Can Germany retain its position as the most stable real estate market in Europe?

Can Germany retain its position as the most stable real estate market in Europe? That is the question being posed this month by TH Real Estate’s report: ‘Think Europe: who is afraid of German volatility?’

The consensus is that Germany is expected to remain one of the most attractive and stable real estate markets in Europe: ‘Germany will remain a stable investment market in the medium term, particularly given the noise from Italy and Brexit,’ Stefan Wundrak, head of European research at real estate management firm TH Real Estate in London, told REFIRE. ‘Volatility comes after a market has grown substantially and creates ‘froth’ towards the tail end of the cycle.’

Nonetheless, office yield levels have hit an all-time low, making it hard to see how sustainable that will be in the long-term, according to Wundrak. ‘We have seen office yields in Berlin at 2.9% - I think the market has bottomed out. Investors are definitely looking more at smaller cities, such as Cologne and Stuttgart. International investors are also looking there but tend to be outbid by domestic investors.’

And although Berlin has witnessed unprecedented office capital value and rental growth in recent years, it is now the turn of other cities to play catch up, particularly Frankfurt and Cologne, Wundrak said.

‘Offices in Frankfurt are being leased more quickly, which is, in part, a response to increased interest in light of Brexit,’ he said. ‘Co-working is also becoming more popular, even in cities such as Heidelberg and Nuremberg.’

TH Real Estate is forecasting office rental growth of around 3.5% in Hamburg next year, outstripping Berlin by 0.5%. Cologne comes a close second, with rental growth of 2.5% forecast for next year and 2% in 2020.

As a result, the JLL Prime Office Index is expected to grow further this year, building on gains of 47% since the last peak. Taking rental growth and yield compression together, capital values for offices in Berlin alone have soared by 120% since 2007, according to TH Real Estate.

‘I expect the JLL Prime Office Index to grow again this year because we expect strong rental growth in some cities,’ Wundrak said. ‘The environment is not going to get any better – capital will not be cheaper than it is today. Also property is a slow sector; it can’t react as fast as financial markets.’

German yields tighten

What is clear is that in recent years, German real estate, without any external influence, has broken with the tradition of relative yield and rent stability. In the early 1980s, German office yields moved within a relatively narrow band of between 4.5% and 5.75%, while in London, Paris, Madrid, and Dublin, the range has been between 3.75% and 6.25%, according to TH Real Estate. Now, in the current cycle, new records are being set as office yields in Berlin dip below 3% and are only just edging above the 3% mark in cities such as Munich, Frankfurt and Hamburg, a development that is mirrored on the rental side. As such, German office markets haven’t experienced the huge swings that have plagued Dublin, Oslo and Madrid, according to the report.

And while it is harder to argue that unusually low yields are sustainable beyond the current cycle, ultra-low interest rates supporting extremely cheap funding by German banks, combined with stronger than usual economic growth, will likely continue to underpin the current cycle. The big question is whether low yields can be sustained in an economic downturn and whether they can survive the normalization of interest rates. Wundrak, for one, is optimistic: ‘The stabilizing nature of the German real estate industry should ensure that any correction will be measured,’ he said. Many investors will be betting on just that. (ssk)