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Real estate as an investment

In times of extremely low or even negative interest rates, the idea of investing one’s savings in real estate is evident. Basically, we should distinguish between two cases: the investment in an owner-occupied residential property and the investment in an investment property used by others.

Real estate as an investment

The former makes perfect sense if you want to achieve a certain degree of financial independence and fulfil your wishes and ideas when it comes to living. Below, we would like to take a closer look at the second case: the investment in a property used by a third party, i.e. rented out, with the aim of generating a return. The real estate returns must always be seen against the background of the investment alternatives and the respective funding conditions.

The corona crisis has continued to push the real estate markets

But what to do when the interest rate turnaround is just ahead?

Its cash flow is the same as a regular government bond with regular coupon payments and repayment of the total amount at maturity. In this case, however, the coupon and redemption amounts are tied to the inflation rate based on an index. Most inflation-indexed bonds guarantee at least 100 % repayment of capital at maturity, protecting investors from prolonged periods of deflation.

Anyone interested in a property as an investment often receives a model calculation or at least an indication of the expected return from the sellers and project developers. The forecasts by property sellers are realised only if the value of the property and the rent increase significantly until the property is sold again and the maintenance costs remain low. However, these assumptions are often very optimistic, especially if interest rates rise again from their current low.

Source: Baufi24 Baufinanzierung AG (adapted)

Private Altersvorsorge - Rentenrechner
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An experienced asset manager can provide much helpful advice in this respect.

What factors are important when investing in real estate?

The following is a list of the most critical issues that determine the success of a real estate investment.
Purchase price
How high is the property’s purchase price in relation to the achievable annual cold rent? Is this a typical ratio for the location? A property that costs less than twenty times the net yearly rent can be considered a bargain. A factor of 25 is quite common. In many sought-after locations, however, prices of 30 times and more are often found, which can be considered expensive.
Incidental costs of purchase
How much are land transfer tax, notary fees and estate agent commission for the property? Often the ancillary costs amount to another ten or more per cent of the net purchase price.
Economic lifetime
Over what period of time should the investment be calculated? The longer, the more advantageous. What expectations are there as to how the property location might develop? When and how should the investment be completed?
Rental income
What net rent per square foot can be expected? Is this rent achievable in the location for comparable properties? Who will take care of re-letting if tenants give notice and the property is vacant?
Management costs
How high are the management costs for the property? What is the scope of the mandate for the property manager?
Purchase price
How high is the property’s purchase price in relation to the achievable annual cold rent? Is this a typical ratio for the location? A property that costs less than twenty times the net yearly rent can be considered a bargain. A factor of 25 is quite common. In many sought-after locations, however, prices of 30 times and more are often found, which can be considered expensive.
Maintenance expenses
What communal maintenance expenses are foreseeable? How high is the housekeeping fee? In addition, what amount should be set aside for repairs and modernisation of the property?
Taxes
How is the land and building divided up for tax purposes? How high is the tax depreciation? What is the marginal tax rate of the respective investor?
Financing
How do the fixed interest rate for the planned financing and the economic lifetime of the property correlate? Will follow-up financing be needed after the fixed-interest period expires? How will interest rates develop over this period? What does a calculation and forecast of rents and hence returns look like if interest rates rise?
Resale
What factors are already influencing the development of the property’s value today? Are there foreseeable risks? Is it realistic to be able to resell the property at the same multiple (ratio of annual net rent to purchase price) as it was bought?

Independence and freedom through owner-occupied real estate as a financial investment

These basic considerations of return on investment are the same for all properties on offer, regardless of whether it is an ordinary condominium for rent or a holiday flat or flats in a retirement home or student residence or an entire apartment building. From the point of view of an asset manager who has insight into the financial circumstances of many clients, it can be stated that an owner-occupied residential property naturally makes a lot of sense. Living rent-free and debt-free in retirement guarantees a high degree of freedom and extensive independence. The benefit of an owner-occupied property, i.e., a property for rent, is a little more complicated to assess. A property in a sought-after and up-and-coming location with rising rents and sales prices can be a lucrative investment. However, investors should be well aware of the high costs, the risks, and the difficulty and length of time it takes to sell the property again.

Real estate is therefore a very long-term and cumbersome investment and often ties up a large part of a private investor’s capital.

Conclusion

It is necessary to compare the characteristics of the real estate investment with the advantages and disadvantages of alternative asset classes and adjust them to one’s circumstances and needs.

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