Germany's retail sector has become a focal point in the search for income security. But investors should be careful to avoid oversights when targeting the sector, says Carsten Loll

Business is booming for German retail property, despite the euro crisis. It would be counter-intuitive for investors to bypass Germany - the country's economy, the biggest in Europe, has a strong outlook relative to the rest of the region and its finances appear quite robust.

Foreign investor interest in Germany is therefore huge. Retail properties are well placed to take advantage of fund inflows and remain top of institutional investors' shopping lists. In 2011, transactional volume increased by a third to €10.6bn.

The current retail boom in Germany is demonstrated by a turnover totalling €415bn in 2011 - compared with just €317bn in the automotive sector - and this trend looks set to continue in 2012. Figures like these have succeeded in attracting international brands, which now view Germany as one of their key expansion targets. Cotton On, Abercrombie & Fitch and Bershka are just a few of the retailers that opened their first stores in Germany last year.

The majority of players in the national and international retail investment markets view Germany as a safe haven for their capital. There are two main reasons for this: first, consumer confidence in Germany has been relatively unaffected by the crisis, and, second, investment in retail property appears to be quite healthy. This is partly because of the deep-rooted belief that retail is a safe investment, thanks to a steady cash flow once units are let, with rent indexing as a hedge against inflation.

However, such a perception might lead to oversights. Investors might forget to consider the market and management knowledge essential to ensure investments are successful. Looking more closely, it becomes clear that retail investment properties are management intensive, lease agreements are not generally fully indexed, and maintenance and ancillary costs are often only partly borne by tenants.

Investors should also bear in mind they must fulfil statutory requirements such as regulations on sales areas or restrictions on product ranges. Newcomers to the market often struggle with these nuances of German retail property, and investment success should not be taken for granted.

In contrast to office property, investors in retail assets have to take into account a wide range of quality criteria for different types of operations. For shopping centre investments, the quality of the centre management is crucial, while in specialist retail centres the tenant's quality and solvency and the corresponding lease agreement are the key drivers.

Architecture or building value is of less importance, with the catchment area's long-term impact having more significance.

However, this could quickly change as a result of developments such as internet shopping and new architectural design trends. Discount stores, for example, are opting to design more visually appealing stores. The concept of a discount store needing to look cheap to demonstrate its value is outdated, and companies such as Netto are now investing in a much more upmarket aesthetic.

Property location and changes in consumer lifestyles are key considerations. Demand tends to be focused on high street units, shopping centres and large specialist retail centres in A-locations. But well-let properties in A-locations are both rare and expensive, and high prices increase pressure on returns.

While most market players refuse to acknowledge the danger of an overheating market or even a retail bubble, the warning signs are present. Inexperienced investors are particularly in danger of accepting overpriced offerings.

Retailers are also looking closely at location and types of operation. Some retailers continue to break down the boundaries between traditional specialist retail centres and high street retail. C&A and Depot, which both used to prefer traditional city-centre locations, are now establishing stores in specialist retail centres. Conversely, companies such as RENO, which have located stores on the outskirts of towns and in specialist retail centres, are expanding their networks in popular town-centre locations.

Understanding these trends in location, together with regional and local knowledge, is the basis for a successful investment, and for many retail investors a local partner is the key to success.

Owners have the opportunity to adapt their tenant mix and be flexible in how they react to developments such as changes in local demographics, evolving fashion trends and new regional economic frameworks. It is therefore vital for investors to understand location-based issues, and the opportunities and risks for the retail sector.

Changes in consumer behaviour also have an impact on investment success. In view of negative trends, such as an increase in online shopping, the primary goal for owners is to find tenants who will keep the unit attractive and its value stable. However, regenerating retail units and portfolios that have run into trouble requires deep pockets, and this has been a painful lesson for less-skilled investors.

When looking to invest, size does matter. If a unit is too small it will lack strategic value - for example, if a discounter tenant terminates its lease on a property, the owner needs to prepare for larger problems.

Conversely, losing a single tenant in a large specialist retail centre is unlikely to result in disaster, as a replacement tenant can easily be found and remaining tenants will provide ongoing cash flow in the interim.

One final word of caution is that investors should take care not to buy a ‘pig in a poke', and must always thoroughly review prospective tenants. Market-leading positions and high market shares do not automatically guarantee a solvent tenant, as insolvent drug retailer Schlecker recently demonstrated.

‘In retail we trust' is a good adage for the current climate, but maximum value will only be gained by experienced investors or those who have relationships with skilled local partners.

While retail properties do not automatically provide investors with guarantees and stability, for the shrewd and diligent investor, the retail sector offers some excellent opportunities.

Carsten Loll, partner at DLA Piper