Financing growth exceeds expectations, but margins suffering
It's that time of year again when the "German Debt Project" appears – a major study of commercial real estate financing market in Germany. For the fourth time, the study has been written and published by Professor Tobias Just and Markus Hesse of the International Real Estate Business School, supported by the Verband deutscher Pfandbriefbanken (vdp), the association of German mortgage credit banks, and nine prestigious sponsors.
Among the key findings of this latest study is that new business growth last year was, at 20%, double the previous year's growth figure and well above market participants' expectations, who had been expecting "about 9%" growth for 2015. So far this year it has risen again by 20%, confounding expectations of about 6% for the whole of the year 2016. The second quarter suggested a slowing-down, however, lagging the corresponding quarter last year.
Professor Tobias Just, head of scientific research at the IREBS Immobilienakademie at Elville, on the Rhine near Wiesbaden, presented this year's findings in Frankfurt recently. “Business is becoming ever more complex. What is noticeable is the strong growth in the financing of operator real estate, properties outside of the top cities and in project financing – in some cases these can be attractive prospects, but this depends on investors and financiers being able to weigh up the specifics of these asset classes properly.”
Plain vanilla deals continue to be highly sought after, but are becoming increasingly hard to find on attractive terms, he said. With ever more sophisticated bank portfolios, the risks rise. The growth spurt in new business has been given a greater than expected boost by purely commercial property financing (+37 %), whereas the volume of loans in the sphere of institutionally invested housing has been taking a breather, falling 8 %.
All commercial sub-sectors have experienced substantial, two-figure growth. The frontrunner has been the trading subsector (+47 %), followed by specialist real estate (+43 %) with offices just behind at +26 %. The regional distribution indicates that during 2015 things once more levelled out – with 57 % new business growth outside of the TOP-7 cities.
A series of institutions, however, are also considering the extension of their overseas activities - with Brexit giving many banks pause for thought as to their future strategies.
Professor Just highlighted the change in LTV values, which at 68.2 % are only slightly above the previous year’s level (67.8%). He noted three aspects: "Firstly the development of the “V” (value), i.e. rising prices in the real estate sector, is curbing the debt component. Secondly, the mix of property types is becoming more sophisticated. Thirdly, the proportion of large institutional clients seeking low debt components is increasing."
"If the average LTVs continue to rise slightly nevertheless, there must also be more offers with more aggressive loan-to-value ratios; in the event of a cooling of the market, this conflicting trend exacerbates the problems in particular for such aggressive market players."
On margins, Professor Just said that on his sample portfolio the nett margin fell in 2015 by 11.5 bps to 118.1 bps, bringing margins to the level last experienced in 2010. For 2016 a further fall of 10 bps is expected given the high level of competition.
Co-author Markus Hesse stressed the need for increased transparency and warned that, at current levels, “Operating margins are only risk-congruent if the real estate market risks persist at their current level and the need for risk provisioning thereby remains low – and regulation does not continue to intensify, although this is a clear probability”.
The broader German economic environment remains favourable and still a magnet for international real estate investors. Big risk-averse investors such as insurance companies and pension funds are increasing their commitment to the German market for real estate debt and equity, the study shows.
Professor Just concluded that, "Either real estate financing has become more attractive at least comparatively, with regard to its opportunities and risks, or the risk assessment of market stakeholders is incorrect – or economic hardship threatens rather from other financial and investment markets from which the banks and investors redeploy moneys into the real estate market."
In other words, the greatest risk right now to the real estate and real estate financing markets are external, and lie outside of commercial real estate financing itself.
23 German financial institutions took part in the IREBS study, which analysed a credit volume of €183bn, representing about half of the commercial real estate financing market.