Unsound proposals of the mediators and finance houses for investors and owners are no rarity – in the last three decades approximately a Milliion of German citizens let themselves be sold a de facto junk real estate as an investment, above all for the age precaution.
It is true that very few of them are actually a case for the wrecking ball or the demolition expert, because they are dilapidated and unrentable. But the rule is apartments on social building level at often more than twice overpriced prices, for which unrealistic dream rents were promised. The risk of making a wrong decision is particularly high for a non-expert because, on average, you only buy a property once in your life. When buying a used car, almost every buyer is accompanied by a specialist or an experienced friend – when buying real estate, the help of experts is probably the exception rather than the rule.
The price of real estate depends to a large extent on the development of the local labour market. In addition, there is the so-called formation of bubbles, for example due to irrationally high demand or manipulated prices. It is therefore a sound rule to always have no less than around 50% of the purchase price available as equity. From the point of view of a sound lender, at least about one third of the value would be lost in a forced auction, whether because in a first auction date there is a minimum bid of 70% of the expertly determined value, and in a second auction date the minimum bid is only 50%. In addition, there are the costs of recovery, collection and arrears of interest and repayment.
Insurance companies and banks like to count on fixed interest income. Therefore, a popular trap is to provide the investor with a fixed-rate loan – grace-free with final maturity of the entire amount. Repayment is then to be made possible at a later date through speculation with shares or uncertain government securities or with life insurance policies. Almost always financial houses and mediators have then a fabulous fortune increase before-calculated to the customer – at most in the small print then it is pointed out that it concerns pure hopes. In the end, when loans expire, pensioners in particular are left with residual debts which then leave them with a life just below subsistence level – and in retrospect the forced sale of the property can be seen to have been foreseeable from the outset. Not infrequently, an actuarial/financial appraisal shows that additional claims are possible for the life insurance used for redemption or that the financing model as a whole was unrealistic, with sometimes glaring calculation errors and omissions that are obvious to the expert.
Even the decision to tie up almost all of one’s assets for the long term, without reserves that can be realised in the short term, can lead to insolvency. It would also be risky to put all your eggs in one basket and lose sight of the diversification of your investments by investing in one property. If a capital is to be invested for smaller investments in real estate, besides very few solid open-ended investment funds, some cooperatives are particularly suitable, where 3-5% distributions have been the rule for decades. The choice of contractors is crucial, as there are black sheep and overstretched managers in both sectors.
Before making any investment, especially if it is partly on a credit basis, it is important to hedge the existential risks. This concerns, for example, the risk of unemployment, illness or occupational disability, and not least one’s own liability. Low interest rates can be a temptation if they are not fixed for a sufficiently long time and the repayment amount is too low. The traditional trick of offering the customer 1% repayment meant in the last century the prospect of being finished with the repayment after 30 years – today in the low-interest phase with 1% repayment a repayment over more than 45 years is to be expected. Without financial mathematics, different offers for financing can hardly be compared, even if Otto-the-normal consumer thinks it is enough to look at the effective interest rate.
Total Surplus Trap
Many models do not count at all on the fact that the real estate is acquired actually sometime once debt-free, and then at least from the rent after costs admittedly not the journey to the golf course with the Golfcaddy, but nevertheless a subsidy for the journeys with the electric wheelchair to the daily care place can be financed. Rather, the realization of the property with considerable profits, calculated as an annual rate of increase on the twice overpriced purchase price is promised. What is overlooked is that real estate, left to its own devices, declines in value, and the tax depreciation of 2% per year on the value of the building is not a pure tax gift, but reflects a real loss in value. Only in the case of the proportional land value can there be hope of an increase in value in good locations. So selling the property will almost never yield what would be needed to pay off the full loan – the dream of effortless profit through appreciation of the property usually ends in substantial personal residual debt to the bank with no future property ownership at all. However, in many cases this is even the better solution than to keep the property.
Often advisers calculate that the dream rent can be used in full, or with very small management costs for the property manager, to service the loan instalments. However, without repairs and maintenance as well as medium-term modernisation, a property will quickly lose value. In the calculations it is almost always forgotten that such costs are always necessary to ensure a rentability, and therefore are out for the loan installments. “Frugality” at this point then expresses itself in the fact that the apartment is difficult to rent out with considerable sacrifice, with increasing vacancies and the chance of encountering tenants who can’t find anything else. With a bit of luck, you can then gain experience with rent nomads who first stop paying rent altogether because of alleged or actual defects. Lucky then is whose tenant moves out again after a few months, leaving only a rent arrears. Not infrequently, however, costs are also incurred for eviction proceedings and carrying out the eviction of an apartment that is often completely cluttered – occasionally, fittings, door handles, locks and radiators as well as copper pipes of the heating and water installations have already been dismantled and sold on the flea market or at the scrap metal dealer, and food has been prepared with the wood of the room doors on the living room carpet after the public utilities had cut off the electricity. It is not only such coincidences that will bring the financing model to a foreseeable collapse.
Financial service providers can provide for follow-up business from the outset, for example by combining a life insurance policy with a 12-year savings period with a loan for which the fixed interest rate expires after 10 years. Such models then lead to a sudden increase in the interest burden, and free liquidity is not available for unscheduled repayments.
In many cases, financial advisors are motivated solely by commissions and bonuses. The business model of long-term customer loyalty has become rare. As a rule, it will prove more lucrative to pay 20,000 euros for good advice than to pay up to more than 60,000 euros for more or less hidden commissions, kick-backs and possibly usurious overcharging. Warned by rulings on consultant liability, consulting firms today are often founded as limited liability companies only for the marketing of a property complex and subsequently liquidated: Here then often only individual consultants can be taken personally or the financing bank in liability.
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About the author
Dr. Johannes Fiala
Dr. Johannes Fiala has been working for more than 25 years as a lawyer and attorney with his own law firm in Munich. He is intensively involved in real estate, financial law, tax and insurance law. The numerous stages of his professional career enable him to provide his clients with comprehensive advice and to act as a lawyer in the event of disputes. »More about Dr. Johannes Fiala
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