John Amram CEO of the real estate service provider HPBA Off-Market-Solutions.
The situation on the German real estate investment markets is more complicated than ever before. For the first time we are now also seeing declining purchase prices. Against this background can Germany continue to be regarded as a safe haven? Yes, but not without some reservations.
The narrative of Germany as a “secure real estate haven” takes in three aspects above all: legal security, liquidity and stable fundamental data. Generally, legal security is guaranteed, but this is merely a prerequisite that does not allow any conclusions to be drawn on the profitability of an investment.
The second aspect is the high level of market liquidity at present. With an (official) reported record volume of 111 billion euros in 2021 and a strong start to this year, with 24 billion euros in the first quarter of 2022, Germany still ranks among the most liquid real estate locations, and is at about the same level as the United Kingdom (approximately 18.7 billion euros). This liquidity results from a high degree of interest on the part of investors to date, yet is not an indicator with regard to future developments.
Vulnerable at present
The third criterion is ultimately a combination of strong economic fundamental data and growth potential for companies. Above all in this respect Germany is currently more vulnerable than it has been in recent years – and even in a comparison with the coronavirus years 2020 and 2021. Ultimately, as a consequence of the Ukraine War the Kiel Institute for the World Economy (IfW) recently adjusted its prognosis for economic growth from 5.1% to 2.1%. This prognosis is thus also significantly lower than the European average of 2.8%.
This situation is exacerbated by the current combination of a heavily inflationary tendency of more than 7%, the interruptions in supply chains, and the energy crisis with an explosion of 39.5% in prices in a year-on-year comparison. This is causing Germany as an industrialised nation challenges it has never before faced.
The challenges on the real estate markets are also numerous: high purchase prices until recently – with average prime yields of 2.61% for core office properties – and the similarly low yields with residential properties (ratio of rental income to purchase price) mean that the leeway for further appreciation in value is limited – and especially so as the de facto interest rates for loans are already between 2% and 3%.
At present we are also experiencing price declines and lower multiplicators as a result of the increase in interest rates. Insofar as it is possible to ride out such short-term dips in prices, an investment in German real estate can serve to retain value and safeguard a portfolio in the long term. This also corresponds to the image of the “safe haven” to a large extent. On the other hand, unexpected vacancies or additional expenses can soon mean that a badly planned investment can become a precarious one.
There are also signs that point to a positive development in value, however. Firstly, office vacancies in the top 7 German cities are extremely low (4.5% at the end of 2021) compared with the averages in the corresponding European locations (7.2%), in the United Kingdom (6.8%), and above all in the USA (12.3%). Secondly, the prime rents in the office segment are still relatively low in an international comparison at 42.50 euros per square metre and month even in the “most expensive” office cities Frankfurt am Main and Munich – so even in the worst-case scenario of a recession and an increase in insolvencies the “downfall” would be significantly less dramatic than in cities such as Paris and Madrid.
Likewise, when it comes to modern apartments and logistics properties, there is, on the whole, considerable surplus demand, at least on the part of tenants. In the residential segment, the current wave of refugees with as many as 100,000 evacuees is now ensuring an enormous surge in demand in cities such as Berlin with major Ukrainian- and Russian-speaking communities.
In the commercial real estate segment, in contrast, it is above all “green” real estate, which is certified as being sustainable therefore, that is in short supply. As more and more companies intend to achieve CO2 neutrality in line with the climate targets laid down in the Paris Accords and as the areas utilised play a very important role in this respect, it may be assumed that demand will remain high in this sub-market – especially so as real estate which meets high ESG standards continues to be quite rare.
Only “green” properties
The same is true for investors such as fund managers, who due to the EU taxonomy and similar regulations can now only buy “green” properties for some fund products. Real estate which does not meet these criteria and which cannot be retrofitted, in contrast, will become usable for fewer and fewer companies and subsequently see its value decline in the medium term. Moreover, institutional investors primarily earn their income on the capital markets. The current bear market can mean, therefore, that less funding is available and that correspondingly less capital can be invested in real estate.
In the long term Germany remains a competitive location with a combination of relatively low government debt measured in terms of gross domestic product, excellently trained skilled personnel and a heavily decentralised economy dominated by SMEs. Accordingly, the signs are positive that both the economy and the real estate markets will prove themselves to be robust.
Furthermore, the perception that German investors rank among the most defensive in the world – and that the proportion of national buyers on the German transaction markets remains high – will ensure a sense of security among international investors. In other words: the image of the “safe investment haven” with a convincing risk/return ratio can also still be appropriate – albeit no longer at every location, in every asset class and with every tenant profile. And above all: only with a fair market price.
The wind is turning
In the short term, however, all the signs increasingly point to the wind on the markets turning and that we are moving into a buyer’s market. This will lead to new challenges, and also opportunities, for both sides. For buyers awash in equity capital, who are only dependent on loans to a limited extent and accordingly can invest despite the shift in interest rates, it will presumably be easier to find a promising product.
For sellers, in contrast, the greatest-possible deal security is now all the more important. As a consequence of the first decline in prices which has now been observed in a number of segments, it is all the more relevant that a planned transaction also comes to fruition. In this respect the seller has to be fully familiar with the market – and know who is a reliable trading partner even in a challenging environment and with higher interest rates.