Development and redevelopment investments in Germany: ways, yields and risks
Development investments in Germany can generate euro-denominated yields of up to 10-15% per annum. For example, in August 2019, the deposit rate in Germany ran at 0.15% per annum, while rental apartments yielded 3-4%.
Development and redevelopment work increases the value of land plots and buildings – this includes the construction of new residences and renovation of existing properties. Banks usually lend 65-80% of the total funding to developers, while investors tend to contribute the rest.
Ways to participate in development projects
Investors can put their money into such projects in two ways:
- mezzanine financing: the investor gives a loan at a fixed rate and claims a share of the profit agreed in advance;
- equity partnership: a loan without a fixed return but the investor becomes a co-owner of the company and is entitled to future dividends.
|Mezzanine financing||Equity partnership|
|Average annual yield:||7-9%||9-12%|
Developers sometimes offer other options like simultaneous hybrid investment in mezzanine financing, equity partnership, or investment via crowdfunding platforms. The latter allows investors to put as little as €500 into a project
What affects the yield rate?
The yields of development investments depend on the risk: the higher it is, the greater the potential return. The level of risk is affected by three main factors:
- the type of participation;
- the type of project.
The type of participation. The developer first pays the debt to the bank, then to the mezzanine investors. The investors can then divide the profit between themselves and the company. A mezzanine loan is considered more reliable, being paid out earlier and at a fixed interest rate. The investors can be left a smaller amount than planned, which implies a higher risk.
Locations. In Germany, locations are classified into three categories: A, B, and C.
A locations are the seven largest and most economically stable cities: Berlin, Munich, Hamburg, Düsseldorf, Cologne, Frankfurt, and Stuttgart. The demand for property is high in these places so the return on development investments is usually lower. Overheated markets are also a disadvantage in these cities and drive up prices.
B-locations are suburbs of the largest cities with at least 60,000 residents: Augsburg, Nuremberg, and Potsdam, for example. These locations are developing quickly because many young families are leaving A-locations due to high living costs and expensive residential property.
C-locations are towns with populations below 60,000. This is where the projects with the highest potential returns play out, but there are also higher risks due to the limited market.
The type of project. The more complex the project realisation, the higher its potential return.
A list of project types (in order of complexity):
- dividing a home into apartments;
- a project after obtaining a permit;
- a project before obtaining a permit;
- urban development plan modification.
The amount of capital gains tax to be paid depends on the type of participation in development projects.
Mezzanine loan returns are exempt from tax in Germany. Foreign investors pay personal income tax in their countries. In Russia, the income tax rate is 13%.
Equity investors pay tax in Germany. The corporate income tax rate in Greece is 31%. Another 15% has to be paid on the dividend income.
The bank which has lent most of any given project’s funding will be the first to see a return.
Then the developer pays out the mezzanine loans and takes a share of the remaining amount together with the equity partners.
An example of how investors receive the profit.
Ainvestor becomes an equity partner on the condition that a share of the profit will be paid as a mezzanine loan return.
Tprofit is then divided equally between the developer and the investor:
- investment amount — €2M;
- term — 2 years;
- property return — €800,000;
- mezzanine loan return at 8% per annum — €320,000: €160,000 per annum;
- remaining €480,000 is divided into the halves of €240,000;
- total investor’s profit — €560,000 or 14% per annum before tax.
Risk and how to reduce it
There’s always a chance that those investing in German development projects may come up against issues including developers going bankrupt, over budgeting, payment delays, low liquidity, and so on. These risks can never be ruled out, however, almost all can be controlled and Tranio’s experts know how to.
The developer’s insolvency. When putting money into a project, the investor receives certain guarantees:
- recording the property on the land registry;
- receiving company stocks as security even if the investment was made as a mezzanine loan;
- personal guarantees by the developer which risks its reputation and may leave the industry if failing to implement them.
Financial model errors. These include over budgeting and commissioning/permit delays. Tranio signs fixed-priced contracts so if developers over spend, they are responsible for the remaining expenses and pay a penalty for the delay.
Difficulties in obtaining a bank loan. The financial model for each project is created in accordance with the bank’s requirements, so there is really nothing to worry about.
Low liquidity. Project realisation delays more often occur in C locations where the demand is lower than the supply. The solution is to invest in projects in A or B locations.
- Development investments yield up to 10–15% per annum.
- The two main ways to participate in a project are mezzanine loan with a fixed yield rate and an equity partnership when the investor becomes a co-owner of the company.
- The profitability depends on the type of participation, location and project complexity.
- The mezzanine loan return is exempt of taxes in Germany. Investors
- With a right approach to investing, the investment risks can be reduced but not eliminated completely.