Looking back, it seems as if the real estate industry was able to operate in near-perfect conditions for many years. Of course, there was the major financial crisis of 2008–2009, triggered by the insolvency of Lehman Brothers investment bank and the bursting of the American housing bubble. But things then steadily recovered and just got better.
Record low interest rates made real estate a sought-after asset class, with prices climbing ever higher. Robust economic performance simultaneously boosted demand across almost all asset classes. Sentiment was so positive that while the Covid-19 outbreak in 2020 put a damper on the property markets, there was no slump. But everything changed in 2022. Geopolitically, Russia’s war of aggression in Ukraine started on 24 February, an event that transformed the political map and had a widespread economic impact – particularly in those European countries that, like Germany, obtained most of their oil and gas from Russia. To all this was added a combination of inflation and higher interest rates, which few observers had expected on this scale. The real estate industry, being highly dependent on borrowed capital, was left reeling.
To mention just one of the impacts: commercial property transactions in Germany fell by 12 percent compared to 2021 according to consultancy firm Colliers, with the fourth quarter posting the lowest sales figures of any final quarter since 2011. However, by the end of the year it had become apparent that inflation and interest rates were unlikely to rise much further.
Easing of inflation and interest rates
According to Eurostat figures, inflation in the eurozone was 9.2 percent at the end of 2022, and thus significantly lower than in November (10.1 percent). Observers believe that the drop in inflation is likely to reduce pressure on the European Central Bank to tighten monetary policy further, following three interest rate hikes in 2022. The feared economic slump has also failed to materialise.
For Germany, the federal government is expecting moderate growth of 0.2 percent this year, while the European Commission is predicting growth of 0.3 percent for the EU. “We have reached peak inflation,” says Michael Bütter, CEO and Chairman of the Management Board of Union Investment Real Estate GmbH. “This more benign situation will help the capital markets to calibrate interest rates accordingly.” Once interest rates stabilise, property prices will readjust and unlock the market, in Bütter’s view. That is namely what is lacking at the moment, not properties as such.
“We have tomorrow’s products at yesterday’s prices,” says Bütter. In other words, many sellers are asking prices that potential investors are not willing to pay, given that debt capital has become much more expensive. According to Bütter, some significant price reductions are already taking place, but this is not yet the case across the board in all asset classes. The CEO of Union Investment Real Estate GmbH expects this to change by the third quarter of 2023, when interest rates will have stabilised. However, that does not mean the company’s fund managers are sitting on their hands. Even in 2022, with all the many challenges, Union Investment boosted its assets under management by 9 percent to over €56 billion. That meant the growth rate was exactly the same as in 2021, i.e. before interest rates started to rise. Last year, Union Investment’s acquisitions totalled €4.1 billion. More would have been possible. “We have deliberately opted for a cautious investment strategy instead of pursuing additional growth. We intend to wait for the inevitable price corrections in the wake of interest rate rises,” says Michael Bütter.
Union Investment is also responding to shifts in demand, as illustrated by an example from the hotel segment. The recent acquisition of an Autograph Collection by Marriott Bonvoy boutique hotel on Lake Tegernsee in Bavaria was the investment manager’s first foray into the crisis-resistant resort hotel sector. Bütter says that purely business hotels are not currently on the acquisition list. Union Investment has also been active on the sales front, disposing of fund properties selectively where the prices are right.
Acquisitions and portfolio investments: getting the timing right
Investment in the portfolio is particularly important in the current market phase. “We regard asset management as key to increasing the value of our properties,” says Michael Bütter. Alongside the creation of additional rental space, investments that enhance the sustainability of fund properties are particularly worthwhile. “Improving energy efficiency is a win-win situation,” explains Bütter. Tenants benefit from lower utility costs, while scope is created for landlords to charge higher base rents. Union Investment is also proactively nurturing its existing tenants. When agreeing long-term lease extensions, asset managers can support existing tenants by not taking full inflation into account in rent indexation. But where it makes sense, increasing rents in line with inflation is an effective way of boosting fund performance, says Bütter.
In addition to these measures on the revenue side, the acquisition of capital is also crucial. “In the current market situation, we’re trying to collect as much capital as possible, and then when prices have stabilised we intend to invest this money and generate attractive returns,” says Michael Bütter, summarising the company’s strategy. Union Investment also plans to target Asia as an additional source of institutional capital for medium to large volume transactions in Europe. Cash will also be freed up by giving domestic or foreign capital minority stakes in existing assets.
We have deliberately opted for a cautious investment strategy and intend to wait for the inevitable price corrections in the wake of interest rate rises.
Bütter intends to reinvest this capital in real estate soon. “By the third quarter of 2023 at the latest, when interest rates should have stabilised, we will see a significant drop in prices in most asset classes, which will unlock transaction activity,” thus his assessment. He believes that three things will be key to seizing the opportunities that arise: “Capital, decisiveness, and the ability to identify the right time to re-enter the market. We are very well positioned in all three respects.”
For Michael Bütter, the past year’s result also proves that real estate funds remain attractive to investors. The returns of Union Investment’s open-ended real estate funds increased from an average of 2.5 percent in the previous year to 3.1 percent. Real estate funds are much less volatile than shares and bonds and they also offer tax benefits, notes the Union Investment Real Estate CEO. “They aren’t a yield kicker, but they are a stabilising element in portfolios – particularly in high-quality, sustainable portfolios that offer inflation protection.”
By Christian Hunziker