GERMANY ARRIVED VERY late to the European commercial real estate party. In fact, no sooner had it walked through the door and taken its coat off than the music stopped. And while revellers such as the UK and Spain are now slowly opening one eye to greet their long and painful hangovers, Germany is looking pretty fresh faced by comparison.
Long the laggard in Europe, the German property market spent the past few years slowly beginning to catch up. According to EuroHypo’s 2007 German Market Report, prime office yields in big cities now vary from 4.25% in Munich and 4.5% in Frankfurt to 6.5% in Leipzig. The enduring problem of this market has been overcapacity, and vacancy rates remain stubbornly high in some areas. Office vacancy rates range from 7.5% in Hamburg to 21.2% in Leipzig but many cities in between are well into double digits.
"If you drive through Leipzig at night most of the high-rise buildings have dark windows – there is simply no one in them," says a property analyst. "Anecdotal stories persist of investors buying blocks of, say, 10,000 flats in Dresden or Leipzig just to tear two-thirds of them down to reduce supply."
But it is just that oversupply that has prevented the development in Germany of the kind of overheated property market that has been seen, for example, in Spain and the UK. "In the recent past, Germany did not experience a house price bubble or a mortgage market bubble comparable to other European countries," says Florian Hillenbrand, analyst at UniCredit. "The charm of the market rather lies in the low downside risk rather than in the upside potential, mainly due to the diminishing but still substantial oversupply mainly in eastern Germany. Hence, paying a small premium to get involved in this stable market per se is not unreasonable."
Because of healthy rental growth, yields in the central business districts of the five largest cities look robust, and the office segment in these districts is probably the most attractive property play. Tight planning controls in the retail sector mean that this should also outperform (with the exception of warehousing). But exposure to office space in secondary locations with vacancy risk will be increasingly shunned. "The appetite for risk has definitely fallen," says Benedikt Kiesl, managing director, European structured finance, at Eurohypo. "People will no longer be prepared to buy a 50% vacant portfolio with two years to run."
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"The German open-ended funds are in a very good position. As the maximum debt they are allowed by law is 50%, they have been largely untouched by the credit crunch" James Lapushner, Morgan Stanley |
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James Lapushner, managing director at Morgan Stanley in Frankfurt, believes that Germany is now the best real estate prospect in the region. "Real estate is an institutional asset class and it is global," he says. "Investors are going to buy where the fundamentals are and Germany has one of the best real estate fundamentals in the whole of Europe." According to the Eurohypo report, economic growth coupled with rising employment means that there has been an increase in letting activity in the office sector and rents in prime retail space have been stable. But the question remains whether rents can continue to rise faster than yields; after the events of last summer, yields across German real estate increased by 20% in the second half of the year, and they are likely to keep rising at least in the short term.
The attractions of a market in recovery have not escaped the many foreign investors that have piled into Germany in recent years and pushed transaction volumes in 2007 to €50 billion. According to CBRE, 33% of inward investment to German real estate during the 18 months from 2006 to mid-2007 came from the US and 10% from the UK. A recent study undertaken by Berlin-based real estate investment group Estavis claimed that of 29 institutional investors surveyed in Germany, the US, UK and Scandinavia, nearly 70% wanted to increase their activity in the German property market and 23% planned to maintain their current investment level. Just 9% intended to reduce their exposure.
But as asset values in, for example, the UK continue to tumble, can Germany remain relatively immune?
Nobody looking at share prices in the German property sector would argue that this market has remained even remotely immune. Even the large, established names, such as IVG Immobilien, have suffered share price falls, and the shares of some of the German property trading companies have collapsed by 60% to 70%. But this should be looked at in perspective, given what has been happening in other European jurisdictions: Spanish property conglomerate Colonial’s share price plunged 38% in two days at the end of 2007.
"You have to ask whether the share price [of German property firms] is a reflection of market volatility and nervous sentiment," says Carsten Schoenen, real estate specialist strategist at Commerzbank. "You have to differentiate between business models: those with core portfolios of long-term holdings (such as IVG and Deutsche EuroShop) should hold up OK. Trading companies whose earnings are driven by the P&L [such as Estavis, which recently lowered its forecasts for the year] may be more infected by sub-prime." The consequence could be a spate of consolidation in this part of the market. Indeed, the recent sale of a 54% stake in Frankfurt-based residential property firm FranconoRheinmain by Grainger of the UK could be a sign of things to come. "This deal has opened up a lot of people’s eyes," reckons one observer.
Even the large players with core portfolios are feeling the impact of equity market volatility. IVG Immobilien has had to change its real estate investment trust plans as a consequence of the hammering that German real estate stocks have taken; its planned trust was recently postponed until values improve. "As long as equity value is at a huge discount to NAV then no asset manager is going to go forward with a placement of an IPO," says Schoenen. Just two German Reits have launched since legislation was passed, although Hamburg-based TAG Tegnersee has also registered a pre-Reit; this will not launch until valuations improve.