DEMIRE study highlights robustness of secondary German office markets

DEMIRE Deutsche Mittelstand Real Estate AG, the listed commercial property investor focused on secondary German cities, published its third annual study this week - “Office Market: Investment Opportunities in German Secondary Locations”. The study, carried out by market researcher BulwienGesa, claims that returns on office investments in Germany’s secondary locations can be more robust than in the so-called Big 7 cities.

The study introduces the Secondary Office Index (SOX) for the first time, which compares the earnings potential and the earnings risk across cities. It compares 31 selected secondary locations with the Big 7, while drawing on data from a universe of 78 cities, each with a population of more than 100,000 inhabitants.

The key takeaway from the study is that the index illustrates that office markets are basically subject to economic fluctuations - but that the bigger markets are more vulnerable to economic downturns than smaller locations. In both the downturn in 2000, when the New Economy bubble burst, and in the aftermath of the financial crisis in 2007/8, the Class A markets (Big 7) suffered bigger declines than the SOX, with secondary locations being less volatile and more stable during the downturns.

Among the reasons for this are that construction activity tends to be less speculative and the market environment is dominated by local players with greater loyalty to their respective locations. The real estate markets of secondary locations are characterised by many so-called hidden champions and a strong Mittelstand, or small and medium-sized business sector.

According to Ingo Hartlief, the new CEO at DEMIRE, “The high demand for office real estate is undiminished while supply remains limited and this has pushed net initial yields to new lows. That can be seen in both the secondary locations and the Class A cities. As investors are increasingly focusing on cities away from the metropolises, the net initial yields here are falling more sharply in comparison with the previous year, although they are still significantly higher in most cases, which makes them attractive for domestic and foreign investors.”

“The newly developed SOX confirms the robustness of office real estate markets in secondary locations. Nearly all leading economic research institutes and the panel of government economic advisers have almost halved their growth forecasts for Germany in the current year. The results of the SOX reinforce our belief that we can generate stable earnings with our investments in secondary locations, even in turbulent times,” he added.

Sven Carstensen, Head of Office and Investment at bulwiengesa and author of the study adds: "For investors who are well versed in the market, secondary locations can still offer considerable investment alternatives even in the current market phase".

Among the findings of the study were that, using the weighted indicators for the newly-devised SOX, the cities of Bonn, Koblenz and Reutlingen have the best risk-return ratios. They are followed by Düsseldorf as the only Class A city among the 20 highest-ranked locations. By contrast, the Class A cities of Berlin, Munich and Hamburg, but also the secondary locations of Leipzig as well as Potsdam and Regensburg, are at the bottom of the scale due to their high rent volatility.

The highest net initial yields in secondary locations range from 6.1% in Schwerin to 6.6% in Chemnitz and 6.7% in Stralsund. In the Class A cities by contrast, the net initial yields average 3.0%. The lowest net initial yields in secondary locations are in Freiburg and Bonn with 4.0% each and Karlsruhe with 4.%. Hence, the yield spread between the Class A cities and the secondary locations examined amounts to at least one percentage point. DEMIRE, headquartered in Langen, just south of Frankfurt am Main, posted its own financial results this month, showing that it doubled its FFO 1 for 2018 to €23.4m, up from last year’s €11.7m. EBIT rose by €42.5m to €127.1m, up from €84.6m in 2017.

Rental income was stable at €73.7m, despite selling several properties, so the increase in FFO largely came about by lower finance expenses from refinancing, along with lower maintenance costs and an upward revaluation in the company’s assets. Net LTV fell from 60.1% to 38.7%, due to upward revaluation of the company’s properties and a big injection of new shareholder capital from the two biggest shareholders, Apollo Global Management and Wecken Group.