Why the German residential sector remains one of our top investment picks

The German residential market has benefited from a long history of strong tenant demand. The German population grew by 3.5 million people over the last 10 years to approximately 84.7 million by the end of 2023, primarily stemming from net migration across Germany’s largest urban cities (Figure 1). At a micro level, international migration has been particularly strong in Berlin, given its thriving tech sector and ability to attract talent. Salaries remain competitive compared to London but living costs on average are considerably cheaper, up to 35% less in some instances including rent.²

Not all migration has been well received. A recent development has been an increase in the public uneasiness and apprehension toward irregular migration following an increase in the crime rate in several cities. This has pressured the German government to reinstate border controls in its nine neighborhoods.³

Figure 1: Population growth components, 2017-2022 combined totals in 000s

The supply-demand imbalance has increased because of limited supply and vacancy now below 1% in most major German markets. Although historically Berlin has had a higher vacancy rate than other German cities, its burgeoning tech sector and rapid pace population growth in the last decade have resulted in a closing of this gap as seen in Figure 2.

Considering the soaring construction costs and financing pressures we’ve seen in recent years, we expect the future development pipeline to remain anemic and below the government’s target of delivering 400,000 new homes annually.⁴ This is further reinforced by the fall in residential building permit approvals in 2024, as seen in Figure 3. We expect this structural undersupply of residential stock to continue in the medium term. Our most recent House View shows that in Germany, residential is forecasted to have the highest rental growth over the next five years, at 3.6% per annum, which is around 50 bps higher than the European average rental growth forecast.

Figure 2: Housing vacancy in German cities

Figure 3: German housing permits (number, 000s)

The appeal of Germany’s rental market is often underpinned by its sheer size and scale, supported by the historical precedence of renting over homeownership as well as a broadly consistent regulatory framework. Looking across Europe, most countries including France and the U.K. have owner-occupied tenures which dominate the residential market, whereas Germany’s rental sector accounts for the highest percentage in the EU at more than half of all tenure types, as illustrated in Figure 4. Rental residential is more culturally accepted in Germany, providing a consistently deep pool of tenants, which leads to stronger rental growth resilience.

Higher transfer taxes on buying homes (ranging from 3.5%-6.5%),⁵ as well as the absence of mortgage interest tax deductions for owner-occupiers, makes homeownership increasingly costly and less intuitive for many in Germany. This is especially true when compared to other markets like the U.K. which provides tax incentives to first time buyers.⁶

Long-term rental contracts with lease terms averaging 11 years⁷ and strong tenant protections also make renting more attractive, providing greater housing security to tenants. Lease terms are significantly longer in Germany than in the U.K. with lease terms averaging 2.5 years, or Norway and France averaging three years,⁸ leaving tenants with more limited rights due to shorter tenancies.

For German landlords, this can prove relatively attractive, with longer leases and lower churn rates providing much more reliable income growth, while lowering operating costs and leakage. Rental housing ownership in the top seven submarkets in Germany is dominated by private individuals (Figure 5), whereas in major cities like Berlin, Dusseldorf, Frankfurt and Munich private company ownership also accounts for a significant share at 17%-25%, reflecting a popularity amongst larger investors.

Figure 4: European markets: share of households in different tenure types

Figure 5: German markets: rental housing units by ownership type

Regulation and government policy often plays a pivotal role when it comes to the residential sector. In Germany, legislation is broadly supportive of tenant rights, but the regulatory framework typically allows holders of new building stock (post 2014) to better capture market rental growth. Given short-term government political uncertainty, it is still uncertain whether a nationwide extension of rent-brake law (Mietpreisbremse) will be finalized. The law was due to expire in 2025 but could be extended until 2029 and stipulates that a landlord is not permitted to charge more than 10% above the local market comparative rent in a tight housing market. This has generally helped to ensure housing is affordable for tenants and provides a more stable rent profile for long-term institutional investors. With this regulation in place, rent in Germany (particularly in older apartments) remains relatively low when compared to other major European economies at 25%, with the average rent-to-income ratio in London and Paris being around 40% for example.⁹

Even with these regulatory measures in place, prime rental growth across the major cities in Germany has been historically robust. Looking at the average annual prime rental growth over the last five years, Germany compares well against other European markets such as the U.K. which is less regulated or markets like Sweden which are very highly regulated. Berlin recorded rent growth of 9.2% p.a., Stockholm 5.1% p.a. and London 2.5% p.a. over the same time period (Figure 6).¹⁰ While future changes to the regulatory environment are always hard to predict due to evolving political cycles, as it stands, with rents still generally affordable versus other major European cities and supply still heavily restricted, German newly built apartments remain well-placed to capture market rent increases.

Figure 6: Five-year average annual prime rent change

In conclusion, despite the challenging macro environment Germany faces from stagnation woes, looming geopolitical risks and increasing trade disputes, we believe these are primarily cyclical issues rather than structural. The residential market has shown relative resistance to economic downturns by demonstrating less volatility, in part due to support from the country’s strong institutional framework and demand for rental housing. This stability, especially when compared to other European markets, places German residential as a preferred sector in our model portfolio, with long term rental growth potential.