Maybe it is the largest construction project in Frankfurt am Main. “Four” is the name of the new high-rise quarter in the banking district: four towers, with the tallest one reaching 228 metres high. Local media are praising the use of geothermal and green electricity, the urbanity and openness of the new quarter. But for the real estate industry, one message is most relevant of all: half of the floor space will be available for offices. The market needs that, almost as urgently as residential space. The lack of existing office space has worsened over the last several years. Now high tenant demand is making the sector interesting for investors who were previously more reserved because of the oversold market. Moreover, in light of the upcoming Brexit and a potential slowdown in the global economy, aspects like liquidity and investment safety carry more weight. The number of properties is also slowly growing: the pipeline is filling up (see graphic).

Demand for office space is growing

The market is responding to the positive economy in Germany, although with significant hesitation. “Demand for office space remained in check for quite a while. After the financial crisis, companies were risk-averse,” reports Ralf Fröba, Head of Office and Investment Markets at Bulwiengesa, an analyst firm based in Munich. Existing capacities were utilised as long as possible. The result: new construction volumes saw below-average growth. Unattractive inventory was either taken off the market or repurposed. Munich lost almost one million square metres of office space. 

Right now, it’s easier to find tenants than establish firm construction costs and deadlines.

Finally, after years of upward trends, many companies now want to expand in style or move into modern offices. “Demand for office space is extremely high, even in secondary or tertiary cities,” explains Matthias Leube, CEO of real estate company Colliers International Deutschland. The growing demand is encountering meagre offerings: in Frankfurt am Main, only eight percent of office space is not let, and that number is shrinking. That also has to do with Brexit. “Individual banks are shifting their staff here so they can continue operations, regardless of what happens at the end of March,” says Felix Schindler, Head of Research at Warburg-HIH. In Munich, empty office space is already below two percent, and the situation in central locations in Berlin is not much better. On average, less than four percent of office space is vacant in leading cities. In 2010, it was still ten percent. 

New properties are being developed, but the pre-letting rates are also high. For example, take the Four project in Frankfurt am Main: Union Investment acquired one of the towers with 25 storeys and 24,000 square metres for the UniImmo: Deutschland fund during development. During demolition on the construction site, 38 percent of the project was already pre-let to the international law firm of Baker McKenzie. The project is not slated for completion until late 2022.

Building sites are becoming scarce

Mixed-use buildings dominate in central locations in particular, because cities want to revitalise their downtown areas. Very few experts believe that new construction could lead to overcapacities in light of the enormous demand. There is very little room for upward manoeuvre because of limited resources in the construction industry. “Right now it’s easier to find tenants than establish firm construction costs and deadlines,” states Fröba, the analyst.

And there simply are not many unused plots of land in most primary and secondary cities, except possibly in the capital. But demand for space is very high there as well. Accordingly, investors see great potential for rent increases, especially since German rates for letting office space are considered low in international comparison. For example, peak rental rates for the year are €390 per square metre in Berlin versus €810 in Paris; Frankfurt am Main (€480) undercuts London significantly (€1,390). “That’s the story for many investors who are willing to accept returns of three percent,” says Felix Schindler, coordinator for office market forecasting at the Society of Property Researchers in Wiesbaden. The forecast, which is compiled from semi-annual surveys of 18 research institutes, predicts a slight rise in returns in 2019 – with the greatest potential in Düsseldorf, Frankfurt am Main and Berlin.

Helge Scheunemann, Head of Research at JLL, also believes that returns have stabilised, however: “It’s still expensive.” Since the prospects vary widely depending on micro-location, appointment and feature quality and tenant creditworthiness, investors interested in deals should “take a very close look.” Scheunemann has noticed a growing need for security among institutional investors. “City centres offer the best foundation and lowest risk for that, even when a lease agreement expires.” Those who prefer a city address – business-related service providers, for example – also tend to be stable tenants during a downswing.

