Questions have been raised about the quality of IPD's German data. Their man on the ground, Daniel Piazolo, explains the challenges of establishing a property market index in Germany
IPD recently published the Pan-European Index for the year 2006 which shows that the total return for property within Europe was 13.3% in that year. At the bottom of the table of 14 markets with just 1.3%, a tenth of the European average, was the largest economy in Europe - Germany.
Yet although this is a dramatically low return compared with the other European countries, the total return for 2006 is more than double that generated in 2005 and marks the end of a five-year downward trend within the German property market. By comparison the best-performing market in the index, Ireland, returned 27.2%.
IPD in Germany was established in 1998 (it was then called DID Deutsche Immobilien Datenbank) although it started recording the performance of the German property market in 1996. Since that time the market has never delivered more than 6% and performed on average at only 3.4%. This low performance and also the low volatility of the German property index DIX (Deutscher Immobilien Index) is quite remarkable and the quality of the DIX has been questioned as a result of this.
The low performance and the low volatility of the DIX can both be explained by the underlying economic fundamentals. After German reunification in 1990, there was a building boom in eastern and western Germany. Because of the reunification euphoria and especially generous tax incentives, this building boom went on far longer than was healthy and led to oversupply.
In the post-reunification years Germany experienced strong growth in GDP but the associated cost burden of reunification has led to prolonged economic stagnation. Government policy led to a deterioration of Germany's competitiveness, and the country became the "sick man of Europe". It took a decade for Germans to accept the implementation of necessary reforms.
In addition to the burden of German reunification there was European monetary unification.
Many countries benefited from a decrease in the real interest rates, which fuelled the property markets in many eurozone countries, such as Ireland and Spain. However, the move from the Deutschmark to the euro did not mean a decrease in the real interest rates for Germany, where rates were already the lowest in Europe.
However, now Germany seems to be positioned well to recover. The forecasts for the year 2007 from most economists and international organisations sound quite promising and signal a change to the previous dire years. Germany is competitive again.
It is thus clear that the 11 years of property performance measured by IPD since 1996 were years of prolonged economic stagnation in Germany, which explains the market's performance.
In the UK there seems to be a concern in the market that the valuation methods employed in Germany take a long-term stabilised view and ignore short-term market movements. It has even been suggested that the current approach in Germany is connected to the desire of the German Federal Financial Supervisory Authority (BaFin) to promote stability. Furthermore, it is implied that a change to a more Anglo Saxon valuation approach in Germany would make the German data more comparable with other markets and better able to answer the question: what would you get for this property if you sold it today.
But this concern is not justified. The Royal Institution of Chartered Surveyors (RICS) puts the German Verkehrswert - the legally required method of valuation for open-ended funds - on a par with the UK "market value" valuation and accepts both methodologies. Both seek to derive a sales price assuming the property is sold in the near future and neither seller nor buyer have any abnormal urgency to close the deal. An empirical comparison by RICS and IPD between the sales price and the previous valuation for four European countries has shown that there is on average a 10% deviation between actual sales and valuation that seems to be quite standard over recent years. German valuations have become better over time and have recently been as accurate as UK valuations, beating Dutch and French valuations.
The low volatility of the German property index can be linked to the stagnation of the German economy. In a recent study, Nick Tyrell, head of research and strategy at JP Morgan Asset Management, examines the use of a number of variables to explain and to predict property performance worldwide. One robust relationship he finds for the seven economies with the longest time series of property performance (Australia, France, Ireland, Netherlands, Sweden, UK, US) is the connection between GDP volatility and property market volatility. He then uses this relationship and the readily available GDP volatilities to derive an estimate for the property market volatility for many countries. The country with the lowest estimated volatility is, again, the largest economy in Europe, Germany. Therefore, this insight can be taken as an argument that the DIX represents the underlying property market quite well.
However, more importantly, the DIX, like all the other IPD indices worldwide, uses primary data and is not based on secondary data from press releases and agents' reports.
The DIX is based on an extensive databank comprising 3,000 properties with a market value of almost €54bn in 2006. It is estimated that the German IPD databank represents 21% of the overall institutional properties and 50% of the relevant institutional property market that is valued each year. The databank covers the performance of directly held institutional properties from the large institutional investors in Germany, ie, open-ended funds, insurance companies, pension funds, asset mangers and listed real estate companies. The institutional investors supply the data to IPD and in return receive a portfolio analysis relative to the benchmark of all participants. Thus, the benchmarks include primary data mirroring the relevant portfolio management systems, financial accounts and business reports of the data suppliers.
In recent years international investors have entered Germany and have injected considerable liquidity into the property market. In many cases they already participate in the IPD portfolio analysis service within their home markets.
In Germany one important goal is to get these investors to supply the data for the DIX databank to mirror their growing importance within Germany. Therefore, it is very good that international investment houses Arlington, Halverton, Prologis, Rodamco and Rockspring are supplying us with their property data.
We want to report on as many data suppliers as possible, but this requires that our clients have at least annual valuations of all their German investments in their portfolios - and that they would like to contribute to an increase in transparency within the German property market through aggregated performance index measures. These criteria are not met in all cases.
The 21% of the overall institutional holdings in Germany covered by IPD compares with 55% in the UK and 62% in the Netherlands; this could be taken as a sign of market maturity.
The increase in transparency within Germany and a higher coverage of the index is also quite important to make the German market better dressed for international investors, not the least for property derivative uses that have seen a tremendous growth in the UK.
However, German entities such as the large open-ended funds are covered by supervisory regulations that severely restrict the adoption of these new instruments; the German legislators still have to ¬enable these investors to use derivatives for investment and for hedging purposes. Thus, there are still challenges to overcome for the German property market before it can reach the standards of transparency and property investment management vehicles found in more developed real estate markets.
Daniel Piazolo is managing director IPD Investment Property Databank, based in Wiesbaden