Demographics underpin German demand, but real returns to remain low

A useful new market intelligence report from Warburg-HIH Invest Real Estate provides an overview of national and international investment and occupier markets, with its main thesis being that real estate will remain a much sought-after asset class through the 2020s, and that demographic change will only increase the demand for secure, stable-valued investment assets.

Structural parameters will ensure that rates of return on the capital markets stay low, believes the author of the report, Professor Dr. Felix Schindler, head of research at the Hamburg-based Warburg HIH Invest.

As Schindler puts it, the year 2019 concluded with a spectacular year-end rally, setting new records of various kinds on the real estate markets – despite or perhaps even because of the current economic and geopolitical jitters. “These parameters and the low interest rate environment will carry us through the early years of the new decade, and will probably ensure that prime yields will remain low on the real estate markets, in some cases below 3.0 %.” 

Schindler expects the ECB key lending rate to remain unchanged at 0.0 percent, the eurozone to experience a GDP growth even slower than that seen in 2019, and a permanently low inflation rate below the mark of 2.0 % in the ongoing year. He believes that a significant deterioration of the economic situation in the eurozone could actually prompt a further interest cut by the ECB. As far as the real estate investment markets go, Schindler assumes that yield levels will remain low, as the intense competition for core assets continues. “In Europe, the post-Brexit situation in the United Kingdom implies a certain catch-up potential,” he said. 

Germany should see its transaction volume maintain its historically high level whereas prime yields, especially those for office real estate, will keep hardening. But even at less than three percent, prime yields remain attractive compared to the interest paid on German government bonds. 

For Europe as a whole, Schindler predicts that Asian investors will keep expanding their share of the market. While this group of investors used to concentrate primarily on London, the investment focus has lately shown a manifest shift toward Continental Europe. At the same time, the origins of investment capital are finding a broader basis. In addition to investors from South Korea and Singapore, Japanese investors with a “core” investment profile have also stepped up their activities in Europe. This is primarily due to the desire for a broader spread of real estate held, outside the domestic market. In addition, portfolio effects driven by macroeconomic factors play a major role, especially for emerging economies in Asia.

The forecast for the performance of European occupier markets shows no sign of a trend reversal this year. If anything, the dynamics of rental growth are expected to slow down because of the gradual increase in construction activity and weakening economic impulses. “In Germany’s ‘Big Seven’ cities, strong demand for space will continue to coincide with short supply,” said Schindler. In fact, given that, these markets are set to see further rent hikes. 

The report draws parallels between conditions in Germany and those in Japan from a demographic point of view, with demographics the key factor driving the long-term trend in real interest rates.

“The ageing of a given society tends to be matched by low levels of inflation and declining return expectations on its capital markets,” said Schindler. Given the steady ageing of the country’s population, he expects the real return on assets to remain low in Germany. “Whether we like it or not, we better get used to the low level of interest rates in Germany, a situation that bolsters the long-term demand for real estate as an asset class,” Schindler concluded.