Should I rent or buy a property in Germany?

Outcome: Buying a property 340.000 € today would increase your wealth by 192.884 € over 15 years compared to renting. The graph below shows how long it will take to recover the purchase fees of 27.200 € given the property appreciation, interest rate fees, maintenance costs, and rental savings. Please note that we assume a 90 % loan-to-value and a 2,91 % mortgage interest rate.

The Net Worth Effect of Buying a Property

Let's see if buying makes sense to build wealth for you

You can see that buying can considerably improve your net worth or wealth. Why is that? First, the intuition underlying the main factors. The first effect on your net worth of buying is the difference between the interest rate you pay on your mortgage, let's say 2,91 %, the cost you pay for maintenance, which we put conservatively at 1 %, and the annual rent you save, which is typically about 4,24 % of the property price. With current interest rates, this first effect on your net worth is initially often slightly negative. This, however, is offset by the second effect, the appreciation of the property of about 3 % minus the interest you forgo on the money you invest in buying the property. Taking these numbers together, your net worth increases by some 3,33 % of your house price per year.

In the figure below, we use your inputs to make an accurate calculation of how the first effect, the interest, and maintenance cost of buying evolve compared to the cost of renting. You can see how, over time, renting becomes much more expensive as rents keep going up while the interest paid on your mortgage goes down. After 10 years, you pay 1,96 % of your purchase price more in rent than you would pay in interest and maintenance when buying.

Comparing the annual cost of buying vs. renting

In the figure above, we scale the expenses with the original purchase price, so you can see quickly how a change in the interest rates or the initial rental rate, the rent divided by the property price, changes the outcome.

In addition to these expenses, you also need to take into account other effects on your wealth: property appreciation and the interest you would earn on your savings if you do not buy a property.

You can see below that these other wealth effects tend to favor buying strongly. Property appreciation becomes more important over time as the price increase compounds; 3 % appreciation in 10 years yields you a much higher euro amount than now.

Only when you assume a very high rate of return on your savings will the wealth effect be negative. Keep in mind, though, that your savings are subject to tax, and you need to use the after-tax return. Also, few people invest all their savings in ETFs or good ETFs. Finally, ETFs have short-term volatility. So, you need to use a realistic interest rate to make a good comparison.

The other wealth effects of buying vs. renting

Taking it all together, the next figure shows you not only what happens to your net worth as a buyer but also your net worth as a renter. You will see that over time, buying is much more attractive.

The overall effect of buying vs. renting on your net worth

The tables below show you the results year by year in €—first the cost factors and then the net worth.

Table 1 Cost comparison

Table 2 Other wealth effects and overall net worth

Get started to see what makes sense for you

How to factor in upfront purchase costs?

Buying a house involves quite a few upfront costs. In Germany, these upfront costs are high. Real estate agent fees can be as high as 3,57 %, notary fees 2 %, and taxes on the purchase can be up to 6,5 %. In the first figure above, these upfront costs are shown as an immediately lower net worth for the buyer.

If you decide to sell the day after buying, you will not be able to recoup these costs. It is money gone. It thus follows that if you decide to stay for a short period, it is only worth it to buy a house if you plan to rent out your house after you leave. Above, we refer to the period you need to recoup your upfront costs as the break-even period. This is the minimum stay needed to make it financially worthwhile to buy.

TIP: It also follows that if you would rather not stay for a long period, you are better off with properties with no real-estate agent fees, such as newly built properties.

Break-even

Does buying make sense from a monthly payment perspective?

Even if it makes sense from a wealth-building perspective, you also have to be able to live a decent life and afford the house every month.

With interest rates now higher again, your cash flow when buying a house is worse than when renting. You need to think of this as forced savings, though. The mortgage repayment is a savings. It also earns you more, as interest rates on mortgages are higher. You can seek a mortgage with a lower repayment rate or scale down your house ambitions. Given the high fixed cost of purchasing a house, we would still advise you to be ambitious in terms of your purchase so you don't feel the need to move in 5 years.

Compared to most periods in history, interest rates are still quite low. In most periods, the biggest obstacle to purchasing a house was the high monthly payments in the beginning periods. Only over time would the payments, relative to their income, come down as their salaries increased, and mortgage payments stayed the same so that people could take a breather.

A deeper dive into two of the key assumptions

1. The expected house price increase

One of the main benefits of buying a house is the expected long-term appreciation. The wonderful thing is that it compounds. This means that the appreciation in the second year also applies to the house price gain you had in the first year. In the third year, it applies to the appreciation of the second and the first year, and so on. Over time, this adds up, and it shows in the house value that the net worth graph is curving up in the outer years (see above).

There is a lot of evidence that house prices appreciate over the long term but that the appreciation is just 1,0–2,0 % percent over inflation, i.e., 3,0–4,0 % percent in nominal terms given the current ECB (European Central Bank) inflation target of keeping inflation under 2,0 %. Indeed, there is no guarantee that house prices always increase. After a period of excessive increases, they may go down, but this is rare and occurs mainly in a deep and prolonged recession when people lose their jobs and are forced to sell. But there are also periods where house prices increase much quicker. When the population and jobs expand, for example, low interest rates make houses affordable. This has been the case in many cities in Germany in recent years, like Berlin.

