The Demographic Trap and Conclusions Drawn for Investors

Published on 2012/10/15
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In its official demographics report, the German Government noted that the country’s population will decline from 81.7 million today to somewhere between 65 and 70 million by 2060, according to model projections. Germany will lose 17 million residents in number, while the residents remaining will be older. The share of those aged 65 and up will surge from 20% today to 34% by that time. While these revelations are hardly new, it is shocking to see that neither politicians nor investors derive any serious conclusions from the fact.

Not only does Germany face the problem of a shrinking population, it also fails to pursue a sensible immigration policy. Countries like the United States or Australia make a pinpoint effort to recruit and welcome professionals that bring essential qualifications to the country. In Germany, by contrast, it is not considered “politically correct” to define which groups of immigrants are a boon for the country and which a bane. Most recently, the number of asylum seekers in Germany has started to soar again; but that is hardly the kind of immigration that will solve our demographic problems.

Even now, it is easy to see that the social security system in Germany will cave in under the pressure of the country’s demographic development. Yet the problem is being ignored, while absurd debates on whether or not “retirement at 67 is socially just” drag on.

The German Government is spending resources counting in the billions to restructure the German energy policy along lines of “sustainability” much in the manner of a planned state economy, and is heading at break-neck speed for a transfer union that benefits Southern Europe above all. Doing so will considerably weaken Germany as economic location in the medium and long run.

You don’t have to be a doomsday prophet to see that the combined effect of the demographic predicament, the burden caused by the euro transfer union and the economic ramifications of the energy shift will dramatically weaken Germany as economic location in the coming decades.

Real estate investors try to dodge the demography trap by investing specifically in regions characterised by positive demographic growth. This creates the problem of rising prices in these selfsame regions. Strangely, Germany’s demographic issues are discussed only in the context of residential investments, although – and Professor Tobias Just of the IREBS Real Estate Academy has emphatically warned against this trend for years – the ramifications for the office real estate market will be by far graver and kick in much sooner.

The only true antidote for investors is actually international diversification, meaning investments in countries with positive demographic growth. Naturally, demographics cannot be the sole criterion to consider, yet it should certainly play a more significant role in investor plans than it used to.

International investments have admittedly been a mixed bag for German real estate investors. Germany’s open-ended real estate funds, which eventually did most of their investing abroad, hardly qualify as examples for successful international investments. The experiences with closed-end real estate funds have also been ambiguous. For many investors, they were most favourable in the United States.

My advice to any investor with a long-term horizon is to invest no less than one third of his or her capital in the United States. Unlike Germany, the United States boasts positive demographic growth; and this is the most important long-term driver for real estate investments. At the same time, it is a country with an economic and legal system that places a premium on the inviolability of ownership rights. Needless to say, the United States has massive problems of its own and the monetary policy pursued by the Fed is every bit as disastrous as that of the ECB. It deepens the risks of inflation, yet the best way to protect yourself against these is through real estate. Unlike Europe, however, the United States does not have to cope with the consequences of a politically inspired currency of shoddy design.

Anyone wishing to invest in the dollar zone should not hesitate for too long, because the dollar is relatively affordable at the moment (one euro will buy about 1.30 dollars), which could quickly change if the euro crisis deepens further. But there is another aspect to consider: I expect the top income tax rate in Germany to be raised from around 47.5% (including Solidarity Surcharge) to 55% (again including the surcharge) in the coming year. The top income tax rate in the United States is 20 percentage points lower at 35%. A German real estate investor earning 178,650 US dollars or less per year will only pay 28% taxes on this income, which is just half of what he or she will soon have to pay in Germany. The few advantages that real estate investments in Germany still have (especially the tax-free disposal after an ownership period of ten years) are sure to be abolished in the next parliamentary term. So fiscal reasons, too, make it advisable to invest part of your wealth in the United States, because real estate investments by Germans in the US will be taxed pursuant to the local tax regime.

Even more important for long-term investors, though, from my point of view, are the demographic aspects. For the people in Germany, the country’s demographics are a destiny from which they cannot escape, except by leaving the country. I cannot think of any way to respond to or remedy the situation. The forecasts will more or less come true along the lines now laid down in the report of the German Government. If anything, the consequences will be even direr than the Government is willing to admit. You cannot say the same for investors. Luckily, demographics are not an inescapable fate for them. Rather, they have the option to bypass the demographic trap through international diversification of their investments.

If you have followed the investment strategy proposed in my newsletters of the past ten years, you will have met with success. Very early on, I recommended investing in German residential real estate, and placing the focus on Berlin. I also kept recommending buying gold bullion. Apartments in Berlin and bullion proved to be a formula for prosperity. No other real estate market in Germany performed as positively as the residential real estate market in the nation’s capital and no other asset class experienced growth as steep as bullion did. If you additionally invested, the way I suggested, in inflation-indexed bonds, you will have earned double-digit gains from German government bonds due to the yield compression and you are well advised to hang on to these investments as insurance against the eventuality that the ECB policy will drive up inflation in the coming years.

As far as equities are concerned, which principally have their place in every portfolio, I more or less got out of the equity market altogether last week, because I consider the medium-term upside potential lower than the threat of corrections, which, if they came to pass, might present great opportunities to re-enter the market.

About the Author

Dr. Rainer Zitelmann is one of the leading experts for the strategic positioning and communications of companies.

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