The German listed sector is small relative to the underlying property market. Alex Moss and Fraser Hughes look at whether this is likely to change soon
In terms of underlying value, Germany has the third largest property market of the developed European economies but it is the least securitised. Typically, the listed sector represents 5-8% of the underlying market, with outliers being Hong Kong at 17% and Australia at 18%. Germany's listed sector represents only 1.6% (see figure 1). Not only is the listed sector relatively small compared to the underlying property market, but it is not significant relative to the overall equity market.
There are, however, a large number of listed companies, but little in the way of critical mass. Figure 2, taken from our proprietary database of all listed stocks globally, shows the largest European real estate markets by market capitalisation and the number of listed companies.
The UK has the largest number of listed companies in Europe. It should be remembered that there are a large number of UK listed stocks (on the AIM market) with overseas assets. Germany has the second-highest, but its combined market capitalisation is only approximately a fifth of the size of France's market cap and a quarter of the UK's. On average, the German listed companies are smaller in market cap and free-float terms, and they have lower volumes compared with the other major European economies.
This has not constrained performance, however; the y axis of figure 3 shows the German sector has performed in line with its European peers. The size of the bubble represents the market capitalisation. We therefore believe there is underlying demand for high-quality German listed companies, but that options for investors are currently limited.
There is investor demand for listed German real estate investment trusts (G-REITs); international investors have expressed interest in growth in Germany. Only one German listed company has a market capitalisation over €1bn, which is just outside the top 20 in terms of size within the European real estate sector.
Why the lack of scale in the German listed sector? First, there is a general lack of equity ownership among German individuals, regardless of sector. According to the Deutsche Aktieninstitut (German Equities Institute), only 5.7% of Germans own equities, compared to a developed market range of 20-30% (Netherlands 30%; Japan 28%; USA 26%; UK 23%).
Second, the most common form of investment in real estate for non-institutional investors is via the German open-ended funds (GOEFs), which are distributed by retail banks. This form of competition for retail investors' money does not exist to the same extent in other European countries.
Third, relative to say the UK, there are investor concerns over the level of corporate governance, transparency and valuation accuracy of some of German listed real estate companies. It is fair to say these issues also exist in the German unlisted or private market.
Fourth, similar to the UK, the German REIT legislation was finally introduced in 2007, exactly at the time when the market peaked, and thus, despite a number of companies gaining pre-REIT status, the number of REITs in Germany remained very low.
However, in Q4 and H1 of 2011, interest in German listed real estate has grown, with two IPOs (GSW and Prime Office) raising £549m (€625m) and three secondary issues from AlstriaOffice, DIC and IVG raising £331m, as reflected in figure 4.
The continued growth of the German listed sector will be dependent on two factors:
• A realisation of the relative attractions of G-REITs compared to GOEFs.
We believe that sentiment towards the open-ended funds has shifted following the well-documented redemption issues during the financial crisis, and credibility issues surrounding the underlying valuations.
At the end of March 2011, 10 funds were temporarily closed due to redemptions and another three were in the process of liquidation: CBRE estimates that this represents around 31% of the sector by funds under management. In 1H 11, GOEFs were net sellers, with disposals of €1.5bn outweighing acquisitions of €1.2bn.
Historically, investors have been unhappy switching from GOEFs to the listed sector, as a number of companies suffered reputational issues. However, we believe the G-REIT, legislation of 2007 provides an ideal vehicle for investors wanting exposure to the direct market without the style drift and corporate governance issues associated with that sector.
• A desire to participate in the less volatile German property market.
We believe the German commercial real estate market has just entered a period where investment capital directed to it will increase substantially, with investors looking for suitable vehicles to participate in the anticipated growth. In a recent survey of investor intentions by CBRE, 340 institutions were asked: "In Europe, which country/region do you believe to be the most attractive for making investment purchases this year?" Germany attracted 32% of the responses, up from 18% the previous year.
These surveys are an important leading indicator of future capital flows, and thus investment demand, downward pressure on yields, and upward pressure on capital values. In March 2010, when the UK attracted 31% of responses, we saw continued capital inflows and yield compression throughout the course of the year, and there is now a consensus that the UK market has become fairly (even over) priced.
This deals with potential European demand, but it is important to note that this has already started to translate into transaction volumes. Germany is strengthening its position as one of the most important investment markets worldwide; in Q1 11 transaction volumes reached €5.5bn, an increase of 18% compared to Q1 10. Overseas buyers accounted for nearly 50% of the total. As a result, yields have remained stable in the office sector, and in the case of Berlin firmed marginally by 10bps to 5.20%.
We expect transaction volumes to increase short term, with some banks having to dispose their real estate investments following regulatory pressure. Moreover, several private equity funds, which still own some of the country's largest portfolios, are considering exit scenarios.
We therefore agree with CBRE that investment activities in Germany are likely to remain ‘brisk' and that the commercial transaction volume could amount to €20bn during the rest of the year.
Alex Moss is head of Macquarie Global Property Securities Analytics. Fraser Hughes is research director at EPRA