Threat of further property price corrections looms

Further price cuts seem inevitable as Germa- ny’s real estate woes continue and its economy remains sluggish.

Germany has been through the wringer this year, battling the rise in interest rates and construction costs, the energy price shock and the economic slowdown. In addition, next year is expected to herald an increase in the number of non-performing loans and further price corrections.

‘We expect to see further price corrections in all of the Big 7 markets and across all types of use,’ said Christian Kadel, head of Capital Markets Germany at Colliers, speaking at a recent online press conference organized by RUECKERCONSULT, titled: “Trend reversal on the real estate market: Which way are prices in the residential and office segment trending?”

‘Transaction volumes have been shrinking and will continue to do so. Office properties meeting top ESG standards take exception to this trend. The downstream effects of the high rate of inflation remain unclear at this time. But the tendency of commercial real estate to act as inflation hedge could arguably stimulate demand,’ he added.

Non-performing loans are also in the spotlight: ‘‘We anticipate an increase in NPLs to a volume of around €40 billion in 2023,’ said Claudius Meyer, managing director of CR Investment Management, speaking at the same conference.

In addition, the real estate sector is expect- ing more market differentiation to come in. In both the office and residential sectors, ESG-compliant properties are considered to be the most stable, according to the press conference, which also featured Pepijn Mor- shuis, CEO of Trei Real Estate.

Debt ratios have fallen by up to 10% since 2021

Price corrections are one of the burning topics at the moment: ‘We are seeing price discounts of up to 5%,’ Meyer said. ‘In addition, debt ratios have dropped by up to 10% since 2021. In the office segment, for example, back-office loca- tions are coming under pressure. Conversely, the values of ESG-compliant products remain more stable than the market average.’

Kadel agreed, noting a modest increase in prime yields this year: ‘These rose from 2.7% to 3%,’ he said. ‘Despite the high degree of uncertainty, transactions continue to move ahead on the market, closed primarily by equity-rich investors.’ Owners whose prop-

erties are occupied by commercial tenants with a high energy consumption will also face increased challenges this winter: ‘Occupi- ers are much more closely scrutinized now in regard to their ability to shoulder their energy costs,’ Kadel added.

Meyer expects to see the strain on metro- politan property markets ease a little. ‘A certain share of those developers who sometimes paid good money for plots of land in recent years and had these acquisitions financed will be forced to sell at some point in the future,’ he said.

The residential sector is facing its own challenges, with price-to-rent ratios of residential real estate falling by one to four points across Germany, according to Colliers. ‘Analogously, we have seen yields harden,’ Kadel said. ‘However, there are a number of factors that bolster prices and have a tempering effect. For one thing, demand for residential real estate remains as strong as ever. In addition, new- build construction is in decline, which benefits the existing stock of buildings. Another factor propping up the rents of standing properties is the continued influx into the cities.’

Uptick in equity financed deals

Predictably, given higher borrowing costs and the state of the economy, there has been an uptick in equity financed deals: ‘We are seeing deals closed with significantly higher equity ratios now,’ Morshuis said. ‘The deviations remain below 5%. Just recently, two out of three large transactions - each with a volume of over €50 million -were purely equity-financed deals, while the third one was leveraged at 50%,’ he said. However, he noted that there are other key variables to consider, including ‘economic growth, the availability of capital, and real interest’: ‘The latter is, of course, negative in Germany, given the current inflation rate of 7.9%,’ he stressed.

Morshuis was also quick to point out that a rise in lending rates does not automatically imply hardening property yields or softening prices: ‘In fact, the correlation of interest rates and property yields is not as unambiguous as is often assumed,’ he said. ‘There are plenty of historic examples suggesting as much. For instance, interest on ten-year Bunds declined by two percentage points between 2007 and 2010. Over the same period of time, property yields climbed by one percentage point.”

He also expects widening differentiation between different asset classes. ‘Residential and logistics are rather on the winning side of the latest trend, whereas office, hotel and retail properties are likely to be among the los- ers,’ he said.