GERMANY - Munich office rental will pick up slowly in 2010 even if there is a speedy recovery, according to a report published this week by Knight Frank.

In a relatively gloomy prognosis for this year, the report said headline rents would decrease slightly, with a moderate increase in vacancy rates.

Office significantly underperformed in 2009 with a 30% decline in transactions to €1.37bn. Single-asset and domestic investors dominated a modest pick-up in transactions in the second half of the year.

Knight Frank investment director Ralf Mejovsek said many overseas investors previously interested in the market were now focusing on problems in their home markets. "The reasons lie in the financial and economic crisis rather than in Munich office," he said.

Where investor interest had remained stable was in modern, fully let prime.  "It isn't sexy but it's very, very defensive," said Mejovsek. "This year we're seeing generally the same situation as we did last year. The focus is still on defensive properties."

He added: "In general, conditions are not very interesting for investors in added-value and opportunistic products.  There are investors who are interested in these risk classes but they are fewer because of the spread between supply and demand, and pricing."

In contrast, prices in core assets have remained stable, with slightly lower yields of between 4.3-4.6%.

Whereas German pension schemes have tended to move away from direct investment into indirect, international schemes are focused on the German market, but not necessarily Munich. "They're focusing on bigger investments and concentrating on big cities. They're always defensive investors," said Mejovsek.

Meanwhile, a study of German real estate over a 15-year period has found that commercial property does not offer a built-in inflation hedge.

The findings for retail were marginally more positive, with some inflation protection for prime. In contrast, rental yield on actively managed office properties was well above inflation.

Although West German property performed better, only during the post-reunification boom years did rent increases for offices in many cities perform above the inflation rate.  Some cities - notably Munich and Frankfurt - performed significantly below the national average.

However, the study of real estate prices from 1975, commissioned by fund manager Deutsche Land, found that rental on actively managed office performed significantly above inflation except for 2007-08.  The study's authors concluded that stable rental income was more important for total returns than long-term price trends.