Property investors showing appetite for bigger risks, lower yields in 2014

Large investors in German real estate are showing an increasing appetite for taking on bigger risks for smaller yield, according to Ernst & Young’s annual real estate barometer. The researchers also expect to see a rise in cross-border transactions this year, with deal volume as a whole expected to rise. The results were presented at a recent press briefing in Frankfurt.

Ernst & Young (or EY, as the group is now called) carried out a series of comprehensive surveys, among which was a survey of investor intentions in relation to 15 European countries, in which 500 responses were analysed.

While in Central and Eastern Europe investors are focused mainly on residential properties, in Western and Southern Europe the pendulum is swinging back in favour of investment in office properties, with investors showing a willingness to look beyond ‘core’ properties, in contrast to earlier years.

99% of respondents described Germany as an “attractive” investment destination, while 72% of respondents expect the overall transaction volume in 2014 to rise from €44bn last year to about €47bn this year. Last year’s figure was itself an increase of 23% on the previous year. 65% of respondents said they expect a further renaissance in the previously moribund CMBS market, which sprang back into life for a number of German deals last year.

While the position of Germany as a ‘safe haven’ was the main attraction in previous years, investors now rate the attractive financing environment as Germany’s most persuasive draw. According to Ernst & Young real estate partner Christian Schulz-Wulkow, whom we’ve often quoted in these pages. “Banks are willing to finance beyond core, even looking at speculative project developments, which were a total no-go in recent years,” said EY RE Partner Christian Schulz-Wulkow. “Equity requirements are still higher than in the boom years, posing a good market corrective. Expectations continue to be good for real estate, with stable to rising rents and prices in the cities – a trend that could only be changed by strongly rising interest rates, which we view as very unlikely in the immediate future.”

Top of investors’ preferences are still residential and office properties in A1 locations. In residential, Berlin still offers the best prospects, ahead of Cologne and Munich, while in the office sector Munich, Hamburg and Frankfurt all vie for the top position. However, although indications are that many investors feel the residential market is topping out, almost none expect price falls – rather, prices are expected to stabilise.

Investors are also perceiving secondary cities such as Bremen, Leipzig and Mönchengladbach as offering the same risks as cities such as Frankfurt, but with yields of more than 7-8% rather than the 5-6% typical of Frankfurt. There are also notably more transactions in some of the industrially weaker areas of eastern Germany, where yields are also attractive.

As a testimony to the desirability of German property generally, 81% of respondents said they see the proportion of non-core acquisitions rising firmly. “In contrast to past years, more risky investments are not seen per se as negative. The willingness to take on more risk seems particularly prevalent in the residential sector, where we’ve seen large transactions in B- and C-locations, a trend we expect to see continuing”, said Schulz-Wulkow.

In the commercial and industrial sector, the majority of recent deals have largely been within the ‘core’ segment, and for activity to spill out beyond this, the gap in price expectations between buyer and seller still has to narrow a lot to significantly boost transaction volumes, according to 91% of respondents. There are increasing signs, however, that risk acceptance is rising in this segment too, despite ongoing high vacancy rates and frequently short remaining lease periods, while 58% of respondents said they expect to shortly see the re-emergence of speculative commercial property project developments.

Respondents also expected (71%) that this year will see more portfolio deals, while 65% expect heightened activity in the CMBS sector. With residual Eurozone fears still lurking, Germany’s attractions for office investment still give cause for 53% of respondents to expect top German office prices to rise in the coming year, as against only 35% last year.

The survey also showed that for the logistics sector, price are expected to rise by 46% of respondents (25% last year). while most investors believe in stable prices for prime retail (65%) and hotels (62%). Those likely to be the most active sellers this year are opportunistic, private equity and open-ended funds, while the most active buyers will be private investors, family offices, insurance companies and pension funds.

Underpinning the relative German property boom is the low level of interest rates, which has continued to help push up residential prices. Buyers are making the simple calculation that what they’re saving in interest payments they’re paying in the form of higher prices. It looks increasingly likely, though, that these interest rates have irreversibly come off their lows. According to the Bundesbank, if borrowers were paying 2.6% last June for a loan fixed for between five and ten years, that rate would now be 2.9%, and rising. A recent study by consultants Feri warns that it expects rates to rise again from this summer, with the same loan more likely to cost 4%.

The low interest rate climate is undoubtedly encouraging Germany’s banks to hold on to their distressed and sub-perfoming loans longer on their own balance sheets, with survey respondents seeing joint restructuring efforts (91%) and prolongations (85%) as likely to be to the fore, rather than enforcements or the sell-off of loans at deep discounts.

Germany is evidently still strongly in the focus of investors, but there are indications that some big investors are taking the benign climate in Germany as an opportunity to exit the market and look elsewhere. The Ernst & Young study also points to investors’ wandering eyes. This year 49% of the survey respondents consider Spain a “very attractive” real estate market, compared to 32% who gave Germany the same rating.

According to Schulz-Wulkow, “Germany is no longer so conspicuous – the investment climate has generally improved across Europe. In the eurozone crisis countries of Spain and Italy prospects have noticeably improved.” While for many investors the safety of their capital will continue to keep Germany attractive, private equity investors looking for much higher yields may be finding it increasingly hard to pinpoint opportunities here, and are rooting around in Spain, Ireland, and other markets.  

Still bullish on the prospects for German real estate (not surprisingly) is Ulrich Höller, CEO of listed DIC Asset AG. Speaking at a company event in Frankfurt earlier this month, Höller predicted a further two good years for the industry in Germany, with the recent obsession with top-quality ‘core’ commercial properties giving way to more traditional investment into more ‘normal’ assets, such as those that listed companies Alstria, IVG and DIC Asset itself deal in.

Höller suggested that the recent problems experienced by IVG Immobilien’s involvement with The Squaire at Frankfurt Airport had affected investor perceptions of DIC Asset’s huge MainTor development in downtown Frankfurt, which will see the central business district in the city now extend all the way down to the banks of the river Main. Despite this scepticism, investor appetite for new, pre-let top-quality office properties is nonetheless still so strong that “the recent sale of one of the MainTor buildings for €155m went almost unremarked, so many other large deals were taking place at the same time”, commented Höller wryly.

Höller believes the winners this year will be those listed companies (Alstria, Prime Office, DIC Asset, among others) that are holding maybe less prestigious, but commercial assets capable of generating generous payouts, through specialised management and a strong cash-flow profile. He sees a shift underway from the residential sector back to the commercial sector, “as they have always done in the past”. In particular he sees an imminent narrowing of the gap between the market capitalisations and the NAVs of the listed companies, citing in the case of DIC Asset, a market cap of under €500m and a net asset value of €850m.