The real estate location
- and how to evaluate an area correctly

 

Interested customers keep asking the question: “I want to acquire real property, but at what location should I buy? What location is best for my rented out freehold flat? What city is worthwhile?”

So what does really matter as far as purchasing an apartment as capital investment is concerned?

What basically holds true is:

The crucial success criteria for a rented out property is the location. An old real estate principle simply is: location, location, location. This principle has been ignored, violated forgotten or denied again and again. And again and again we were able to see: buying properties at the right locations and the right sites one hasn’t only won a bit, but all the way. No wonder: real insiders know the best locations of the republic and they buy where the highest value increase or the greatest stability of value can be expected.

But how does one know what good and less good locations are? How does one differentiate good from bad locations at all? Let us first define the difference between the location of the property and the site within the location. Example: North Rhine-Westphalia as federal state is a location. Location as a city is a site.

The choice of a location is based on a few but important criteria:

If one has decided upon a location one then goes on evaluating the site within the location. The following criteria are important then:

Within a city, there are always good and not so good locations. In Duesseldorf for instance, the south of the city is not such a good location as the north, where the preferred quarters are. Insiders know even more precisely that certain districts hold the best locations, such as e.g. Duesseltal, Pempelfort, Derendorf, Unterbilk, Rath and Flingern-Nord. In other districts there also are popular locations but one usually needs to look a little harder. In Essen the reverse applies: here one must only buy in the south (with very few exceptions), meaning in districts inside and southern to the city.

Thus we can say: in every city there are excellent and wanted so-called individual locations. Locations in quarters can sometimes be better than central locations. Example: the district Sachsenhausen in Frankfurt is much better than the area around the main train station, even though latter one is more central to the inner city. And again, certain districts inside the large cities cannot be recommended at all.

What knowledge of the place is necessary to determine what location within a city is good and what is bad? Exactly: extensive knowledge! Thus every choice for a property must be done by an expert.

Sometimes investors ask themselves another question when they evaluate a location: could I imagine living in this vicinity myself?

Though this question is a bit delicate. A farmer spending most of his life on a farm will possibly never be able to imagine living in a city – no matter what location. To the reverse there might be people who are used to living at the most noisy places where interurban train, car traffic and entry lane meet. So the last question is not decisive, but it has subjective importance. It however becomes important if one really wants to use the property oneself one day, for example when one retires and wants to move from a large house into a city apartment.

Finally there is another question which is very crucial:

Is the price which I pay for the property appropriate to this location? In other words: can this property be sold again in several years for the same or a higher price if I want?

In order to evaluate this it is important to do price comparisons. An important and national source for price comparisons is the monthly index of the newspaper “Bellevue”. This index compares sales prices and rents in more than 100 cities. It distinguishes simple, medium-class and good locations. This index is based on current evaluations of the biggest estate agent associations RDM and VDM as well as single enterprises active on the market and the editorial department’s personal research. It gives good indications and one can trace long-term changes with it.

If the price of the property that is offered to you lies within these values it is ok. If the price is below the level for simple locations then you should inspect: where is the property? What is the reason for the low price?

If the price is within the medium or top range then you should yet not immediately assume that it is righteously so. Inspect if the location legitimates the price.

Of course at every location one can get bargains time after time. For instance a team of researchers is busy since years finding such bargains in good sites. Accordant information sources and a fast actionability are prerequisites to finding bargains. For these are never kept on the market very long. Some real estate commercial enterprises are specializing on buying bargains and keeping them until they get resold to investors. Usually these enterprises have waiting lists of interested customers who would like to purchase for a price below the market level.

The current rent is only secondary when evaluating the location. “Good locations bring higher rents; less good locations bring less high rents.” That might be logical – but not always the case. One should keep in mind: the current rent, at best, plays a subordinate role when looking at the real estate investment. The average market rent is much more important; you can find it in the index too or can find it out from RDM or VDM and other real estate agent associations. Now make the following contemplation:

If the current net rent (no added costs, electricity or heating etc. included) is according to the average market level then the yield of the property should be around 5% (more data on how to calculate the yield you will find further below).

If the rent currently lies below the average market level then the yield should be at least 4%. Depending on the rental contract one has more or less leeway for raising the rents. If e.g. one has a longtime rental contract and if the tenant has been in the apartment for more than ten years then the low rent should also clearly be reflected in the sales price, for in such a case one does not have a big chance to strongly change something about the rental contract within short terms.

If the current rent is above the average market level then one also needs to take care: in such a case the yield should in any case be 5,5, to 6%, otherwise the sales price is too high. A sales price which is too high will lead to the situation that one perhaps needs to lower the rents when changing tenants and thus one has a yield clearly below 5%.

So here is the formula for calculating the yield:

Monthly net rent (no added costs included) multiplied by 12 = annual net rent
Annual net rent multiplied by 100 divided by the sales price = percentage of yield.

The added purchase costs (property acquisition tax, notary, court; around additional 6.5%) are not included into this yield examination. Also the tax advantages do not play a role when calculating the net yield.

Rule of thumb:

Only buy at good locations with strongly attainable rental income, for prices according to the market.

 

 

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Important note: Any evaluations, advices and indications on our information and internet pages are mostly subjective evaluations and solely have the purpose of giving real estate investors a general orientation. They make no claim to be complete, right or constantly valid. Most real estate information is founded on conditions or legal regulations (taxes, regulations about apartment ownership, tenant’s rights and more) which might have been current or of interest for real estate buyers at the time the text was written. These conditions and legal foundations – especially also fiscal aspects – possibly have changed by now. Thus we recommend, before one does any property purchase, to get the current data on the real estate markets, tax- and other legal regulations and innovations, as far as these could be of importance to the objective and subjective success of the investment.