Munich and Hamburg have been hailed as the top European investment destinations by ULI and PwC's Emerging Trends report. Paul Benjamin explores the outlook for both markets and German real estate as a whole

As the global economy tanks under the weight of the credit squeeze and its corresponding recession, Germany is finding that its hangover - while bad - isn't as painful as those of its more reckless European counterparts. Which isn't to say that the world's largest exporter is in good shape. Far from it: in recent months, Chancellor Merkel has pledged over €60bn of fiscal stimulus for an economy that has been in recession for the last three quarters of 2008; ailing property lender Hypo Real Estate Group has been propped up by over €50bn; exports have bombed; car sales are on their knees; confidence is down, and job losses are up sharply.

In 2009, the Economist Intelligence Unit expects Germany's first full-year contraction of the economy since 2002, with GDP falling by 0.7%, and prone to further downward revisions if the credit landscape worsens, as many fear it will. But Germany's reputation as a sensible and stable destination, which lacked the allure of higher-risk, higher-return markets in previous years, is now starting to look more attractive. While the German economy is in trouble, things look worse elsewhere in Europe and beyond. Even its low-risk rival, Japan, posted a sharp GDP fall of 3.3% in 2008 Q4.

Europe's biggest country of 82m people is dominated by the ‘big five' conurbations of capital Berlin, Düsseldorf, Hamburg, Munich and Frankfurt. Some analysts include the city of Stuttgart to make a ‘big six'. Munich and Hamburg lie at the southern and northern ends of Germany and have recently been applauded as top destinations in the report ‘Emerging Trends in Real Estate Europe 2009', published by the Urban Land Institute (ULI) and PricewaterhouseCoopers (PwC). These two cities have their own unique characteristics and foundations, but the report names both as low-risk, safer-bet options with solid fundamentals.

Peter Schuijlenburg, Germany VP and general manager, AMB Property Corporation, believes the diversity of Germany's big six is a fundamental part of its strength. He says: "Germany doesn't have the primate cities of the UK and France, which are dominated by London and Paris. In Germany you've got six big areas to invest in. They are all comparable in size but each has its own characteristics and that makes it an interesting place for investors. Quality is high and markets aren't as volatile. Financing has dried up for the time being and the number of banks providing real estate loans is limited, but that has to change in the medium-term when confidence comes back."

Many analysts tip 2009 as a year-long tug of war between buyers stubbornly waiting for a bargain - and bidding accordingly - and stunned developers still trying to adjust to a pricing situation they never envisaged when they entered into the market. This face-off doesn't look as drastic in Germany, which avoided the credit-driven bubble of the US, UK, Spain and others.

Markets have been much more stable, so the gulf between buyer and seller is more manageable. Helge Scheunemann, head of research for Germany with Jones Lang LaSalle (JLL), says: "German companies have seen a long period of structural reform and seen from this angle they are looking good. In times where risk is key, Germany could be seen as a better and safer haven. We do not expect such high figures in insolvencies as we saw in the recession of 2001-2003. That means that the default of cash flows is limited.

"In general, investors will focus on the most liquid and the safest markets in 2009. This could be London, as the UK has seen a dramatic price deterioration, but it could also be Germany, as it is less volatile and investments in Germany can be seen as a having a strong ‘safety margin' within a portfolio for investors orientated to the long run."

Jaroslaw Morawski of RREEF Research adds: "The main strength of German markets in the current situation is their stability. Historically, Germany has been far less volatile than other European locations like London and Paris. In effect, German markets did not experience the enormous boom of 2006 and 2007 seen in those markets. This gives them a cushion in the current downturn, preventing the freefall seen elsewhere.

"Also, German office markets are comparably cheap in terms of rents per square metre compared to many European metro regions, giving them a comparative advantage. Prime rents in London are above €90 per square metre and in Paris above €65 per per square metre, while in Frankfurt prime office space can be rented for about €38 per square metre per month."

Looking to 2009, Morawski adds: "We expect only a slight decrease of prime office rents in the key markets, say of 3-4% on average. Vacancy rates will increase in most markets. Capital markets are likely to correct further with cap rates moving out by another 50 basis points during 2009."

Scheunemann says: "2009 is all about risk, security and survival. Total office take-up volumes will fall by around 17% in 2009 for all the big six. In comparison to the last economic downturn of 2001-2003, we do not expect an oversupply shock, as developers are stopping new projects or postponing planned developments to 2010 or even later.

"In the light of the ongoing global credit crunch and weak fundamentals, prices for property are falling. For offices we expect a further yield increase of 45-70 basis points in all big-six German cities.

"We expect investment volumes in 2009 to remain at the same levels as 2008 or slightly lower with slightly more activity during the second half of the year. Active players in the market will be equity investors, insurance groups, pension funds, the open-ended funds (re-opened), privates and sovereign wealth funds."

So Germany may be weakened, but it still looks good as a ‘safe haven', in part only because the rest look so bad. Even so, according to the ULI/PwC report, it does harbour a world-beating star pupil in the form of Munich, its third biggest city. Survey respondents put it at the top of the investment market league table, up three places from its 2008 rank. Munich also came top of the European City Risk league, and came third in the development market rankings, although the report's authors stress that although Munich is top dog this year, its market is weaker than it was last year.

