If you study real estate valuation for long enough you start to hear grumblings about the German property valuation method. Germany is part of the European Union but Germans were apparently not satisfied with how the rest of the world calculates the book value of real property. Instead, they have chosen a more complicated and more regulated approach to real estate appraisal. After researching and interviewing dozens of people in and around the German property industry I learned that the country’s regulations, political landscape, and unique culture all contribute to the changing real estate technology landscape. As other countries struggle to regulate and standardize the techniques and technology behind how we value real estate Germany offers some important lessons for the impacts of regulation.
First, I think it is important to understand just how unique Germany is. Germany has a prosperous economy, one that is based mostly on production. In 2017 they accounted for 28 percent of the entire European economy, according to the IMF, and have had a trade surplus for decades. Germany is quite conservative economically. Compared to the other large EU countries, its government spending to GDP is very low. German citizens also have the most personal savings of any large country in Europe. Germany is also highly regulated, particularly when it comes to the property industry. In April the country’s constitutional court struck down a proposed law that would cap residential rental rates in the entire country and allow renters to take legal action against their landlords that didn’t abide by the rent freeze.
A highly standardized approach to regulation has created a real estate industry unlike any other in the world. The first, shockingly unique difference in the way the German property industry functions is that very little property data is publicly available. Unlike most countries, which have a public land registry that records everything from sales prices to tax liens, in Germany almost no data is easily available. So, rather than being able to quickly compare sales prices of other properties to get an estimate of value, appraisers and valuators have to request average local property metrics from a municipal appraisal authority. These numbers are not updated regularly and, as you can imagine, some local governments are rather behind when it comes to technology. “There are many areas where you have to use a printed book that comes out every two years,” said Ron Hess, Chief Marketing Officer at On-geo, a German property valuation tool.
The opaque nature of property transaction history has created a bit of an oligopoly when it comes to German commercial property valuation technology. Currently, there are two large companies that control the bulk of the market, one being Hess’s On-geo and the other, a family-owned appraiser turned software provider called Sprengnetter. Both of these companies have been able to gather enough of their own sales data from users on their platform to produce comparable data to be a substitute for a public land registry. The lack of publicly available property information has also given power to another powerful organization, an association of mortgage banks called VDP. They even have their own software offering, VDPResearch, which can aggregate data from its members, although an industry association selling software has its own inherent complications.
It isn’t just the access to data that makes Germany stand out. As I said, the very way that they calculate value is different. “Our specialty is to make everything complicated,” Hess explained. While recently sold comparables are useful for determining a property’s “market value,” most commercial appraisers look more to a commercial building’s profit as a proxy of its potential price. This calculation takes into consideration the net present value of both income and expenses, including an allowance for depreciation. Germany appraisers are required to split this into two separate calculations, one for the land and another for the building. This method is actually more precise as only the building depreciates and there are few things more German than the love of precision. The calculation is similar to how the US calculates property tax increases as just the value of the land is given the increase.
German buildings are also held to a much more conservative definition of future value. The accepted method in most countries is take into consideration rent increases, both ones written into leases, and what an elevated market rate a vacant unit would bear. In Germany, the calculation is done just with the rental income on the day of the calculation. The German’s don’t count their chickens before they hatch. Or, to use one of their beautifully Germanic expressions, don’t divide the bearskin before killing the bear.
The complicated valuation requirements, combined with a requirement that appraisers see a property in-person, have limited the amount that technology has been able to automate the appraisal process. Automated valuation models (AVMs) are starting to be commonly used by many other countries as a quick, cheap way to value buildings. This is particularly true for banks, who often just need to be able to quickly understand the loan size compared to the estimated value of the property. But German mortgage banks have very little freedom in how they do their calculations. I spoke to Jan Peter Annecke who has worked as a banker for over 20 years and is now the manager of real estate F\finance for a bank called Helaba. He told me that in order to take advantage of the comparably cheap Pfandbrief funding, the law requires Pfandbrief Banks to carry out a calculation of the Mortgage Lending Value (MLV). The calculation of this value is heavily regulated by law and can only be carried out by certified Mortgage Lending Value appraisers. The MLV must not be at or even above the market value.
