Strong economic performance has driven Germany and Nordic markets to the top of investor shopping lists, but those seeking large liquid markets should still be looking at London and Paris, as Gail Moss reports

If the traditional maxim for property investing has always been "location, location, location", then the latest trend is "Germany, Germany, Germany", as institutional investors pile into the heart of Europe on the back of the country's long-established stability and new-found economic recovery.

Germany has now overtaken the UK as the preferred location for investment in non-listed real estate funds, according to INREV's 2011 Investment Intentions Survey.
In particular, German retail was named by 36% of investors as their preferred location and sector - a significant change from 2010, when German retail failed to reach the top ten.

In contrast, the survey shows the UK is seen as less attractive than the German, French and Nordic markets.

"The time has come again for investors to diversify away from their home countries," says Thomas Beyerle, head of CSR and research, IVG Immobilien. "You won't get double-digit returns, but Germany isn't volatile like London. All the time it's stability, stability, stability."

What has given Germany extra appeal is its sudden economic turnaround, with last year's GDP growth of 3.6% the biggest since reunification.

"Unlike the UK, however, the economic boom will not lead to rocketing property markets, but rather a smooth increase," says Beyerle. "Furthermore, Continental investors are attracted by euro pricing, which means the absence of any currency risk."

Over the next two years or so, Beyerle expects German prices to forge ahead.
"New developments have been scarce in the past few years because of the economic downturn and lack of financing, and real estate development lags behind the economic situation by three to four years," he says. "So the lack of new supply should force up rents and prices throughout 2012 and 2013."

Research from Henderson suggests consistent rental growth for prime offices in excess of 3.5% p.a. for Frankfurt, just under 3.0% p.a. for Munich and Hamburg, and around 2.5% p.a. for Berlin and Dusseldorf between now and 2015.

Simon Mallinson, director of European research, Invesco Real Estate, tips Germany for a good, solid income return, and sees this continuing over the near future.

"The German economy had been very dominated by exports, but recently we have been seeing the German consumer drive some of the economic growth, which means the country is no longer so reliant on exports," he says. "So whatever happens, Germany will be well-placed as the global economy recovers."

Furthermore, Mallinson points out that the country is polycentric - that is, there is no major centre such as London or Paris which sucks in most real estate investment. Instead, there is a top tier of comparable cities such as Berlin, Munich and Frankfurt.
"That means the market doesn't provide cyclical opportunities for investors to get in and get out," he says. "But for many investors, that is attractive."

Invesco Real Estate itself has just bought a portfolio of neighbourhood shopping parades occupied by grocery-led retailers in small regional centres, which Mallinson says should deliver strong, stable - rather than exciting - returns, with the potential of upside growth.
Other retail activity in the market as a whole is centred around retail warehouses and the large (€250m-plus) shopping centres, such as those coming onstream from developers ECE and MFI.

Meanwhile, the commercial portfolio run by the Pension Fund for Doctors in North Rhine Westfalia (NAEV) is spread throughout first-tier cities including Hamburg, Munich and Cologne.

But its strategy has been affected by the increase in market activity.
"In Germany, where 50 to 60% of our portfolio is invested, we are choosy, " says Hermann Aukamp, chief investment officer, NAEV. "So we have started buying property in Berlin, as a niche alternative. It is not the most exciting market for German investors in terms of offices, but we have started looking for good medium-sized investments, fully-let."

The fund has already acquired a small (under €30m) office building in Georgenstraße which Aukamp says is "Not cheap, but good value. We think there is some uplift in Berlin because returns are very low compared with other German cities and other European countries."

And he says investors are already being priced out of top-quality stock.
"Everybody is looking for fully-let Class A properties in prime sites," says Aukamp. "Prices have gone up and we are reluctant to overpay. So we're now looking for opportunities in Class B-type buildings in first-tier cities."

Georg Allendorf, head of RREEF for Germany, Austria and Switzerland, is another fan of Berlin, which he considers has star potential.

"Because of its insular character, sandwiched between East and West, Berlin has traditionally lacked an industry base," says Allendorf. "But it has now become the new trendsetter, attracting young people because of its cosmopolitan nature and cultural pre-eminence. It is also attracting companies in the creative sectors and new media. The return to its status as capital is also leading to more demand for office space."
While there are still sizeable vacancies, Allendorf says that good quality property in the city centre will benefit from Berlin's improving popularity.

He also likes Hamburg, where he sees potential for growth in values because of the city's export industry. "The logistics sector is interesting because of its proximity to the harbour, but we also see very interesting developments in the office sector," says Allendorf. "Hamburg is very stable from a yield perspective, but there have been some increases in value, especially in retail."

However, trends such as demographic movements - for instance, migration from east to west and south of the country - mean that RREEF invests on a deal-by-deal basis, rather than allocations to specific places.

He says other cities with good prospects for value include Stuttgart - where supply is physically constrained by its geographical situation within a valley - and Munich, a popular and affluent location because of its affluence, restrictive planning policies, strong industrial base and good quality of life, thanks to its position close to the Alps.

But like many other investors, he is cautious on Frankfurt - the so-called diva of the German markets because of its volatility, a consequence of its close reliance on the financial sector.

Even so, Allendorf sees a strengthening of inner-city zones in line with the economic recovery, although he expects the fringe areas to remain affected by the economic hangover.

But Germany isn't quite the only game in town. "Across Europe, things are now moving so fast that as soon as something is hot, it's not," says Mallinson. "Last year, the focus for international capital shifted from the UK to France, then to Germany. And at the very end of 2010, the Nordic region became popular as well."

The Nordic countries appeal to investors because of their relatively favourable economic performance, with both exports and consumer spending on the increase. Furthermore, after the banking crisis in the early 1990s, the banking system throughout the region was restructured, leading to strict lending criteria and less exposure to problem loans then their counterparts further west.

However, Invesco Real Estate only focuses on Sweden and Finland.
"Norway is a small market, largely made up of prime properties, but domestic investors can usually outbid everyone else," says Mallinson. "And Denmark is more like a West European country in terms of consumer debt and the house price bubble."

In contrast, he says that Sweden has a liquid property market centred on Stockholm - a relatively large city for Scandinavia - while the Finnish market is becoming more liquid, and is within the eurozone.

Meanwhile, although London and Paris remain attractive to investors, the lack of supply is making it difficult to implement strategies in these markets.

"We all know it's pricey in Paris and London, but for the time being we are still looking for opportunities there, because they are large, liquid markets," says Aukamp. "But we are not looking so much at the provincial markets in either country, although we think these will pick up."

Some central and east European countries have seen their recent popularity dented by the financial downturn, but investors still consider those markets - especially in Poland and the Czech Republic - as useful add-ons to existing portfolios. NAEV sold investments in Warsaw and Prague at the market peak, and is now planning to return.
However, Aukamp cautions: "There has been a degree of overbuilding in many locations, so you have to be picky about where you go."

Mallinson says that Invesco Real Estate will be looking for opportunities in eastern Europe towards the end of this year.

"The region is a maturing market, giving opportunities to get more attractively-priced assets than in other European countries," he says. "In 2012, those countries will perform well economically, and that will feed through into the real estate market."

Unsurprisingly, however, Spain and Italy are being given a wide berth by most investors, although Invesco Real Estate does have current allocations for the right assets in these markets.