With national and foreign investors storming the real estate market in Europe's largest economy, capital inflows could reach €35 bn this year, market watchers predict.

With national and foreign investors storming the real estate market in Europe's largest economy, capital inflows could reach €35 bn this year, market watchers predict.

At first glance, Karsten Kallevig appears to be in an enviable position. The 39-year old has unquestionably the deepest pockets in Europe with €27 bn to burn in the next few years. Of course, it is not his own money, but a – relatively small - proportion of the €667 bn assets under management of Norway's giant oil-fuelled Government Pension Fund Global. In his capacity as Chief Investment Officer Real Estate, Karsten’s task is to grow the property allocation of the fund from the current 1.2% to 5% – without getting into risky positions that could run down the retirement provisions of Norway’s 5 million citizens. That is no easy task at a time when property prices in many parts of the globe are rising faster than rents.

Kallevig's strategy is conservative. His primary goal is ‘to safeguard the fund's real estate assets through prudent risk management’. Consequently, the fund is primarily targeting prime commercial properties in capital cities like Berlin, London and Paris. But according to market watchers, in Germany the Norwegians are also after core assets in cities like Frankfurt, Hamburg and Munich. 'Germany with its robust economy spread out over the six large office markets of Berlin, Düsseldorf, Frankfurt, Hamburg, Munich and Stuttgart offers foreign investors the diversification that countries like France and the UK lack given that their major office markets are confined to the capital cities,' noted Markus Schmidt, Head of Research at Aengevelt Immobilien in Berlin.

BUMP ON THE ROAD
As a result, domestic and foreign investors are queuing up to get their hands on German real estate, even if the country's GDP shrank by 0.2% in the second quarter of this year. 'The economic slowdown is viewed as just a bump on the road to further growth due to the crises in the Ukraine and the Middle East,' added Schmidt.

In Germany alone, institutional investors have poured €3.1 bn into indirect real estate vehicles like the special funds (Spezialfonds) in the first half of this year, up 14% from the €2.7 bn in the same period last year, according to a new study by Barkow Counsulting in Düsseldorf. 'It was the best half year ever for Spezialfonds,' noted Managing Director Peter Barkow.

Altogether investment volume in commercial real estate in Germany increased by 31% in the first six months of this year. 'We saw transactions with a total value of €17.1 bn, up from €13.06 bn in the same period last year,' said Ignaz Trombello, Head of Investment at Colliers International in Germany. In the second half of this year, Trombello expects even more money to flow into the market. 'Total transaction volume this year will very likely hit the €35 bn mark,' he predicted.

Other market watchers confirm the trend. 'Record low interest rates and the massive drop in yields of triple-A rated government bonds are driving national and foreign investors into the German real estate market,' agreed Timo Tschammler, Member of the Management Board of JLL in Germany. Among them are a growing number of pension and sovereign wealth funds from Asia and the Middle East, according to a study by Savills. 'Those funds are aiming for investments with a minimum volume of €100 mln each,' said Marcus Lemli, Head of European Investments at Savills. Malaysia's state pension fund EPF alone is looking to invest €300 mln into industrial property in Berlin, Munich and Frankfurt.

'We are registering a growing interest from foreign institutional investors, especially from Asia, in German property,' said a spokesperson for Deutsche Asset and Wealth Management (DeAWM), the real estate fund arm of Deutsche Bank. However, most German fund providers are not benefiting from the mounting interest in their country’s property market from outside investors as they are specialised in Spezialfonds, the indirect real estate vehicles that are geared towards German tax rules – and thus domestic institutional investors. A drawback is that these funds are not compatible with tax regulations in other countries. 'There is no money from foreign investors in our Spezialfonds,' confirmed Christian Pommée, a spokesperson of Dekabank, the Spezialfonds provider of the national Savings Banks Finance Group.

Deutsche Bank is a notable exception. 'Through our London office we are able to set up real estate investment vehicles like closed ended funds or even private REITs according to individual demands,' a DeAWM spokesperson said. He declined to comment on where these funds are domiciled, but according to market insiders they are often set up in tax havens like Bermuda, the Cayman Islands, Luxembourg or the Channel Islands.

In the first half of this year, foreign investors snapped up commercial property in Germany with a total volume of €7.1 bn, accounting for 44% of all transactions. However, in the coming months German investors may well boost their market share as closed-ended funds spark to life again. No new funds were set up after the German government introduced new regulations in mid-2013 forcing asset managers to regroup as new entities called Kapitalverwaltungsgesellschaften. But, according to a new study by rating agency Dextro Group in Darmstadt, established fund managers like Commerz Real of Commerzbank, Hamburg Trust, Hannover Leasing, Real I.S. and Wealthcap are setting up new vehicles for institutional and private investors with a total volume of about €2.7 bn. 'A wave of new products is flooding the market,' noted Sonja Knorr, analyst at rating agency Scope in Berlin.

They are becoming active on the deal front. Just recently Wealthcap, the closed-ended fund provider of UniCredit's German subsidiary Hypvereinsbank, snapped up three office buildings in Munich for a total of €130 mln for its new closed-ended public fund. Real I.S., the fund provider of the Sparkasse-Finanzgruppe (group of German savings banks and associated companies), is currently on the hunt for 8 to 10 office buildings in major cities like Berlin, Hamburg and Munich. 'We are setting up a portfolio with a volume of around €300 mln for our new closed-ended fund,' said Markus Lang, head of marketing at Real I.S. 'Our focus is on office buildings with attractive yields and long rental contracts.'

That is not an easy task. The growing demand for commercial real estate in Germany has driven up prices and sent yields downward. 'In the six largest office markets yields are currently within the range of 4.3% to 4.7%,' commented Andreas Trumpp, Head of Research at Colliers International. 'Geschäftshäuser, the typical German inner-city mixed commercial buildings with retail stores on the bottom level and offices on the floors above, are currently trading at yields between 3.7% and 4.3%.'

The yield crunch brings some experts back to the peak of the last investment boom in 2007. 'The German real estate investment market is far into its current cycle,' said Andreas Pohl, Member of the Board at Deutsche Hypothekenbank, a leading real estate finance bank. However, that does not mean that prices will lose ground any time soon, he added. 'As long as 10-year German treasuries yield only 1%, property yields at the current level are still very attractive for investors,' Pohl said. 'Even if property prices drop somewhat in the years to come, investors still stand to net considerably higher profits with real estate than with bonds.'

For Investors like Kallevig whose state fund pursues a buy-and-hold strategy a possible drop in market values is not a big concern. 'Those funds are interested in generating long-term stable cash flow,' Pohl pointed out. That is something that prime office buildings in large cities rented out to companies with good financial standing are set to deliver in the years to come, even if Germany's economy should falter further in the near future.

Richard Haimann
Correspondent Hamburg