Endless upswing?

Constantly rising prices, ever-increasing transaction volumes – the German investment market still seems to be in the stratosphere. But investors shouldn’t be overly euphoric.

Julian Deutz couldn’t believe his luck. “The price we received is well above our original expectations,” said Deutz, Chief Financial Officer of the Axel Springer media group, after closing the sale of two publishing buildings in the Berlin-Mitte district. The Norwegian sovereign wealth fund Norges Bank Real Estate Management and the investment companies Blackstone and Quincap paid an impressive €755 million following a bidding war with numerous other investors.

Many sellers of German real estate have shared Deutz’s experience in recent months and have enjoyed proceeds that would have been unheard-of just a few years ago From the mixed-use Sony Center in Berlin and the Tower 185 office building in Frankfurt to the Leuchtenbergring office and hotel project in Munich and the Logicor logistics portfolio – a wide variety of locations and use classes are profiting from domestic and foreign investors’ interest in Germany’s property market. With a transaction volume of some €55 billion for commercial property, the major real estate brokers had one of their best years ever in 2017, with half of the invested capital coming from abroad.

All systems go

The “Emerging Trends in Real Estate: Europe 2018” study by the Urban Land Institute and auditing firm PwC shows just how attractive Germany is to property market professionals. The study again ranks Germany Number 1 in Europe for investors, finance providers and project developers. In addition, four German cities – Berlin, Frankfurt, Munich and Hamburg – are among the six European locations with the best investment and development prospects.

There is good reason for that, according to Susanne Eickermann-Riepe, Real Estate Leader and Partner at PwC Germany: “Population growth, new business resulting from Brexit, a good economic environment and political stability – exactly what investors want.”

Other studies confirm this view. The “Global Commercial Property Monitor Q3 2017” by the Royal Institution of Chartered Surveyors saw Germany move to the top of the pile in terms of the dynamism of the European property investment markets. And Germany, long seen as a bit dull, can even boast about its image, having pulled ahead of France and the UK to top the Nation Brands Index, in which British policy advisor Simon Anholt and market researcher GfK measure the “brand image” of 50 countries.

That optimism is backed by unimpeachable facts. Provisional figures indicate that Germany experienced economic growth of at least 2 percent in 2017, and the state-owned KfW Bank anticipates that gross domestic product will increase by 2.5 percent in 2018. Unemployment was down to 5.3 percent in November 2017, the lowest level in quarter of a century. Even population numbers are on the rise, contrary to earlier forecasts: the German Federal Statistical Office anticipates that the number of inhabitants will increase over the next five years and still be 82.2 million in 2035, approximately the same as today.

Booming office market

The office market is the main beneficiary of the economic upswing. Companies are creating jobs while growth in the number of office buildings remains moderate, so available office space in leading cities – including Berlin, Hamburg, Munich, Frankfurt am Main, Düsseldorf, Cologne and Stuttgart – has become a scarce commodity, causing rents to rise. According to researchers from JLL, between autumn 2016 and autumn 2017 prime rents increased 2.7 percent in Frankfurt, 4.3 percent in Munich, and as much as 9.4 percent in Berlin.

There are no signs that the economy is overheating to a level that will threaten the whole system.
Matthias Pink, Head of Research Savills

The German capital is the new darling among investors, particularly foreign investors, who have made Berlin Number 3 in the world in terms of cross-border investments according to JLL, surpassed only by London and New York. Above-average growth in GDP, increasing demand for office space, and the city's excellent image are all factors in the top prices now being paid for office buildings in Berlin. The vacancy rate for offices (between 2.5 and 4 percent depending on the source) is at historic lows. Rents for offices, long very low for a capital city, now average some €30 per square metre for prime properties.

Tenants in Frankfurt must pay considerably more. The city, known as a banking centre, will likely find Brexit particularly profitable. “Brexit could cause 8,000 jobs to move to Frankfurt,” predicts Sven Carstensen, manager of the Rhine/Main branch of the Bulwiengesa research firm. “That would correspond to demand for between 120,000 and 150,000 square metres of office space.”

The European Banking Authority will be moving from London to Paris – not Frankfurt – but that hasn’t put a damper on the mood. In any event, Oliver Barth, head of the Frankfurt branch of BNP Paribas Real Estate, expects that many banks will still locate in Frankfurt. And, he says, companies already located there are seeking additional space.

Are prices too high?

