Author: Monika Leykam
International investors, for whom German real estate had become too expensive in the boom years, are now setting store by rising returns. In individual cases this strategy has already paid off. Prices are still too high for the majority, however.
“You now get more for your money on the German real estate market; German properties are becoming more attractive for investors.” When a sentence like this is uttered by a heavyweight such as the global developer and asset manager Hines, it pays to listen more closely. Hines currently has nearly 2.5 billion euros of equity capital to hand for real estate purchases in Europe. Its funds make purchases in the risk spectrum from core plus to value-add.
Alexander Knapp, Chief Investment Officer Europe at Hines, is confident that in the current year the funds will strike a deal more frequently than they did last year. “We are looking forward to 2023,” he says. “Across all the risk classes there will be a larger number of motivated sellers than to date, as not every owner will be able to get the refinancing they are looking for. We will complete more deals than last year.” Knapp hopes to find the “motivated sellers” among owners whose bank loans are expiring, among smaller fund managers, and among developers sitting on building land for which the financing clock is ticking.
Hopes of having an opportunity to enter the market are even rising for fully-leased properties in the core risk class – which are traditionally particularly expensive in Germany. Peter Schreppel, responsible at CBRE Germany for accompanying international investors, has been pleased with the “very positive feedback” from his clients since the shift in German prices. “Investors expect that returns for top German products will rise a little further in the near future. Investors with strong equity positions such as sovereign wealth funds and pension funds are waiting in the wings. They can see a window opening here.”
The window is not yet wide open, however, if one believes the reports by brokers. Ultimately prime yields for classic German core office buildings as officially communicated by brokers still have a three in front of the decimal point. “Political numbers” is how Oliver Obert, a partner at the real estate consultancy Oceans & Company describes this. “The price slump is actually much greater.” CBRE consultant Schreppel expects the turnaround to come about when the magical three is no longer to be seen in front of the decimal point: “An international investor feels quite comfortable with the prospect of an initial return of 4% when his three criteria with regard to building standards, sustainability and location are fulfilled, namely quality, ESG, CBD.”
Yet Schreppel also sees considerable interest in the segment below the one formed by core properties – albeit often still without a tangible result. “Return-oriented investors are participating in bidding processes, but their bids are sometimes 20% beneath the lower price limit. They cannot yet fulfil their expectations.”
One of these is Justin Meissel, the head buyer at the European investment boutique Henley. He would like to buy in Germany this year, but he knows that he will probably have to be very patient. “There are now more opportunities for us in Germany than a year ago. But we are of the opinion that sellers will have to lower their price expectations by 10% to 25%.” This has not yet happened in full, he says. “The transaction market has not yet really picked up, and it is quite possible that this situation won’t have changed by the end of 2023.”
Meissel sees “more realistic price expectations in Great Britain, the Netherlands and Ireland than in Germany”. According to the global research and analysis firm MSCI the purchase offers for German office properties are currently 25% lower than the asking prices.
In none of the European markets analysed by MSCI is this divide greater than in Germany. For Great Britain the head of European research at MSCI, Tom Leahy, sees a difference of nearly 23%; in France, in contrast, the market players are for the most part in agreement
(-4.5%). And while in 2022 the level of investment in England – just as in Germany – was considerably lower than that for 2021, France posted an uptick of 3% in turnover.
A similar pattern is revealed in a survey by the fund association Inrev, in which the relevant professional large-scale global investors disclose their respective investment preferences. Accordingly, non-European real estate investors have a particularly keen eye on France for 2023 (88%), followed by Great Britain (75%). Germany only takes third place in the list of the most sought-after European real estate markets, with 63%.
The price issue is particularly relevant for buyers from other continents as they invest in the upper echelons of the risk spectrum more frequently when they venture into the European market. 80% of the Asians surveyed by Inrev and 83% of the North Americans would like to invest in the opportunistic and value-add risk classes in Europe this year – in their region the Europeans focus on core (57%).
Jan Eckert, Head of Capital Markets for Germany, Switzerland and Austria at JLL, doubts that the hopes of foreigners seeing a price slump in Germany in their hunt for good returns will become a reality. In this respect the market here is too stable, he believes. “Germany is, in contrast to Poland and Spain, not as heavily dependent on foreign capital thanks to its broad domestic investor base. As a consequence the price fluctuations are not as great. Naturally this is not pleasing for every foreign investor, as they would like to see prices slump to a greater degree.”
“A lot of pitches, but very few transactions being consummated,” is the observation by Eckert at present. “Private equity funds with high target returns have raised quite a lot of capital of late as they were hoping for major shifts in returns. But here in Germany there are not that many emergency situations at all. We are not facing a major real estate recession, in which those aggressively seeking good yields can strike lucky on a big scale.”
But has the combination of war, inflation and a gloomy economic outlook actually failed to leave its mark on Germany, with no impact on its image as a “safe haven”? No, concedes even the otherwise confident JLL consultant Eckert. “The war has changed the perception of Germany. We are now holding the safe haven discussion on a totally different level compared to the past ten years. For Asians Germany is very close to Ukraine, for example. Since the outbreak of the war the sale of German condominiums to Asia has plunged sharply.”