Two very practical indicators can help guide you to make price expectations:

1. House price trends tend to be sticky. That means if prices go up, they tend to go up further. If the increase is decelerating and prices are well above the long-term trend, this may be an indication that prices may start stalling.

2. For prices to decline, this usually requires forced house sales, notably because people lose their jobs and cannot find new ones. This can occur in an economic depression, i.e., a deep and prolonged recession.

2. The interest rate on the mortgage

Interest expenses are the main expenses for owning a home. They tend to be much and much larger than maintenance expenditure, even on older homes.

While interest rates are up compared to the extreme lows experienced in 2020-21, they are, fortunately, still modest from a broader historical perspective. Interest rates that apply do vary, and indeed, you need to check which interest rate would apply to you and what repayment rates you can choose from: you can do that using Hypofriend’s intelligent mortgage recommendation tools.

Importantly, your interest expenditure on your house declines over time, in contrast to your payments if you rent. Your interest payments go down as you pay off more and more of your mortgage. With a repayment rate of 3 % (which corresponds to repaying your mortgage in about 30 years), your interests are down about 30 % after 10 years. In contrast, your rental payments might be up 30 % — 40 % over that period. This is also one of the main factors why homeowners in Germany (and many other countries) are much better off.

It is important, though, to take into account so-called interest rate risk, the risk that interest rates move higher and you are confronted with much higher rates at a later date when you need to refinance your mortgage. The good thing is that Hypofriend advises you on the optimal period to fix your interest rate to make sure that the risk is manageable and optimal from your perspective. We designed tools specifically for that purpose.

What if you currently pay a very low rent

In this case, buying a property for yourself may make little sense. But you should consider buying a property to rent out. The results are very similar to buying yourself and then paying a high rent. The reason is that from a tax and financing perspective, properties that you rent out are treated very similarly in Germany to those that you own. So if you pay low rent and like your place, you might as well stay put and instead buy a property that you rent out at market prices.

In this way, you are:

• Hedged in case your rental contract is canceled

• And you make your money work hard for you.

What if you buy a much bigger house?

That may be a beautiful idea to buy a nice property. But how do you factor that into the financial comparison above? It is very simple: instead of putting in your current rent, put in the rent that the large apartment or house would command. Then, the results reflect the two alternatives you are facing: buying a property or renting one that gives you equivalent pleasure.

What about my alternative investments?

In the calculator above, you best fill in a realistic assessment of your average return. We think that 3 % after cost and taxes is realistic for most people who like to invest some of their assets in ETFs. We estimate a long-term yield before cost and tax of the world stock index (the MSCI World) of about 6 %. For Pensionfriend, we aim for 8 %. However, most people don't fully invest, and many people incur much higher costs and go for suboptimal portfolios or instruments.

Moreover, we think that most people will not fully invest their money in stocks when they don't own a home and have responsibilities like a family. If you do and are firm about remaining invested, you could reflect this by using a higher number.

If you are an optimal investor, we will counsel you to consider the best strategy of all: buy a property and don't fully pay off the mortgage, but cash out when you can (e.g., when the loan-to-value ratio drops to 60 %) and then invest that money. We also advise using your assets as collateral when buying a home instead of selling them.

Then, you benefit from the appreciation of house prices and the appreciation of the stock market. This is the strategy that I have followed myself to the extent I could — but I had a very solid public sector job, giving me a lot of job security and hence allowing me to take quite a bit of risk in my investments.

Particularly when you pick the right home with significant appreciation, this strategy allows you to gain net worth at a higher pace than just investing all your money in stocks. Unless, of course, you are a stock-picking genius, but less so when it comes to finding value when buying property. ;)

The emotional factors

There is much more than financial considerations that drive us. Houses and their ownership bring with it many emotional considerations. Some people don't like the responsibility of owning a house, including for repairs, others like the freedom ownership gives: more choice of house, and the much greater ability to adapt the house to your wishes. Some people are worried about the financial risks that homeownership brings with it. Yet other people focus on the fact that owning a house is like making a relatively safe, leveraged bet that typically leads to much greater financial freedom over time. In the end, you own your home and live rent-free, and thus far more secure.

Related Advice

The evidence for Germany is that most renters put their money in bank accounts that earn next to nothing. As a result, there is quite a divide in wealth between homeowners and renters in Germany. Renters don't benefit from appreciating house prices, nor from high returns on investment on their money. If you choose to rent, we do advise you to strongly consider better investments than bank accounts. There are investment vehicles that allow you to invest in real estate and stocks in a well-balanced manner and, over time, should earn you significantly more than bank accounts.

Finally, if your job requires you to be mobile and move from town to town, ensure you are adequately compensated for the extra cost renting brings with it in the long run.