Yield compression continues, not just for office buildings but also for other types of property. According to JLL, investors in first-class retail parks and logistics properties had to make do with initial yields of 4.7 percent in autumn 2017; they earned 4 percent on top hotels and just under 3 percent on commercial buildings in city centres.

That’s why market participants are increasingly wondering whether prices are still reasonable or whether the German market is overheating. “There’s a risk of paying too much for core office properties in the current environment,” says Nikolai Dëus-von Homeyer, Managing Partner of the asset manager NAS Invest. And Karsten Jungk, Joint Manager of Wüest Partner Germany, a consulting company, observes that “some investors are tempted to massage their investments.” This happens, he says, when investors interpret risk classes creatively: “Core Plus is presented as Core, or Value-Add is presented as Core Plus.”


billion euros was the volume of real estate transactions in Germany in 2017.

Top deal of the year in 2017: Alsterarkaden in Hamburg (pictured) is part of the portfolio of five trophy properties with nearly full occupancy in four leading German cities, acquired by Signa Holding of Austria for €1.5 billion.
Franz Brück
In the past, the market for health properties has developed very independently of the overall economic situation.
Florian Bauer, Managing Director of Swiss Life Asset Managers

This doesn’t mean that most experts think the prices can generally no longer be justified. Matthias Leube, CEO of Colliers International Germany, actually considers it likely “that we haven’t yet reached the low point for yields.” And Marcus Lemli, CEO Germany for Savills, points to the clear difference that still exists between yields on core real estate and government bonds. “Against that background, real estate offers attractive investment opportunities,” he emphasises.

However, the experts at Savills anticipate that the initial yields on retail property will continue their rising trend. The background to this is the effects of e-commerce, which makes it more difficult to let retail space and has put pressure on rents outside of top locations. “There’s no doubt that e-commerce is making things challenging for retail properties,” confirms Martin Mörl, Managing Director of Prelios Immobilien Management, an asset and property manager specialising in retail properties.

“There are still good reasons why brick-and-mortar retailing will continue to play a prominent role. It offers the possibility of a personal experience even in the digital age.” He adds that “investors are increasingly following a value-add approach by upgrading lower quality shopping centres.

Residential property: still worth a try?

The outlook for the residential market is also a hot topic According to a survey done for Engel & Völkers Investment Consulting, 85 percent of German institutional investors want to invest more in residential property. New entrants in this segment are also convinced of its potential, which is why Union Investment created its residential real estate fund for private investors in 2017, in cooperation with the residential specialist ZBI.

In contrast, NAS Invest sees itself on the seller side. “The cycle is peaking in our view,” says its Managing Partner Nikolai Dëus-von Homeyer. The portfolio holder WERTGRUND has recently moved away from residential properties as well. Its CEO Thomas Meyer explains this by saying that “some cities are approaching or have already reached a price plateau,” meaning that prices will not increase any further. Data from consultant F+B Forschung und Beratung für Wohnen, Immobilien und Umwelt also indicates that the rise in rents has slowed. Average German residential rents under new leases increased by only 2.2 percent between autumn 2016 and autumn 2017. This makes it even more important to identify the right locations if investing is to be a success. “Given the clear price increases in large cities, investors are increasingly turning to smaller cities,” says Ulrich Jacke of the consulting firm Dr. Lübke & Kelber, looking at the residential market. The same applies to the office market, and investors are increasingly turning their attention to secondary cities, such as Hannover, Nuremberg, Leipzig and Mannheim. “Germany has a decentralised structure, so there are many economically strong cities with correspondingly attractive office markets outside the Top 7,” explains Guido Nabben, Spokesperson for German Property Partners, a network of commercial property service providers.

Smaller markets are often less volatile than the larger ones, says Karsten Jungk, but he urges caution: “Very ambitious prices are now being charged in cities outside the Top 7.” Not only that, adds Sven Carstensen of the Bulwiengesa research firm, but people should take care not to acquire excessively large properties in smaller cities. He thinks yield-oriented investors will find better investment opportunities among office buildings on the edges of leading cities. Those locations offer “increased value as a result of urban development processes,” agrees Florian Bauer, Managing Director of Swiss Life Asset Managers.

