Secondary German Cities: Outperformance Ahead

Germany stands out as one of the most polycentric economies worldwide. Unlike London, which is generating about a fourth of the national GDP and Paris responsible for a third, Berlin contributes just 4.6 % of Germany’s economic output. Even combining the Top 7’s¹ economic power equals to 19 % of the national GDP, which is still undershooting the dominance of the French and British capitals. Asian dominant equivalents are Tokyo (20%; Tokyo Metro, ca. 40%) and Seoul Metro (ca. 50%).

The roots of its polycentricity lie in Germany’s fragmented history and its federal political system. In modern times, this dispersion has created an unusually broad base of strong, investment-grade cities.

For residential investors, particularly international entities, this set-up is both a blessing and a curse. A blessing because the markets are generally very liquid and transparent and the polycentricity enables “in-country” diversification strategies, due to its broad and deep market structure. At the same time it’s a curse, because the market can appear difficult to navigate beyond the well-known Top 7.

A shifting demographis landscape
Hower, the time has probably never been better structurally and cyclically to explore investment opportunities in secondary and tertiary markets.

The timing for looking beyond Germany’s gateway cities is particularly favourable structurally and cyclically. Demographic and lifestyle trends are reshaping demand patterns. For two decades the Top 7 outpaced the rest of the country in both population and rental growth. Since the late 2010s, this trend is changing. When analysing internal migration, which is migration within Germany, the large cities tend to lose population, while the surrounding cities and even more distant markets are gaining.

Several drivers explain this:

Affordability
Rental value and capital value growth has been extraordinary in the large metropolises over the last two decades. To a point that the cities have become quite unaffordable to a large part of the population. While the average rental cost to income ratio was 24.5 % in 2024, this can be as high as 35 % in Berlin or Munich. For the top product in the market, the cost-to-income burden is even higher.

Lifestyle and sustainability
Ecological awareness is changing demand for living spaces as greener lifestyles have become more relevant. According to a recent study from TU Darmstadt², environmental behaviour is a key determinant of place of resident decisions. Clearly, this is more difficult to achieve in dense metropolitan areas than in small and medium sized cities.

Remote work
Digital connectivity allows greater freedom of residence. Similar to the broad availability of the car and public transport in the 1960s and 1970s, which caused a massive suburbanisation, modern digital connectivity can have a similar impact – this time in favour to smaller, more liveable centres.

Different to the suburbanisation era that lasted until the 1990s, today’s secondary urbanisation will likely favour urban communities, which are both affordable and attractive. Hence, cities from the second and third tier are poised to see a lasting increase in population and as a result of rental growth.

Market fundamentals support the case
On top of these structural drivers, the market cycle itself is favourable. Years of insufficient construction have pushed vacancy rates in prime locations to below 1%. This has caused a broad and steep rise in rental values. With permits and new starts at record lows, shortages will persist.

At the same time, market pricing in the multifamily sector has corrected markedly. Here, in general, initial yields are significantly higher in second and third tier markets than in the large metropolises offering better income returns. Combined with the superior growth prospects of many of those cities, secondary markets are likely to outperform on total return basis over the medium to long term.

Germany offers more than 100 investment-grade cities – a breadth unmatched in Europe. Choosing the right ones requires more than demographic and economic metrics. Affordability, quality-of-life factors and local dynamics are increasingly decisive.

For international investors, this means that deep local knowledge and on-the ground execution are essential. Identifying the most promising markets, securing assets and managing them effectively demands a sophisticated strategy. Those who combine global capital with local expertise will be best placed to capture the opportunities that Germany’s polycentric structure presents.

(1) Berlin, Cologne, Dusseldorf, Frankfurt, Hamburg, Munich and Stuttgart are typically acknowledged as Germany’s “tier 1” real estate markets
(2) Pfnür et al: So wohnen wir in Zukunft: Eine Metaanalyse zur Transformation des Wohnens in Deutschland, TU Darmstadt

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