As strong points they cite an increase in government spending, a broad economic base, and a fast-growing population that has increased over 6% in the past five years. Consumer spending power is growing and Munich is also one of the most visited cities in Germany,  averaging 4.7m visitors a year.

CB Richard Ellis said that submarkets close to the city where competitively priced premises are offered could benefit from the current economic conditions, as businesses in need of restructuring may head there to make savings. JLL predicts that retail rents in Munich, like those on other major German high streets, will rise slightly in 2009.

Marcus Lütgering, Munich regional manager at JLL, says: "Munich is home to more Dax headquarters than any other German city. HQs domiciled there range from Allianz, Munich RE or BMW to other big players in their field such as Linde, Infineon or Microsoft, which has based its biggest European Office in Munich.

"Prime rents in Munich were at a high level but did not skyrocket during last year's boom. And they stayed pretty stable during the last 10 years when we had various downturns in the economy. Vacancy levels in the inner city are traditionally low. During the course of a recession this will lead to reductions in rents, but we will see sufficient demand for vacant space and low vacancy rates." He continues: "The biggest threat is the pipeline of speculative, not pre-let, buildings which are in the construction process now. These buildings will compete with class-B or C buildings, home to the vast majority of companies at the moment. Competition will affect rents for both new and old product. It is likely that tenants will move to more modern space, leaving a question mark over the usage of those that lose tenants.

"We expect that the automotive industry will be hit hard by the recession, but the service sector will recover more quickly. The service industry is strong in Munich with a lot of top law companies, advertising and financial institutions.

"One of the big issues for Munich is that in the last boom we had a vacancy rate below 1%. Tenants were forced to sign long leases in locations and space that did not really suit them. A lot of these leases will end in 2010/2011 creating demand."

At the other end of the country, Germany's second largest city after Berlin and Europe's second biggest port after Rotterdam, Hamburg, also scored very well in the ULI/PwC report, taking second place for investment prospects in 2009, sixth spot for development prospects and third on the risk table for its relatively low risk levels, which put many investors at ease.

Like Munich, the city is growing in size with a population of 1.8m and a total catchment of 4.2m and is one of the richest areas in the EU. Beyond the logistics sector, it has a strong media presence and is one of three global hotspots for the aviation industry. Container shipping is a key industry, particularly trade with Asia and Russia, and this sector demands a strong hinterland of businesses in road haulage, and shipping insurers and lawyers. The government has also undertaken a massive mixed-use development project known as Harbour City (HafenCity).

RREEF's Morawski says: "Hamburg's focus is on the port. The city is the main logistic hub in Germany and one of the most important in Europe. Container shipping towards Asia and Russia is of particular importance. "A chance and a risk at the same time is the development of the old harbour area into a prime office location. So far the new supply in this area has been released very carefully and Hamburg has the lowest vacancy among the largest German office markets. However, increasing the construction activity beyond the absorbable amount could destabilise the market." Andreas Wende, Hamburg regional manager at JLL, says: "Hamburg's vacancy rate is currently at 7.1%, which is the lowest among the big five. The city has many private investors who do not have to sell their properties, and this shows that the potential of the market could be far higher.

"In terms of media companies, Hamburg is in competition with Berlin and has been losing some important companies, such as Universal and MTV. "We are seeing a trend towards renting office space in CBD and close to inner-city office locations. As rents fall under more intense negotiation, we are forecasting a slight fall in prime rents and a fall in office demand over 2009."

The logistics sector employs 2.5m people in Germany and, although it is likely to bear the brunt of a fall in export demand, Peter Schuijlenburg of AMB adds that quality will hold out and the Hamburg logistics sector is marked by a lack of land availability in prime locations.

He says: "The good thing about Germany is that industrial market rents have been quite stable. €5.50-5.70 per square metre per month is achievable. In 2009 we expect prices to decline but cannot say to what extent, though we expect some level of competition for good quality buildings. Rental levels should remain stable and there's even some possibility of growth in micromarkets where there's strong demand, like on the southern outskirts and the airport.

"The logistics sector has always been considered a hidden jewel. Although it is not as sexy as hotel or retail, there's less competition and not as many developers who have expertise. The sector is very much characterised by long-term stable cash flows with single tenant sand buildings that are easier to maintain. While it is a sector that is heavily driven by economics, even during a downturn there are opportunities among companies looking to restructure."

In these difficult times it seems that investors sitting on capital can polarise: more speculative takes exposed by the downturn with potentially higher yields, or greater back-to-basics exposure to safer products in core districts in core markets.
Thomas Beyerle, head of global research at DEGI/Aberdeen Property Investors, believes Germany is entering unique times where the downward cycle is driven by financial architecture, rather than demand and supply.

He adds: "The market is much more positive than the headlines reflect. Hamburg and Munich are places for investment in both good times and bad. Now is the time for core investment and value-added refurbishment. A lot of shopping centres that were built after reunification in the early 1990s are due for refurbishment."

He says the challenge Germany now faces is to hold on to any cash invested into real estate as "short-term parking money" for the longer-term. To do that, Germany may have to find an offering to match yields in hotter, sexier countries riding an upturn. But then, investors who have had their fingers burned in the credit crunch may have grown to value stability.