With high prices prompting investors to stray into peripheral markets, is Germany now a riskier prospect? Russell Handy reports

Germany, for all its safe haven credentials and stability, may be edging closer to the point where investors struggle to make inroads and find suitably priced real estate.

Since the peak of the market in 2007, when investment topped €52bn, appetite has never been greater for German real estate. International investors, says Fabian Klein, CBRE’s head of investment, have “high confidence” in the sector, with €5.5bn invested in the country’s office and retail in the first six months of 2014. US investors dominate the foreign pack, followed by UK and French investors.

Although local investors are the majority in Germany, German fund manager Union Investment says their international counterparts are “trying to get a bigger slice of the cake”.

“This offers attractive opportunities for locals to sell properties that do not fit into their portfolio strategy any more,” the fund manager says, acknowledging a “rush for products in Germany’s top markets”.

Anna Zabrodzka, economist at Moody’s Analytics, says in an environment with uncertain equity markets, sovereign debt problems, and low interest rates, German property is an attractive investment opportunity. “Especially in large metropolitan areas in countries considered safe havens such as Germany,” she says.

In a joint venture with Pramerica Real Estate Investors, Sweden’s third pensions buffer fund AP3 is investing in German retail, attracted by low unemployment, low household debt and rising wages.

In July, Cornerstone Real Estate Advisers bought Pamera Asset Management, a property asset management platform, as it looked to increase its presence in Germany.

Buying into German platforms is also what Internos Global Investors’ did late last year with its purchase of a €1.6bn Spezialfonds business from Commerz Real. Cornerstone’s acquisition gave the US-headquartered fund manager an additional €1bn in office and retail assets, as well as five offices and 38 staff in Germany.

The ‘big six’ cities in Germany – Berlin, Hamburg, Munich, Cologne, Frankfurt and Stuttgart – are still the most popular destinations for property investors, says Zabrodzka. “[Commercial] prices and rents in Berlin are still relatively low compared to the other five cities,” she says.

Office vacancy is falling, according to JLL. In Germany’s seven most prominent office locations empty space fell by 7.2m sqm by the half-way point of this year, with prime rents static. The agent predicts total office take-up of 3m sqm this year.

With yield compression in the main cities and prime locations, the limited stock has made life difficult for buyers reluctant to invest at yields of 5%.

In the office sector, investment volumes decreased in Berlin and Frankfurt by 21% and 18%, respectively, while Munich experienced a 3% fall in the first half of this year – due to a “scarcity of suitable products”, according to CBRE. Vacancy levels of above 11% in Frankfurt could also be a factor.

“Core Frankfurt is so tight at 5% – we can’t take that on, it’s not value for money,” says Valad Europe CIO David Kirkby of the company’s core-plus European Diversified Fund. “We’re focusing on regional rather than prime locations.”

Another international investor said the country could become too expensive soon, adding that its “quite tough already” to invest in the country’s real estate sector.

Investments in secondary cities with growth potential are, Union Investment says, “a good alternative to expensive core investments” in Germany’s main markets. As well as secondary cities, assets with vacancy and projects could be an alternative for investors ready to take “controlled risks”, the fund manager adds.

International interest in secondary cities has heightened, Cieleback says. “It’s not something new that people look at secondary cities – it’s more visible now,” he says. “But local investors started moving in that direction around one and half years ago. International players are now following the local names.”

The sale of portfolios could rise, CBRE says, bringing secondary B-locations further into focus. The agent predicts that Germany will see more portfolio sales, similar to PATRIZIA Immobilien’s €1bn purchase this year of the 18-asset Leo I portfolio in Hesse.

Portfolio sales are typically more common in Germany’s residential sector. Savills estimates that German residential portfolio transaction volumes totalled €6.8bn in the first half of this year, an 18% increase on the same period in 2013.

Andreas Trumpp, Colliers International research, says with a 31% year-on-year increase in transactions in H1 to €17.1bn, portfolio deals have been more common. “One significant difference compared to the past five years is the share of portfolio transactions – now at 39%,” he says.

Although Union Investment expects more portfolio deals in the coming months, Marcus Cieleback of Patrizia Immobilien is less confident, but he says the residential and food-anchored retail sectors will continue to provide scope for portfolio investors.

The focus for international investors is changing. As is the case in mature real estate markets, secondary locations and cities are usually the domain of local investors. Location and asset quality are even more important in secondary cities than in ‘A’ markets, Union says. “The main risk is the reduced fungibility and liquidity of the secondary markets,” it says.

Cieleback agrees that investors could find it harder to divest assets in secondary cities. “The risks are there and can be tremendous if you read the market wrong,” he says. “Lease expiry and location could be an issue – those are the dangers.”

The smaller the city, he adds, “the harder it becomes for international players to understand the market. But as long as the property fits the overall market then it will be fine.”

Cieleback says yield requirements are still the main factor in investment decisions. “Product is available in regional cities and is not fundamentally different in terms of risk profile to that found in Germany’s main six or seven cities,” Cieleback says. “That is what investors need to assess. Investment depends on what kind of yield requirement one has.”

