Chasing the elusive 5% yield in challenging market conditions

We’ve grown used to reporting on the annual study carried out by researchers Bulwiengesa – with the traditional support of law firm BEITEN BURKHARDT – which attempts to pinpoint where investors should look to ensure a 5% yield on their investment. In the current circumstances, no easy task.

A big audience tuned in for this year’s sixth annual running of the event, as always presented very succinctly by board member Sven Carstensen from Bulwiengesa in Berlin, and ably assisted by Klaus Beine, partner and notary at BEITEN BURKHARDT’s Munich office. Carstensen gave us a preview of the forthcoming study, which will be published in April, and which covers the residential, office and retail segments of the German real estate industry.

Not surprisingly, it became even more difficult for professional investors to lock in secure returns in 2020, where even the traditionally liquid and stable asset classes such as offices in A-cities have seen risk and yield spreads widening enormously. Whereas in 2019 it was still possible to achieve an IRR of between 0.9% and 3.3% in the core sector – for stably leased properties in sustainably good locations – in 2020 the range fell from 0.0% to 2.8%.

A-cities suffered the biggest decline, while the B-cities held their own. While risks are increasing, purchase prices in ‘core’ areas remain high. Increasingly, finding and managing suitable properties requires a great deal of local knowledge and expertise.

As Sven Carstensen said, “Working from home doesn’t mean the death of the classical office. But many investors are uncertain about how home office working will affect the future demand for office space. It is indeed foreseeable that companies will allow their employees to work from home more in the future than before the Corona crisis. However, a possible reduction in space will be offset by the need for more distance in the office. The slump in office employment growth feared by many has also failed to materialize so far."

While the rapid recent growth of office employment has indeed been losing momentum, Bulwiengesa still expects a growth of 1.0% per annum as early as later on this year.

The emerging legal ramifications of home office or mobile working mean that the phenomenon is not yet mature enough to seriously threaten to replace office working. BEITEN BURKHARDT’S Beine commented: "Legislative measures have raised question marks in the real estate sector not only since the beginning of the pandemic. The so-called ‘right’ to home office does not even cover the real issues regarding the workplace, which are regulated, for example, in the German Civil Code, the Labor Protection Act and other laws, or even data security implications."

The investment market for shopping centres is currently moribund, with only isolated assets being traded, and with the demand outlook cloudy. Buyers are having to factor in high expenditure for the conversion of (parts of) areas. Investors are uncertain about the extent to which future rent adjustments will fail or stores will close. With these risks priced in, the yield spread has widened significantly, from between 3.2% and 3.9% in 2019 to between 2.5% and 4.3% in 2020 for core properties. 

Food-oriented retail space, less dependent on the economy and e-commerce, remains much in demand. Retail parks with a high proportion of ‘essential’ needs offerings are benefiting, and these assets remain in demand. The yield range is 2.4% to 3.3% p.a. The comparatively low margin reflects the perceived safety of the asset class.

The safest asset class is residential housing, where the least has changed since the previous year. The Bulwiengesa researchers forecast purchase prices showing lower growth between now and 2024 than in previous years, with project developments in expensive city locations becoming fewer, with prices having reached a high level in absolute terms. Still, despite the uncertain economic environment with more short-time work (Kurzarbeit) and the unemployment figures creeping up, housing demand remains strong.

In many cities, supply is still low and new building plots are scarce and expensive. The achievable yields remain at a low level, between 1.5% and 2.5% for residential properties in A-cities. The potential for price increases is increasingly limited by legal regulation. Carstensen said, "With a base value of 1.94%, there is still value protection for residential real estate but it’s getting tougher. At the same time, market risks remain very manageable - residential continues to be a very safe asset class."

Beine, talking about the value of the research, said: "For us as a commercial law firm, the study is always valuable because we can see how political influence affects the market – right now, the keywords are rent brakes, rent caps, preservation statutes, conversion bans or building land mobilization laws." In other words, that elusive 5% will have to be sought elsewhere in the real estate domain – and as the full study will show, that’s likely to be in certain industrial/logistical sub-sectors, or even offices in the least liquid markets – with commensurate risk, and for investors with strong nerves.