Why buy-to-let is so attractive in Germany

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Dr. Christian Mulder

Jan 9, 2022
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Have you ever thought of buying a property to rent it out? If not – here's your chance to think about it. Germany has an unusually generous system for buy-to-let properties!

Special advantages of buy-to-let in Germany

  1. After ten years, you can sell a property that has been rented without any capital gains tax, unlike for example ETFs.

  2. You can deduct 2- 2.5 percent of the value of the building in addition to your mortgage interest and maintenance costs from your rental income before you pay income tax !

  3. Banks give you great terms: Interest rates and repayment terms are very similar to German self-use home buyers – these favorable conditions are not available to people that do not live or pay tax in Germany.   

In an international context, these generous conditions are unheard of. Typically, mortgages need to be repaid in 20 years and the interest rates are several percentage points higher for investors. Nearly everywhere, the capital gains are taxable, and rarely can build-up costs be depreciated.

As a result, investing in rental houses can be as attractive as buying one for your own use in Germany. The return on your the capital you invested investment (IRR) is under reasonable assumptions about 12% in the first 10-15 yers.

The assumptions are 95% Loan to Value ratio, a rental yield of 3%, annual rent and price gains of 3%, 11.5% purchase costs etc. Of course you run risk on the capital invested, but these are very attractive returns also compared to a stock based index where you have gross returns of 6-8 percent (net as low as 4.5 to 6%) and need long holding periods to avoid the risk of loss of capital.

You can also use our rent-or-buy calculator to calculate a typical annual return in the range of 5 percent of the home price if you hold a property for ten years.

Sample calculation annual return buy-to-let

The total return for a relatively conservative appreciation of 3 percent is hence 4 to 5.5 percent. For more information on the increase in value, please see our detailed report on German house prices.

This is of course a simplified calculation – our customers can get a detailed spreadsheet to calculate their returns and check the cash flows under different scenarios. The simple calculation above ignores:

  • Purchase costs: They can range from 5.5 to 12.25 percent. They need to be amortized over the holding period. For example, a purchase fee of 5.5 percent reduces return by about 0.55 percent if the holding period is ten years.

  • Taxation

  • Compounding: Over time, all items, except the interest rate, will grow, adding to the return.

  • Interest rate risk: After the end of the fixed interest rate period, interest rates will change.

  • Leverage: The return on the money you actually put in is higher.

Discover your mortgage options with our German mortgage calculator

Leverage is a key consideration when buying-to-let in Germany

Indeed, as an investor, leverage is a key consideration. Take the following example: If you spend only 20 percent of your own money on a house with additional purchase costs of 10 percent, and borrow the remainder (90 percent), your return is much higher.

A quick calculation

Say your average return is 5,000 euros on a house of 100,000 euros. Since you have put in only 20,000 euros of your own money, your rate of return is 5,000/20,000 = 25 percent. 

Over time, as you pay off your loan and tax increases, this return goes down. We calculate compound rates of returns of about 12 percent for a ten-year holding period, declining to 8 percent for a 30-year holding period. 

This is still incredibly high. Of course, these are based on scenarios and there is risk involved. 

High return on investment

But the point here is that the returns are potentially very high. As house prices rarely decline in nominal terms, your rental yield is already so much higher than the interest you pay, the investment tends to be relatively safe. In Germany, buy-to-let is hence a very attractive investment option.

No wonder, many people in Germany use buy-to-let properties to supplement their retirement income. 

Tax advantages

In addition to the revenue from rental income, tax breaks also increase the return on investment. The tax authorities grant them in the form of depreciation for use ("Absetzung für Abnutzung", short: AfA). With this building depreciation, owners can claim the acquisition and production costs of their property against tax.

For houses built from 1925 onwards, you can depreciate 2 percent per year. For houses built before the depreciation, it’s 2.5 percent. There are limits on the costs per square meter you can deduct. 

You can only deduct the cost of the building. I.e. the purchase value plus renovation cost minus the value of the land. The land cost is usually determined based on local community land value tables. In the public Boris.de database, you can find indicative values.

Historic returns on house prices

The Federal Reserve Bank of San Francisco paper “The Rate of Return on Everything, 1870 - 2015” calculates historic returns on house prices in Germany as 7.82 percent – based on the longest available series.

Returns using longest possible sample for each asset

Find your ideal property to rent out with our Hypofriend property search

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Dr. Christian Mulder

Dr. Christian is a former Senior Economist and Manager at the IMF and World Bank. He is a Hypofriend Co-founder.

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