Is it worth investing in a rented apartment building?

Frankfurt. More and more Germans fear that they will receive too little pension in old age. They are therefore looking for other ways to secure their income in old age. An option that seems lucrative: renting out apartments in an apartment building.

The fact that many wealthy people and family offices have been investing in real estate for years seems to support the hope of a good return. But a survey by the owners' association Haus & Grund recently showed that many private landlords only cover costs or even make a loss on their properties.

So how lucrative is it actually to rent an apartment building in the current environment of rent regulation, high real estate prices and increased interest rates? Below are three sample calculations and one costly mistake buyers should avoid.

“The biggest mistake when buying a property as an investment is to make yourself the benchmark for evaluating the property,” says Jürgen Michael Schick, managing director of Schick Immobilien in Berlin and honorary president of the IVD real estate association. “If a man or woman asks themselves whether they would like to move there themselves, whether their children will move in there and whether they personally like the location, that is an expensive mistake.”

Because then the buyer chooses a neighborhood that is too expensive and a property that costs more than necessary. “As an investment, a simple to medium-sized house in a medium location is sufficient for a good return – you usually pay top prices for top locations,” says the professional.

“Many investors invest in prestige and aesthetics instead of paying attention to profitability,” warns real estate investor Gerald Hörhan, who calls himself an “investment punk.” Small, simple apartments in functional locations, on the other hand, offer exactly what is important: predictable rental income, solid demand and manageable risks.

“Buyers should ask themselves whether the location is right, the building is in good condition and the city has population growth in the future - but they should not make their own taste the criterion for the purchase decision,” advises Schick.

First-time buyers should also look for a property in a location that is not too far away from their private residence, says the real estate expert. “It helps if you know the area and have a feel for the city and its locations.” He recommends a maximum distance of 100 kilometers. In this way, interested parties minimized the risk of making a wrong decision when making a purchase.

With the help of the experts Schick and Hörhan, the Handelsblatt created three model calculations for the purchase of an apartment building and its subsequent rental. The theoretical house is located in a major German city away from the largest metropolises, the purchase price is one million euros, and the additional costs for notary, land register entry and broker amount to ten percent.

In the example calculation, the building generates an annual net rent of 44,000, 55,000 or 61,000 euros. This rental income reflects three different cost levels: In the first, the house to be rented out with all additional purchase costs costs 25 times the annual net rent, in the second this factor is 20, and in the third it is 18. The following text deals with the calculations for the factor 20, which, according to Schick, applies to most major German cities.

The landlord also has to cover maintenance and repair costs from the net rent. The calculation therefore assumes management costs of 11,000 euros in all scenarios, which cannot be passed on to the tenants. Possible increases in value from increasing rental income were not taken into account here, nor were special tax depreciations, as these only apply to new buildings.

Ten years were chosen as the observation period. After that, the property is not completely paid off, but after ten years the speculation period for real estate ends, which means that any profit from the sale is tax-free.

For the first calculation, it is assumed that the buyer brings around 200,000 euros of his own capital - so around 900,000 euros must be financed from outside sources. An annual interest charge of 3.5 percent and an annual repayment of 1.5 percent are assumed. The buyer has to pay 31,500 euros annually for the interest in the first ten years, and the repayment costs him another 13,500 euros. However, the latter goes into added value because he uses it to pay off the house.

In terms of income, he receives a net annual rent of 55,000 euros, from which 11,000 euros of costs that cannot be passed on to the tenants are deducted. This leaves a net profit of 44,000 euros on this calculation. If you now deduct the annual interest burden of 31,500 euros from the net income, the bottom line is a profit of 12,500 euros. In this calculation, the return on equity would be 6.25 percent.

If, from a conservative perspective, you also take into account the expenses for repayment of 13,500 euros, the landlord's expenses rise to 45,000 euros - which means that he actually pays more in the capital calculation in the first ten years. He still retains the value of his increasing shares in the property, but this may not be realized until a sale.

In the second model calculation, we assume an apartment building with a net annual rent of 55,000 euros for a purchase price of 1.1 million euros including additional purchase costs in a B city, the repayment is 1.5 percent and the interest burden is 3.5 percent. This time, however, the buyer brings 300,000 euros in equity and has to finance 800,000 euros with a loan. Once again, the bottom line in his annual accounts is a net profit of 44,000. Interest costs of 28,000 euros must now be deducted from this, leaving a bottom line profit of 16,000 euros. In this calculation, the return on equity would be 5.33 percent.

However, if you take into account the costs of repayment in a conservative calculation, another 12,000 euros are added. The bottom line is that of the 44,000 euros in net profit, around 4,000 euros would remain net in this capital statement - in addition to the investment in the property. This would equate to a cash flow yield of 1.33 percent.

In the third example calculation, we also assume that the apartment building is in a B location, the costs including additional costs are 1.1 million euros, and the repayment and interest rate remain at 1.5 and 3.5 percent respectively. This time we are assuming that the buyer has around 400,000 euros in equity. A loan of 700,000 euros would be needed to finance the property. If this calculation again assumes a net annual rent of 55,000 euros and a net profit of 44,000 euros per year, this time interest costs of 24,500 euros must be assumed. This leaves the buyer with a bottom line profit of 19,500 euros per year. In this calculation, the return on equity would be 4.9 percent.

However, if you deduct the repayment costs here, you will have to add an additional expense of 10,500 euros. If you remove this sum from the bill, you end up with around 9,000 euros. The cash flow return would be around 2.25 percent.

“The amount of equity is an important lever,” says Jürgen Michael Schick. The more equity the buyer uses, the lower the return on equity will be when looking at the interest burden alone. In addition, high equity reduces the buyer's risk. “So anyone who invests their money in an apartment building has to consider whether they would rather make it safer or whether they would rather optimize the return,” says Schick.

“Most Germans have overly optimistic ideas about the overall return on real estate and equally unrealistic ideas about the actual risk,” warns author and asset manager Gerd Kommer. “In the long term, real returns of two percent to 3.5 percent per year after taxes and costs can be expected for real estate that is not financed by loans,” says Kommer. If a loan has to be serviced at the same time, the return will be even lower. “Returns such as those achieved in the ‘golden German residential real estate era’ from 2012 to 2021 are not representative of the long-term past and probably not of the long-term future either.”