Demand by office users in top cities increasingly includes the outskirts, so B locations could gradually become A locations. Swiss Life Asset Managers doesn’t limit its investments to office properties, and also invests in healthcare facilities such as nursing homes and medical centres. “The market for healthcare facilities has proven to be highly independent of the business cycle,” says Bauer. Given the limited supply of core real estate, other investors are paying more attention to niche properties such as nursing homes, multi-storey carparks, student apartments and data centres. “It generally makes sense to invest in niche properties,” says Jungk, but they are only for investors “who either have the necessary know-how or are willing to pay for it.”

According to Colliers CEO Leube, investors are also getting involved in project developments earlier and assuming more risk. The advantage is that project developments are more complex than fully-let existing buildings, so there aren’t so many bidders. Moreover, says Leube, in view of the increase in office rents, vacancies are “perceived as an opportunity these days”.

But how long will the upward trend last? Quite a while, according to most experts. Strong economic growth, continued stable or gradually-rising interest rates, Germany’s reputation as a haven of stability – specialists see no reason for a downturn in the foreseeable future. “There are no signs that the economy is overheating to a level that will threaten the whole system,” says Matthias Pink, Head of Research at Savills.

But investors should always keep the possibility of a downturn in mind, warns Andreas Pohl, who will soon retire from his position as Chairman of the Board of Managing Directors of Deutsche Hypo. Based on his many years of experience, he says, “Every upward trend must someday come to an end.”

Alejandro Obermeyer is Head of Investment Management Europe at Union Investment Real Estate GmbH in Hamburg.
Union Investment

“Confidence in rent increases”

Alejandro Obermeyer of Union Investment Real Estate GmbH still sees investment opportunities in Germany – particularly given the country’s stable economic trend  

Mr Obermeyer, given the high prices, is it still advisable to invest in office buildings in Germany’s leading cities?
An excellent question. One advantage in Germany is its economic growth, which boosts confidence in stable, healthy rent increases – and puts the low initial yields in perspective. Even in the absolute top locations, it’s still possible to find investments with a promising story. But you have to look very closely. Not everything in the city centres is worth the money being paid for it at present.

Did Union Investment do any buying in major German cities in 2017?
No. Not due to a lack of interest but because we often emerged from the competition in second, third or fourth place. We are prepared to pay high prices if the whole package works. But if the location, the building and the rents don’t inspire confidence then it’s hard for our fund to contemplate buying with an initial yield of three percent.

In today’s situation, does it make sense to switch to the seller side?
In the current market phase, it would generally make sense to divest some properties that no longer fit in strategically with our special assets. However, we have arrived at such a high level of quality with many of our fund properties that the question arises of why we would sell. Of course we do clean up our portfolio as we go along.

Do you agree with the general opinion that locations on the outskirts of major cities are of particular interest to investors?
I do think that investments in B locations in major cities make great sense. The potential for new builds in city centres is limited – many companies setting up new offices must move to peripheral locations. That makes those locations very attractive to investors. That’s not the case for C locations: we have to be able to sell our properties in the future, and that’s not always certain in C locations.

What outlook do you see for B and C level cities?
Cities like Bremen, Hannover, Darmstadt, Mainz and Nuremberg are certainly of interest, but you have to be careful to invest only in locations in those cities which have the necessary fungibility.

Are you also getting involved in developments?
Buying project developments is a promising strategy for getting a toehold in a difficult market. To do that in B locations, we need a healthy pre-letting rate, while speculative project developments can also be of interest in good locations in Top seven cities.

Do German investors still have a home advantage over their international competition?
Domestic investors don’t necessarily have a better chance than anyone else. It’s highly likely that we won’t be the buyers of fully-let existing buildings in the best locations, which are marketed internationally, because other competitors are willing to pay higher prices. Where we have the advantage is when things get more complex. Some owners are happy to sell to us even when another party has offered a bit more because we’re reliable and can guarantee certain completion of a transaction.

Do you share some other investors’ enthusiasm for the Berlin office market?
Berlin is a fascinating market with an exceedingly low vacancy rate, and it’s very hip. Still, if I had to choose to invest at three percent in Munich or three percent in Berlin, I’d always opt for Munich. Munich’s economy is more broadly positioned than Berlin’s.

How much will Frankfurt’s office market profit from Brexit?
Frankfurt will be one of the winners, even if we can’t say how great the demand for office buildings will be due to Brexit. What this means for us at Union Investment is that our objective is to invest in Frankfurt in 2018.

Interview by Christian Hunziker.

Title image: Maurizio Rellini/SIME/Schapowalow, Maico Presente/Getty Images, Rico Wasikowski/Getty Images, Cordelia Ewerth/mauritius images

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