We are living in times when forecasts can become obsolete overnight. Not long ago, real estate services provider CBRE was bullish about the German property markets, hailing an economic recovery, robust fundamentals and a transaction volume of at least €85 billion. And now? “The current circumstances are radically different from the start of the year,” says Jan Linsin, Head of Research Germany at CBRE. He is cautious in his latest outlook: “The German economy is bracing itself to deal with exogenous risk factors.” In other words: facing the consequences of the war in Ukraine.
The Russian invasion represents a turning point that spells significantly weaker economic growth, rising interest rates and inflation, plus threats to energy supply. The German property market is not immune to these impacts. An appetite for risk and deals has been replaced by restraint and caution; many market players anticipate that the geopolitical and economic situation could change at any moment.
Fewer transactions – but international investors are not quitting the German market
There is an additional reason for this wait-and-see attitude. “The prevailing mood at the moment seems to be that in most markets properties will be cheaper in the medium term,” says Timothy Horrocks, Head of Real Estate Continental Europe at Nuveen Real Estate, which is one of the world’s biggest investment managers with assets under management of €113 billion. Potential buyers expect prices to fall, whereas sellers are still frequently fighting the trend. The market needs to reset, which takes time.
Is the German property market still viewed as a safe haven, even in these more challenging times? The “Trendbarometer Immobilienanlagen der Assekuranz 2022” report on trends in property investment by insurance companies, published in July by EY Real Estate, shows that Germany is still the most popular location for real estate investment. Transaction volumes in the first six months of 2022 were five percent higher than in the prior year, with foreign investors accounting for a substantial proportion. The biggest deal was the acquisition of a 91.6 percent stake in Alstria by Canadian asset manager Brookfield. Statistically, “that helped push up the share of foreign investors to 42.3 percent,” says Matthias Barthauer, Lead Director Research at JLL. “But even without the Alstria deal, the proportion would still have been a hefty 39.8 percent.”
It’s highly probable that global investors won’t leave Germany, although some may well sit on the sidelines for a while.
Compared to the first quarter, however, the volume of transactions almost halved in the second quarter to €12.3 billion, reflecting the general uncertainty. But neither geographic proximity to the war nor the gloomy economic outlook have so far caused global investors to retreat from the German market – unlike Eastern Europe, where some investors have already stopped doing any new deals. Compared to other EU countries, Germany has proved resilient in terms of transactions.
“As a major established property market in Europe with high liquidity and a solid equity base, Germany is very attractive to global investors as a real estate location,” says Nuveen manager Timothy Horrocks. Compared to other large markets such as the UK, the German market is also less volatile, he adds. “That definitely makes the country more attractive.”
Inflationary and economic risks deemed manageable in Germany
Given the rising cost of debt finance, Horrocks sees an advantage for equity-rich German investors in particular who know their domestic market well. As such, there could be “a delay in seeing market corrections”, with international investors likely to hold back initially. “It’s highly probable that global investors won’t leave Germany, although some may well sit on the sidelines for a while.”
In Europe’s biggest economy, inflationary and economic risks are regarded as manageable, partly due to the low level of debt by international standards, which gives the country some leeway in the eyes of investors. Yields on ten-year German government bonds thus remain low. Although the property market is not as transparent as in the US and UK, Germany regularly features in the top ten of JLL’s Global Real Estate Transparency Index and actually moved up a place this year. For investors taking a long-term view, the availability of high-quality, sustainably built properties also counts, believes analyst Jan Linsin: “Rising vacancies are generally associated with poor property quality.”
Indexation of commercial leases an important hedge against inflation
Modern space in good locations continues to be coveted by tenants. According to BNP Paribas Real Estate, in the first half of the year 1.82 million square metres of office space was taken up across the top eight German cities, an increase of 34 percent on the prior year. One factor that is now nearly as important to investors as strong demand is indexation of commercial leases, which provides good protection against inflation. In other countries, this practice is far less common. In the UK, for example, commercial rents are typically adjusted every three to five years through rent reviews.
