7th German Debt Project study show bank margins recovering slowly

The seventh edition of the study “German Debt Project” carried out by Professor Tobias Just and his team at the IREBS International Real Estate Business School has just been published – this year a little bit later than usual. The study, supported by the VdP Association of German Pfandbrief Banks and sponsored by several leading lights in the German real estate industy, provides detailed information on the country’s commercial real estate financing market.

It is a useful study – if a little obvious in the light of the myriad of indices tracking much the  same thing - offering some insights into the thinking behind many of the leading lending institutions and their views on the market after ten years of effectively uninterrupted growth. 

The purpose of the study, say IREBS, is to both increase transparency in the German commercial real estate financing market, and also to enable meaningful comparison, particularly in risk analysis. Twenty-four German financial institutions took part in the survey, with a credit volume analysed of €93 billion.

The caution becoming more apparent over the past two years shows little sign of abating. New business declined in 2017 and 2018 after six years of expansion, with the fall last year of 8% similar to that in 2017 (although savings banks and co-operative banks are under-represented in the analysis, hence the overall decline is assumed to be less).

In 2019 the volume of new business underwritten is at last year’s level, although with extensions and lower premature repayments, overall credit volume grew by about 3.5% in 2018 and is likely to do so again this year.

Given stiff competition, margins for banks continue to decline, with a third of respondents reporting falling net margins, down by 30 bps on average since 2013. However, on project developments, pressure on margins is reported as being reduced, with a growing number of banks reporting a moderate increase in margins, particularly for more complex financing.

For low-risk transactions the margins, already very low at 50-70 bps, are increasingly being earned against a background of more competitive maturities and covenants, while banks continue to see reasonable margins by agreeing financing beyond purely core strategies, such as financing for niche products and operator-run properties, project developments or overseas deals. There is evidence of more available financing for properties with upside potential, for example with vacancies or refurbishment needs, as well as assets in more secondary or tertiary locations, to compensate for the low margins available in more plain vanilla deals.

Risk provision against bad debts is declining again, and the market for non-performing loans remains flat. Within asset categories, office property has seen the strongest rise in favour among lenders, with logistics also high, although there is concern about falling rents. Residential is still viewed as a safe haven. Retail property lending is viewed the most critically, although lenders differentiate between urban district locations and simple shopping centre lending on the one hand, and investment in retail parks (Fachmarktzentren) and prime inner-city locations on the other. There is also a growing belief among many banks that the recent aversion to lending to the retail asset class may have been taken too far.

None of the banks surveyed expect a steady rise in interest rates over the coming years, which could lead to upheaval on the real estate financing markets. If anything, worries about an economic downturn far outweigh fears about rising interest rates, with the geopolitical situation being viewed as fragile. The evidence (as provided in the report by Real Capital Analytics) is clear of overall caution – “The volume of transactions in Europe fell in the first half of 2019. The German market, however, is in a relatively good position with a decline of (only) 12% and is currently the strongest market in Europe. Good properties are still in demand as international investors continue to want to strengthen their allocation in Germany.”

Pressure for more consolidation among the banks – especially in standard business – is set to increase as more burdensome regulation requires higher margins. As Professor Just concluded in his report, there is no immediate expectation of a collapse in demand, but all are aware of a new raft of uncertainties. He says, “In this context it would be appropriate not to unsettle the real estate market stakeholders by regulatory actionism as, at the current level of rental incomes being achieved, even slight changes in stakeholders’ expectation may lead to severe effects on prices.” (In other words, now’s not the time to upset the applecart with yet more legislation. Berlin,BaFin, Bundesbank - are you listening…?)