Demand remains muted for non-core German office

There has been much talk of investors in German commercial property raising their sights from the overbought ‘core’ office properties in the business districts of the larger cities, and heading into secondary locations to unearth “undiscovered gems”. But it’s difficult to find much evidence of a widespread shift in attitude among investors – particularly international investors – that suggests anything like a stampede into Germany’s provinces to invest the money that’s allegedly burning a hole in investors’ pockets.

The latest report from the very active research team at IVG Immobilien AG under Thomas Beyerle underpins the perception that at least German institutional investors aren’t abandoning the bigger cities just yet. They are still focused on core-plus assets amid yield compression in the central business districts of the biggest 7 German cities, and are so far showing a marked unwillingness to move too much further up the risk curve, the report says.

Despite a partial rental recovery in some secondary sub-markets adding pressure on investors to rethink their largely exclusive preference for core, IVG’s Thomas Beyerle said they would look to investment opportunities only marginally down the risk curve, such as high-quality offices in city fringe sub-markets.

“Investment demand is expected to remain high, but supply of core products will be scarce. It will depend on the strength of the economic recovery in Germany and the euro-zone whether investors are ready to accept higher risks or not”, say the researchers.

The firm expects rental markets to regain momentum in the second half as a result of the euro having been “almost rescued”. But demand from overseas investors will continue to focus investment on the seven largest markets, which last year accounted for 86% of office deals, compared with 60% for commercial property as a whole.

“If the economy recovered and investors took more risk, then commercial property investments would rise in the regional centres – it has already happened in the last two years – but also in the major seven markets,” said Beyerle, adding that he did not expect any major increase in non-major regional markets in the near future.

Meanwhile, IVG expects the yield spread between good quality and obsolescent secondary to widen, with the latter attracting capital only as a result of an exceptional location or lack of vacant space in other categories. Both are unlikely, given tight property lending and a continuing high vacancy rate across much of the German office market.

“While high-quality products in good secondary locations of the major seven markets attracted demand from investors, there is almost no demand for outdated, obsolescent stock in secondary locations,” said Beyerle.