For Allianz Real Estate, a major global real estate investment manager, Germany remains an important market, says Nicole Pötsch, Head of Investment and Strategic Development for North & Central Europe. “At present we’re extremely selective about new activities, but continue to be open to opportunities if they’re compelling enough.” In March, Allianz joined forces with developer Edge and pension fund Bayerische Versorgungskammer (BVK) to develop sustainable office properties in four leading German locations. The first site, Wriezener Karree in Berlin, was purchased shortly afterwards, in April. In late June, Allianz Real Estate then acquired a logistics property. Offices and logistics are areas where Pötsch sees demand in the future too – and the potential for rent increases. “When it comes to residential, we’re currently a bit more cautious.”
That stance is understandable. Rising construction, materials and financing costs are hitting viability in almost all real estate sectors, but especially in the residential segment. Due to regulation, a widespread lack of indexation and falling real incomes it is becoming more difficult to pass on higher costs to tenants in a timely manner. In the case of new builds, there is also an increased risk of voids. The landscape needs to change for it to be worthwhile for investors to get involved, says Ulrich Schmidt, an expert in financial markets at the Kiel Institute for the World Economy. “I expect significant price corrections if interest rates remain at their present level or fall.”
Apartment buildings are already trading at 20 to 25 times the annual rent rather than the 30 times that was previously the case, he adds.
It might therefore be worth waiting – or changing tack. “In future, we intend to invest more in the subsidised housing sector,” says Allianz manager Nicole Pötsch. The state-defined financial framework and reliable occupancy make this type of investment particularly attractive in times of crisis. According to Pötsch “it’s pretty unbeatable in terms of stability”.
The altered market conditions are also invigorating other niche areas. W. P. Carey, for example, a New York REIT, specialises in sale-and-leaseback transactions and says it will be investing some $800 million in Europe this year. In the past, only a small proportion of its transactions were in Germany. “We like Germany as a location very much, but it was also very expensive,” says Christopher Mertlitz, Head of European Investments. That could now change, and rising loan rates are also likely to make companies more interested in alternative sources of finance.
Mertlitz certainly sees “good prospects for finding properties”. Additionally, North American investors like W. P. Carey are benefiting from the tailwind of the US dollar’s strength against the euro.
Having said that, the course of the Ukraine war, the European Central Bank’s interest rate strategy and the state of the economy will dictate how things play out. “A severe recession would affect occupier markets across the board,” warns JLL researcher Matthias Barthauer. In the case of an “intermediate scenario” without major upheaval, however, Germany’s real estate market would benefit from the desire to hedge against inflation and from the scarcity of investment opportunities, he believes, because the pressure is increasing with each month that passes. “We expect a strong finish to the year.”
“Every market situation offers opportunities”
Alejandro Obermeyer, Head of Investment Management DACH at Union Investment, talks about the company’s view of Germany as a real estate location.
What strategy are you currently pursuing in the German property market?
In colloquial terms, we’ve got our foot on the gas and the brake at the same time. The markets are getting more difficult, but every market situation offers opportunities. It’s all about leveraging them systematically. We are perfectly placed to do that.
Where do you see opportunities, specifically?
Location quality is fundamental and plays a major role. There are also increasingly tough requirements when it comes to a building’s technical standards, while structures need to be contemporary and modern. This can be achieved on new build projects as well as with good existing stock.
Are enough attractive properties coming onto the market?
We’re currently seeing a tendency to put projects on hold. If there is less new product, the rental markets will stabilise, not just in the new build sector but also in terms of existing properties. That scenario offers excellent opportunities for investment.
Do foreign investors have an advantage?
Yes, but foreign investors typically finance their investments through borrowing so significantly higher interest rates work against them. In addition, international investors usually take longer to adapt to changes in market conditions. We have in-depth knowledge of the German market and are a reliable partner, particularly in tough times. Sellers appreciate that.
Von Christine Mattauch