Identifying ‘hidden champions’ in German residential
Among the ‘hidden champions’ for residential investment in Germany are Bonn, Fulda, and the Volkswagen city of Wolfsburg, along with Braunschweig, Lübeck and Koblenz, according to the latest Risk-Return Ranking 2015 published by property adviser Dr. Lübke & Kelber.
The Frankfurt-based Dr. Lübke & Kelber has produced an even bigger study than its inaugural edition last year, this time analysing 110 cities across Germany for their relative attractiveness as an investment location compared with their risk profile.
The comprehensive study weighs up each city, accounting for population, social and economic aspects, the housing market structure, levels of rent and purchase prices, and demand and supply factors. The study, which includes Germany Big Seven cities, then uses a proprietary measure to assign a score to each city based on a combination of the above factors and the risk associated with an investment in the location.
According to Ulrich Jacke, CEO of Dr. Lübke & Kelber, “The goal of the study is to correctly describe the location risk to investors. Only then is it possible to say what return has to be achieved in order to be sure that the location risk has been adequately priced in.”
Big cities such as Frankfurt (risk premium 0.6%) and Munich (0.4%) did indeed score highly, with a low location risk factor, along with Regensburg (0.9%), Ingolstadt (1.0%), Hamburg (1.1%) and Stuttgart (1.1%) – all big cities where prices have surged in the past few years. Yet yields in these cities are relatively low, despite rock-bottom interest rates. For example, an investment in Munich with 40% equity and a loan at 1.85% still only produces an equity return of 4.95%, whereas in Greifswald or Gera, the yield return would be much higher – but at much higher risk.
Hence, Jacke cautions that investments in such low-risk locations, which are in high demand, often result in a disproportionate fall in yields. “The very short supply in these locations meets especially high demand, which lets prices rise and yields fall,” he said.
Jacke recommends that investors should look beyond A-cities into smaller locations. “Among the top ten cities in the risk ranking, five locations are not among the largest seven cities,” he said. Investors need to observe, however, that these markets are less liquid, investment tickets are smaller and access is more difficult, particularly for investments of €100m
The study divides the 110 cities into four categories depending on their risk score: A++, A+, A, and A-. The minimum return required for an investment in each location is then calculated and ranked against an agreed benchmark (including the risk-free 10-year government bond, plus state-dependent transaction costs) to highlight the most attractive locations. Depending on federal state, the risk-free spectrum ranges from 3.15% to 3.35%.
The study also points out how small-scale exit strategies involving many of the hidden champion locations, such as the sub-division of portfolios into smaller clusters for sale to several investors, can be used to positively influence yields. Spreading large investments in small tranches across a variety of B-cities with a good risk-return rating can prove a good diversification strategy, with strong upside potential.