Much of German office market still very stable - CLS Holdings' Rolf Mensing

CLS Holdings is a UK-listed property company, active as an investor in three main markets – the UK, France and Germany. It has nearly 600,000 sqm of future-focused office workspace, with a strategy of investing in non-prime locations.

REFIRE spoke recently with Rolf Mensing, the head of CLS in Germany, about the German commercial property market, where the company has been active for several years.

REFIRE: What are your thoughts on the current real estate market in Germany?

Rolf Mensing: We’re seeing a tendency for more and more market players to gradually coming around to accepting a “new normal” with its new market conditions. For me, this was already evident at the recent Expo REAL in Munich. A "new objectivity" is emerging on the investment market and the number of transactions could pick up again in 2024, albeit at a lower level. Still, the market shakeout that began in 2023 will continue in 2024.

Overall, we’re tentatively drawing a positive picture of the German property investment market, and we’re cautiously optimistic about the coming year.

REFIRE: We’re well used to the headlines about a ‘crisis’ in the retail property market. But right now it’s all about total disruption in the office sector, with among others, the need for more digitization. Offices are your area of speciality – how important is this?

Mensing: Of course digitization is having a major impact, but actually the question presumes there’s been a collapse in demand for office properties. This is not really the case, despite what you might gather from the gloomy headlines and doom-laden opinion articles. The market is much more differentiated than many assume, and if you look closely you can actually observe the emergence of opposing trends.

REFIRE: How so?

Mensing: Firstly, efforts to save on rental space in peripheral locations are countering the robust demand for better-quality, well-connected office space in more central locations. In addition to A and B locations, these also include city district locations with good transport links.

Secondly, the issue of Home Office versus working in the company’s office is still very much in a state of flux, with returning to the office very much a part of many corporate strategies, even while tolerating hybrid working. Still, the number of hours spent working in the office is again on the rise in Germany.

REFIRE: But not everywhere, surely?

Mensing: You have to consider the respective structure of demand in various markets. For example, markets with a lower proportion of large companies tend to have a more stable demand for space.

The higher the degree of digitisation, the higher the proportion of home office vs. working in the office. In large metropolitan regions, with many international companies that are more digitally advanced, the proportion of home offices and therefore efforts to save space are comparatively higher.

REFIRE: Surely though, digitization will also increase in the SME sector, where projections suggest demand for office space will also slump over the next ten years. Can you still invest in offices with a clear conscience?

Mensing: Again, you have to take a more nuanced and differentiated approach, which market experts are increasingly doing. JLL even sees bottlenecks and shortages in individual sub-sectors, while the vacancy rate remains largely unchanged. We see continuing demand from the public sector, for example, which is an important and reliable tenant group for us alongside companies in the SME segment. The declining volume of new construction is also likely to further increase demand pressure on high-quality, sustainable existing properties, particularly in A-locations.

This will present opportunities for those companies that have a decarbonisation strategy combined with a high level of implementation expertise. These companies can certainly integrate a green premium into their IRR calculations. For us at CLS Germany, it’s also very high on our agenda and we are working towards this.

REFIRE: Specifically, what kind of office properties do you consider the most promising?

Mensing: We definitely see more differentiation across the market. For example, the monolithic office in a business park no longer has a future. The future belongs to quality properties in an urban setting that have a good energy standard and flexibly configurable space, which include other types of use in addition to offices.

Office property owners must also be open to new user groups, such as life science companies or doctors. In addition, office properties in B-locations in A-cities and A-locations in B-cities are performing in a comparatively stable manner: according to BNPPRE, there was a significant increase in turnover on the investment market in smaller cities, for example.

On the letting market, demand for sustainable quality properties in well-connected locations with an urban environment is at a stable level and is therefore better than that in A-locations in the top locations. Not many companies can afford the current prime rents in A-locations, which are in any event likely to continue to rise. The aforementioned public sector is also ensuring stable demand in these locations.

REFIRE: What about secondary locations, but still near the biggest cities?

Mensing: Good B-locations in the top 7 cities, that is, those with good transport links and attractive surroundings, as well as A-locations in economically strong B-cities therefore continue to offer a good alternative for companies looking for high-quality and energy-efficient space. In economically strong metropolitan regions with comparatively long commuting times and high rent levels in A-locations, companies are increasingly tending to switch to B- or city district locations. These are simply closer to employees' homes.

REFIRE: Are you seeing many such properties on the investment market right now?

Mensing: Not too many as of right now. But it is slowly starting - especially with fungible properties between €20m and a maximum of €50m in well-connected locations. There may still be some movement in the purchase price to get the market going again. We expect one or two buying opportunities in the coming year if sellers come under pressure due to prolongations. But the main value driver now is the handling of our own properties – it really is all about highly active asset and property management.

REFIRE: You stepped into the market last year with your purchase of prominent building The Yellow in Dortmund, just after the shock of the Russian invasion of Ukraine. You then took an extended break from new buying. Are you planning to stay longer on the sidelines?

Mensing: Well, we are certainly keeping our eyes open. We already see opportunities in anti-cyclical behavior. Purchase prices are currently already below the five-year average. But there is still a lack of real offers.

In principle, however, we would say the following: only those who work intensively with their own office property portfolio in this environment and can upgrade regarding current user requirements and energy standards will continue to attract new tenants even on weakening letting markets and secure or increase vacancies through the value of their own portfolio.

However, finding the right adjustments and meeting the individual requirements and needs of tenants is likely to be a fine art. Cooperation between tenant and landlord is therefore crucial to success - the keyword is "know your customer".