The same holds true for the government. Warburg-HIH acquired the newly built DB Brick and DB Tower in Frankfurt’s European quarter for several pension funds. Deutsche Bahn is leasing the properties for 20 years, and the first employees will move in at the end of 2020. Warburg-HIH wanted to secure an especially attractive development “in an early project stage.” Aurelis was the seller. Union Investment acquired the Rathaus Mitte building in Berlin from a joint venture. The federal government is using it as an administrative building. “It was an extraordinarily good investment opportunity for us as conservative, long-term-oriented investment managers,” notes Alejandro Obermeyer, Head of Investment Management Europe at Union Investment Real Estate GmbH. Niche investments like care and nursing properties or car parks may promise higher yields, but are riskier. “Personally, I feel alternative investments are not all that simple. People invest in a comparatively small pool, and niches are not as liquid in times of crisis,” Colliers CEO Leube points out. “That can trigger heavy fluctuations.”

Lack of experience

And co-working? According to Bulwiengesa, the percentage of flexible workspace out of total floorspace turnover in Germany’s big seven – Berlin, Düsseldorf, Frankfurt am Main, Hamburg, Cologne, Munich and Stuttgart – grew over the last five years from 0.5 to almost 8 percent, and studies still attest to growing demand. Nevertheless, “Investor behaviour is somewhat reserved here, at least until more empirical data emerges,” observes Scheunemann. Do companies cancel leases for comparatively expensive office space first in a crisis? How stable are the letting situations when competition between providers is growing all the time? And how sustainable are business models where the yields develop as dramatically as the losses? The segment needs to prove itself first in the eyes of conservative investors.

By Christine Mattauch

“Central locations benefit from a tight job market”

The German office property market is a preferred investment objective of La Française Global Real Estate Investment Managers. CEO Marc Bertrand still sees a great deal of potential for rent increases

Mr Bertrand, La Française focuses on internationalisation. Do you want to expand your involvement in Germany as well?

That’s a resounding yes – provided we find properties with acceptable yields. Two years ago, yields in Germany were higher than in France. That’s no longer the case. Generally speaking, however, we see more potential for rent growth in Germany because the supply there responds slower than in France.

Which cities do you find particularly appealing?

We like Berlin and Munich because vacancies are very low, but we also looked around in secondary cities. Because of Germany’s federal structure we invest more in smaller cities than we would in France, especially if they combine economic growth with a science and research profile. We prefer A-locations in dynamic secondary cities like Leipzig or Nuremberg compared to B- and C-locations in top cities.

Where did your company acquire a property most recently?

We were very active in 2017 and purchased an office property in Hamburg, one in Stuttgart and Campus 53 in Frankfurt. We’ve also invested in Berlin. The office sector was somewhat disappointing for us in 2018 because we didn’t find any properties that met our requirements. We’re currently in the process of concluding a transaction in Essen. However, we were successful with leasing in 2018. In Berlin, for example, we were able to re-let 4,000 square metres for double the price.

How do you assess the long-term prospects for the office sector?

Germany has traditionally been an industrial country and will continue to add services. This is precisely the sector that generates demand for office space. The key question is: how much leeway is there for rent increases? We feel positive about that. However, there are significant differences in the square footage per employee between cities like London or Paris and Hamburg or Berlin. That has to do with rent levels. In other words: when rents go up, there is above average rationalisation potential in Germany. We see a forerunner of this development with co-working. The usage density in this area is much higher than in the traditional sector.

What is your strategy?

We follow the tenants in our investment decisions. In our opinion, demand will increase in central locations, especially in quality properties with modern features and equipment. The German office market has less inventory to offer in this segment than Great Britain or France, and needs to catch up. By contrast, old buildings in peripheral locations will have an increasingly difficult time. That isn’t exactly a new development, but the gap is widening, also because of new ways of working. The more flexible businesses and their employees become, the more important it is to be networked, and a central location facilitates that. There is yet another point in favour of central locations: the tight job market in Germany. Good, centrally located office properties help companies recruit young talent.

How heavily will rising interest rates influence the German market?

The person who can predict that has it made (laughs). I think that the effect of growing investor competition will be balanced out because Germany will become even more attractive as a safe investment location in light of increasing global uncertainty. Thus, we do not assume that slight increases in interest rates will negatively impact yield prospects.

Christine Mattauch conducted the interview.