumption that whatever is being talked about is basic knowledge, shared by ALL of humanity, making you ignorance on legs. The same legs that have now walked you to the point of no return at which you can’t possibly ever ask for clarification given that it would reveal you nodding as the charade it has been all along … Yeah.
Why do I know how to accurately describe this conundrum you ask … well, Mietrendite.
For a period longer than I care to admit, I actually did exactly that whenever a realtor (or my knowledgeable real estate friend) shared a property exposé with me. These documents list a return factor. That simple number, somehow the holy grail of real estate decisions, always did a simple number on me. I did what I had to do: smile and nod. Or in an ever bigger attempt at “pretend competency”: actually comment on the number by saying something smart but sufficiently vague. I had no clue. There. I said it.
My dilemma only improved when I finally remembered to google around a bit after one of those meetings. And since there wasn’t really a “dummy’s guide to Mietrendite”, well, I am writing it. You are welcome. As with most things assumed to be known to all mankind but you: not that hard to understand in the end. Phew.
Getting back to the factor. It basically describes how long it will take for the average yearly rent to match the purchasing price. Or put differently: It’s a simple calculation of the expected return, calculated by dividing the property purchase price through the yearly net cold rent. A recent exposé for an apartment in a central part of Berlin from last week for example pegged this number at 30.7. The smaller the factor, the better the investment.
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So far so good. But, as Germans say, paper is patient - which doesn’t really translate but certainly should, given the alliteration makes it an even better proverb in English. If you buy a property at a relatively cheap price and there are high monthly rents the factor would look great. What’s not considered, though, are investments and repairs that might be just around the corner. Which is a long way of saying: these numbers are a snapshot, most likely of the kind meant to impress you. It's on you to have a more realistic look at the risks involved. Kinda like in life I guess?
Several factors determine investment returns in real estate (and, surprise!, only the first two will make it into the “factor” that you are given).
Purchase price: It’s not just about the factor mentioned above, but more importantly about a comparison to what else is out there in a similar location. Assume that something like a factor 30 (and above) is likely what you’ll see in these crazy times in bigger German cities - and you want to look for the outliers.
Rental income per square meter: Realtors bending numbers to their own will? Yeah, this is where that seems to happen most often. Make sure you are being told the cold rent, if a place is already rented out - not the all inclusive rent. And if it isn’t, well, sellers still can’t pick just any number. As there’s rent control in many cities in Germany, it’s important to look into local regulations and, again, do a comparison. The price that underpins the model calculation: is it a dream or reality? Is it based on a more exotic business model? How likely is it that rents will rise?
Additional purchasing costs: Realistically, factoring in all these costs will affect your return, yet most model calculations completely gloss over additional purchasing costs. You will need a notary (who charges a fixed price based on transaction volume). There’s local differences in how much land tax will set you back. And depending on whether you worked with a realtor, they will want to be paid as well (meaning you save big bucks if you manage to buy directly from an owner or property developer).
Taxes: As discussed in one of the last editions, depreciation is dependent on how the purchasing price is split between land and building. Also worth looking into your tax brackets to avoid (unpleasant) surprises.
Mortgage conditions: Commonly, your interest rate is fixed for a certain period of time (which you get to determine). If you want to hold your investment beyond that, a follow-up financing might have very different conditions. Worth calculating how even a few percentage points in interest can totally change return calculations.
Operating costs: Will you need a property manager or out of the ordinary insurance policies? Realistically, costs might be much higher than what a model calculation is based on.
Maintenance and repairs: Setting aside money to cover maintenance and repairs is crucial, given that a new roof or heating system will get real expensive, real fast. There’s different formulas to calculate what’s needed but chances are banks and realtors are not necessarily on the conservative side on this one. Rule of thumb suggests setting aside 1% of the purchasing price per year as a prudent precaution - but even that might be eaten up faster than you can measure your thumb if you have purchased an older building.
Think you already need a crystal ball for all these drivers of financial return? Think again because you will need a several sizes larger future prediction device for this one: After all, one of the biggest levers in your return calculation is something that has little to nothing to do with the operational business of renting out apartments. Yes, I mean the long term property value. While you could say that your entire real estate investment is a bet on the future (as in: will this roof still be a fully functioning roof in nine and a half years despite severe storms?) - the real bet in the mid- to long term is whether (and how much) the value of your property changes if you decide to resell. Clearly, that question is decided by a multitude of factors, many of which might be little more than wild guesses. But long term property value development is a real consideration in your overall investment return, so it makes sense to think about how long you can and want to hold a property and what the tax implications of reselling it are going to be.
It’s important to remember, though, that financing the majority of a property (or even all of it) through a bank loan - which is what makes real estate as attainable right now - is a lever that still works both ways and the math is relatively simple. At the risk of stating something that’s super logical and clear: You get access to more capital through a bank loan. If you invest in real estate and your return is higher than the interest rate, having a bank provide the cash heightens your return, meaning you have a bigger lever (= more capital that can earn those returns for you). But it’s never as easy as it sounds and nothing is a “safe deal” with exactly zero risk. If the return, for whatever reason, falls below your interest rate, you are depreciating the return on your investment overall. You would have been better off not investing (or even getting that loan in the first place). Whether it’s your money or that of the bank: you shouldn’t lose it I guess. Thanks, Captain Obvious.
Now that we find ourselves at the sadly familiar crossroad of “it’s complicated” and “it depends” again … consider this a somewhat random roundup of links and resources that are interesting on the topic and definitely worth taking into account as you whip out that gigantic calculator:
In buying real estate, there’s the obvious risks that are hard to plan and calculate for - like the above mentioned repairs that can get costly or a tenant who’s behind on payments. New data shows that risk factors in your own life (like health emergencies or unemployment) contribute to loans defaulting much more, though, simply because “money is cheap” and the siren song of an easy mortgage entices people to be overly optimistic in their calculations - and Covid certainly won’t make that any better.
Speaking of that damned virus: Looks like the pandemic plays a role in rents falling for the first time again in 27 of the 50 most expensive cities in Germany. At the same time, property costs are rising steadily still, meaning that the delta between purchase price and net rental income is getting even wider, making it harder to find worthwhile property investments.
In less doom and gloom news: Those willing to invest in an older property in need of a bit of TLC have better chances at a higher return. Sounds obvious and has been officially confirmed, with numbers. Depending on how well you handle a hammer, this is a different kind of investment risk I guess.
And lastly, this tool (albeit in German) is pretty awesome to calculate a real estate budget with ALL the costs. Because if we have learned anything: a calculation that doesn’t include it all basically is no calculation but a pretty dream (alternatively, look up the German word Himmelfahrtskommando).
The main takeaways
So what, if anything, do we take away from this? Maybe the following:
While a real estate investment is seemingly easy to grasp - it remains a somewhat risky investment category. A crystal ball would make it much safer, but those are as hard to come by as that cheap dream house in Berlin Mitte.
Never trust a dreamy sounding return on investment figure that someone else promises when selling real estate. The glossy prospectus is a trap.
Since you have to do the math yourself anyway: don’t skip any of the costs when you do.
Now that the numbers might not look rosy anymore: no investment is still better than a bad investment. Sad but true.
Have I saved you a google or even better yet: the embarrassing nod and grin? No worries, friends, glad to be of service!
Next time, on Rente aus Stein: Are you overwhelmed with all the investment advice out there? Let’s look at all the option together ...
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We are not lawyers (sadly) and as such can’t give you legal and/or tax advise. We are simply telling our story in the hope that it’s inspiring to you.