At this point in the cycle and with southern Europe showing signs of recovery, selling a Frankfurt office at a 5% yield and buying an Italian or Spanish shopping centre at 150 basis points higher might not be foolish. German investors – including the country’s funds – have looked abroad for opportunities this year, buying in the UK’s secondary cities as well as taking steps into neighbouring Holland.

Looking beyond the ‘big six’
Earlier this year, Manfred Binsfeld, head of real estate research at German consultancy Feri, noted that investors were turning their focus to less populated German cities.

Binsfeld said investors looking at secondary cities for extra yield should pay close attention to local economies and demographics to avoid unwanted risk. He warned that they would not necessarily benefit from positive yield movements. “Investors have to improve their risk analysis so as not to mistake all high gross yields for a good investment opportunity,” he says.

The secondary cities with the highest yields at a similar risk level to the biggest cities are Wolfsburg (9.47%), Ingolstadt (6.9%) and Paderborn (7.8%). Low-risk cities like Munich or Stuttgart were yielding just over 4% and almost 6% respectively.

Feri recommended focusing on cities “with diversified local industries, university populations and a high quality of life”. These locations should also appeal to investors interested in residential. Berlin, however, is still a first stop for 16.7% of investors in the sector, according to research by consultancy firm NAI Apollo. Nevertheless – and on a parallel with German commercial real estate – the firm notes a willingness by investors to consider other locations.

Berlin’s share of some €5.7bn invested in the first half of this year has decreased since the 20.5% share recorded in June 2013, NAI Apollo notes, suggesting a steady move away from the capital city towards other German cities.

Residential bubble overstated

Concern for the residential sector began to mount as far back as October last year when the Bundesbank warned that house prices might be overvalued by 10-20% in Germany’s big cities.

Axel von Goldbeck, managing director of German property federation ZIA, is unconcerned at the idea of a bubble. He said the fact that demand is higher than supply has kept Germany’s residential sector on an even keel. “There was a very popular concern that there was a bubble risk,” says Von Goldbeck. “This is not the case – the biggest problem for investors in the German market is a lack of supply, and that’s impacting on investment levels.’

Strong rising rents in prime markets prompted the German government to introduce a rental brake in some neighbourhoods. When in place, the cap, says CBRE Global Investors, is expected to mitigate excessive rent uplift.

The fund manager says there is concern that in some areas the rental caps will affect existing investor portfolios – as well as deter future investors from entering Germany. 

However, the environment for rental growth will remain positive, CBRE Global Investors adds. Rents from new property will be exempt from the cap, following modifications made by Germany’s coalition government.

CBRE Global Investors says residential rents in major residential markets are forecast to increase, while rents in prosperous medium-sized cities will “continue to benefit”.

Von Goldbeck, who has been heavily involved in lobbying on the rental cap, says there are still a “number of good, macro-economic reasons” to invest in both residential and commercial property.

“Investors have been cherry-picking the market and there’s little low-hanging fruit now,” says Von Goldbeck. “Interest rates will rise again – sooner or later, that will be a reality.

“We have to ask ourselves, what will happen then?”

A lack of properties and simultaneous strong demand has led to a “growing acceptance by investors of secondary locations outside traditional investment locations”, says NAI Apollo. The firm’s report says transactions have increased in Dresden, Leipzig, Bremenand, Jena and Kiel.

“Transactions continue to focus on traditional locations in cities and urban areas,” NAI Apollo says. “However, the growing problem here is the increasing supply shortage that is causing prices to rise sharply.”

NAI Apollo predicts further increases in demand for investment opportunities in “higher and middle-order centres” outside Germany’s main conurbations, but it does not expect residential investment to exceed €10bn, down a third on the €15bn invested in 2013.

As investment volume levels off, a lack of construction is one of the main reasons the market is not at risk of entering a bubble, according Aberdeen Asset Management, which believes the sector is “close to fair value” and not overpriced.

In July, following a three-year investment programme, Pramerica Real Estate Investors and Kauri CAB Management sold a portfolio of Berlin residential properties for €78.6m. The 25 Altbau buildings in Berlin were part of portfolio of 953 apartments amassed and refurbished for Pramerica’s institutional fund, PRECO IV since the joint venture was launched in 2011.

The sale, however, does not mark a retreat from the sector, according to Sebastiano Ferrante, head of Germany for Pramerica. Ferrante said the sale would allow Pramerica to “capitalise on future investment opportunities” in Germany’s residential sector.

Axel von Goldbeck, managing director of German property federation ZIA, says that those who invested in residential real estate three years ago may “see sense” in selling now.

“From a relative point of view, it does seem like a good time to sell, as prices have risen considerably in the last couple of years,” he says.

Despite the recent turnaround, German house prices are just 6% higher than their 1994 level, Aberdeen estimates. “There has not been any significant slowdown in prices or investments since then,” says Zabrodzka.