In 2022 the sentiment towards Germany was not quite as buoyant among globally active investors because of the many elements of uncertainty, but the prospects improve if we look to the future, says Hines manager Knapp. “None of our investors is of the opinion that investments in Germany are problematic. On the contrary: they would be happy if they could complete more deals here.” He still regards Germany “as a safe haven – relatively speaking”. Germany is a “relatively safe haven in the European context” is also the almost identical phrasing used by Henley head buyer Meissel, and he lists his arguments: “An economic heavyweight with a real estate market that offers more volume and liquidity than many of its neighbouring countries.”
The buyers of German real estate are quite prepared to continue paying good money for these many benefits of Germany as a location. Oliver Obert from Oceans & Company accompanies a number of foreign value-add investors from the private equity sector in their search for opportunities in which an owner could really use a problem-solving partner, and he says that not a lot is happening yet. “International value-add investors are looking for deals, but can’t find any that suit their target returns. Now, in February 2023, it is still too early in the cycle, the purchase prices are still too high for most value-add buyers. They do not wish to catch a falling knife.”
The reason for this is the sharp rise in interest rates, which makes a complete recalculation of returns necessary. “Those now borrowing to finance purchases have to deploy a much greater amount of equity capital than before and pay higher lending rates. The expected exit prices at the end of the holding period are also lower than before the shift in interest rates. So that investors can nevertheless attain a double-digit rate of return, they have to buy very, very cheaply, therefore.”
The majority of sellers are simply not in a position to offer such mark-downs, however – because of the valuation on their balance sheets or the third-party financing which they would no longer be able to repay. On account of the constant fluctuation in interest rates a number of elaborate calculations for various deals, for which exclusivity had already been agreed upon, have gone up in smoke on a number of occasions, sighs Obert.
In theory investors with strong equity positions could avoid this problem. But they cannot operate independently of the rest of the capital market. “In the meantime it is once again possible to attain very good returns with US government bonds and corporate bonds, as well as bonds from publicly-listed real estate firms,” explains Obert.
“In this situation equity investors tend to ask themselves: Why should I – with comparable yields at present – take the risk of a real estate investment when I can also get good interest rates elsewhere? At the moment the more expensive office properties with their lower initial returns are suffering as a result of this perception. Investors cannot find an answer to the question of what an appropriate risk premium is for such investments because of the uncertain interest rate situation.”
Alexander Knapp from Hines describes the problem as “new versus old mathematics”. Hines is now looking for deals which also function on the basis of the “new mathematics”, without cheap borrowed capital and a lack of competition from interest-bearing alternative investments. When asked about example transactions which function on the basis of this new mathematics, he points to the purchase of the Georgstor office building in Hamburg for the Hines European Property Partners fund in December 2022. According to reports the price was 110 million euros. In January 2022 he would certainly have had to pay more for the property, says Knapp.
Those looking for more examples in which the “new mathematics” is already having an impact only need to ask John Amram. His brokerage firm HPBA specialises in off-market deals, in transactions that take place beneath the radar of other brokers and their structured bidding processes, therefore. About 70% of HPBA’s clients come from abroad. “A lot of state funds and large family offices are now tending to allocate more new capital for Germany than before. They are hoping to see discounts on properties in top locations,” reports Amram. “This functions in individual cases, but not on a broad basis.”
Yet institutionals from Asia, private equity funds and investors from the Middle East are currently to be found on the look-out in Germany, with some of them newcomers to the German market. “The argument that Germany is a safe haven is still applicable as far as they are concerned. They appreciate the legal certainty, the strong economy and the positive population growth,” says Amram. And the majority hope that Germany will get to grips with its energy problems.
In the past three months foreign investors have on a number of occasions found what they were looking for, reports Amram. “Newly-constructed apartments which were being sold with a purchase price factor of 30 to 32 one year ago, have now changed hands for 26 and 27 times the annual rent. Portfolio apartments in Berlin which would previously have cost 3,000 euro/sqm have now been sold for 2,200 euros/sqm. Core offices in Berlin and Frankfurt have now changed owners for 27 times the annual rent – but the deals have never been published.”
International money has also been placed on the developer market. According to Amram, various project developments in the affluent metropolitan commuter belts have changed hands at half the prices compared to those seen when the market was at its peak at the end of 2021. In inner-city areas the discount has been as much as 30%. “The projects would otherwise no longer have paid off given the explosion in construction costs.”
Amram is convinced that transactions such as this are possible right now because international investors have not yet come to the German market in droves. “The herd mentality is a big topic among investors. Many of the discussions I have held recently have revolved around the question of whether someone should buy when lots of other investors have not yet been buying. In these cases I always say the same thing: Buy now, because there are scarcely any competitors at present.”
The crucial question of whether German purchase prices will soon fall so low that the transaction market as a whole then picks up is answered by Amram with an unequivocal ‘yes and no’. “The market has not yet stabilised, and no actor likes uncertainty. A purchase decision in such an environment is a question of mentality.” But he feels there are signs that the gap between sellers and buyers is narrowing. “More and more owners are beginning to accept the fact that they will not get more money for their properties than buyers are currently prepared to pay.”