Usually, in these days of rapidly increasing market values, the MLV is typically 30 to 60 percent below the market value, depending on the property type. Only 60 percent of this MLV can be used in a pool of loans which serve as the basis for the issuance of public bonds called Pfandbriefs. “The rules around Pfandbriefs are very strict so every bank should come to the same valuation,” he said. While thus the Mortgage Lending Value is used for refinancing purposes only and is not suitable for AVM due to its heavy regulation, the market value in contrast, which is used for assessing the risk associated with a loan, is slowly but steadily becoming the subject of increasing interest from AVM approaches. But currently, almost all banks in Germany do the calculation of both, the MLV and the market value, in-house.
So, while banks in other countries are allowed to use AVMs to assess the risks of their loans, in Germany they are mostly used to double-check the required manual appraisal. This has slowed the adoption of AVMs, but not stopped it. One of the newcomers to the German valuation sector that has been able to make some inroads is PriceHubble. The company’s CEO Julien Schillewaert explained that “AVMs help prequalify the deals. It is about being more efficient and faster but also about being more sophisticated than a normal appraisal.” Since the average property valuation data is standardized, its enterprise value has dropped to almost zero. For banks and acquisition teams to unearth a property’s hidden alpha they turn to computer modeling.
There are organizations lobbying for AVMs to play a larger role in the European property industry. The European AVM Alliance (EAA) is calling for standardization of the way AVMs calculate property value in order for them to be used in lieu of a traditional appraisal. The group is comprised of valuation technology providers from around Europe and publishes regular standards for valuation models. But, their ability to push legislation through is limited. For real changes to accrue around the way Germany uses AVMs there would need to be pressure from the banks themselves. Right now Germany has over 1,500 banks but they quickly consolidating. “There is a lot of pressure on the banks right now, they are under pressure to cut costs, and reducing the burden to get an appraisal for every financing event would be a great place to start,” said Schillewaert.
The appraisal industry itself is struggling to keep up with the demand. Convincing young talent to take up a career in property appraisal is hard in almost every country but this is especially true in Germany where the certification process is especially difficult, expensive, and time-consuming. A number of people I talked to told me that finding appraisers was getting more difficult, resulting in a price escalation.
In the US, AVMs are being used en masse by so-called “iBuyers” that are offering instant cash offers for qualifying houses. The thought is that by reducing the hassle and risk of selling a property, particularly when the seller is in the process of buying another, these tech companies can buy and sell houses quickly for a slight profit. In Germany, this practice is all but eliminated by a six percent tax on the sale of a property. But, we might see parallels to the way that that iBuyers like Zillow used an AVM to break into the market. “The biggest threat that AVMs have to the German property industry is if they start to be offered directly to the consumer,” said Jan Sprengnetter. He is CEO of the aforementioned Sprengnetter and son of the company’s founder. Sprengnetter has developed its own AVM, one that builds upon the standardized German model to try to understand the future demand of a property. Jan thinks that some of the property listing companies in Germany could start to use AVMs to attract buyers. This would provide important soft data to the models, such as how much interest there is in a particular property type or area, and could help familiarize the industry and the general public with the process.
German politics and financial regulations have created a property industry unlike any other in the world. While this regulation is burdensome and seems to have slowed the innovation in the space, it also serves to prevent speculation and the bubbles caused by it. In this regard, German laws have done well. Germany has one of the most stable real estate prices in the world and was one of the least affected by the mortgage crisis of 2008. Every country is trying to find the proper place for AVMs in how we calculator the value of the biggest asset class in the world. To understand the arguments, both for and against, regulating property valuation the world needs to look no further than the most populous and one of the most prosperous countries in Europe, Germany.