Frankfurt commercial property market set for quieter 2020

Frankfurt’s commercial real estate market ended the year on a new high but 2020 is likely to usher in a more muted market.

Despite a record fourth quarter thanks to €4.4bn of transactions, the deal volume in Frankfurt this year is unlikely to match the €10bn of deals last year which put Frankfurt in third place behind Berlin (€15.8bn) and Munich (€10.9bn), according to JLL.  The office transaction volume in Frankfurt last year was €4.85bn, around half of the €8.47bn recorded in 2018.

‘The general trend that we’re seeing is the unwillingness of investors to sell,’ Marcus Lütgering, head of office investment Germany, told REFIRE.

This week (27 January), AEW acquired Baseler Palais, an office building in Frankfurt on behalf of its AEW Europe Value Investors II fund for an undisclosed sum. The transaction marks the fund’s first deal in Frankfurt and the second in Germany, following the acquisition of the Accor Building in Munich last year, and increases EVI II’s assets under management to over €230m with nine assets in the portfolio.

‘This acquisition presents an opportunity to acquire a well located office building in one of Germany’s strongest office markets and a major financial centre, which has benefited from the aftermath of Brexit,’ said  Tobias Schnurer, director of investment at AEW. ‘With extremely low vacancy across the city’s office stock and strong occupier demand, rents are continuing to grow and we expect this investment to be well placed to capitalise on this trend.’

The seven-storey building, which comprises around 5,300 sqm of lettable space, is 50% let with a WALT of about 4.6 years. The main tenant is Leibniz-Institut Hessische Stiftung Friedens-und Konfliktforschung (HSFK), one of the leading peace research institutes in Europe. The asset offers asset management and refurbishment potential in the medium term. AEW was advised by Ashurst LLP, Drees & Sommer and Nova-Ambiente. GSK Stockmann and JLL acted for the vendor.

 ‘This year, Frankfurt has some potentially big deals on the cards,’ said Lütgering, declining to give further details. ‘However, investors are not keen to sell because rents are increasing. If you bought an office four to six years ago, you’ve now got a cash on cash return of 6% to 10%. This is the main reason why the deal volume is down.’

Another challenge is increasing rents and the pressure on initial yields. Initial yields for offices in Frankfurt are just 2.85% and they tightened by 30 basis points last year, according to Lütgering.

As a result, more and more investors are looking for investment opportunities in city-fringe and peripheral locations where we also see more yield compression, according to Linsin: ‘There’s plenty of money available to invest because Germany is flavour of the year,’ he said. ‘However, after a record year 2019, I think we’ll see lower investment volumes this year due to the lack of investment opportunities. There’s tough competition.’

Office lettings expected to fall in 2020

This year, take-up in most of the seven large markets is likely to decline by an average of 4% compared to 2019, to reach just under 3.9 million sqm, according to Helge Scheunemann, head of research at JLL Germany.

‘On the supply side it is still the case that little space is available in central locations,’ he said. ‘In terms of demand, the weakening economy will likely affect the office lettings markets with a corresponding time lag.’

Last year, there were 580,000 sqm of new office lettings in Frankfurt, compared to 630,000 sqm in 2018 and a record 700,000 sqm in 2017, according to Markus Kullmann, senior team leader office leasing at JLL. This year, JLL is forecasting around 550,000 sqm of new lettings.

‘The level of supply is the lowest it has been since the early 2000s,’ Kullmann told REFIRE. ‘Also, there are often delays in the delivery of new space and construction has become very expensive. In light of this, the real question is: will prospective tenants trust developers and sign the lease on an office under construction? This is putting pressure on developers.’

Average office rents in Frankfurt have increased by 6.5% to €21.48 per sqm/month. ‘Big corporates can afford to pay around €40 per sqm because, for them, it’s about the whole package,’ Kullmann said.  Prime rents sit around €41.50 per sqm/month and some are even above that level, he said.

For Jens Böhnlein, global head of office investment at Commerz Real, the attraction of Frankfurt, from an investor standpoint, is that ‘it offers more high volume-opportunities than other German cities because of its high-rise office towers and its competitive incentives for tenants’.

‘Occupiers are looking for modern, top-of-the-class offices in urban environments,’ he said. ‘Compared to other German office markets of Munich, Berlin or Hamburg, Frankfurt still has some vacancies in central locations. For us, as an investor, this means that it is paramount – even more so than in other markets – to make sure that any office building we invest in is able to “out compete” other buildings in terms of its attractiveness for occupiers.’

There are also some sizeable office developments underway, One of the most ambitious projects  is ‘FOUR’ in the banking district, which will comprise four towers, two of which are resi and 2 are offices, which is being developed by Groß & Partner. The project will provide around 600 apartments and 92,000 sqm of office space as a well as shops and restaurants. The office leases are typically 10 to 15 years. Law firm Allen & Overy leased 10,000 sqm last year and is due to move in during 2025. ‘This highlights how long a process it is to find a space, sign a lease and then wait to move in if it’s still being built,’ Kullmann said.

Frankfurt is seeing some increase in office supply as developments are completed. In the OmniTurm, for example, the biggest tenant – whose name is confidential - has taken 5 out of 41 floors, according to Kullmann.

‘The question is, how long will it take to fill up these towers with smaller tenants? Will they find bigger tenants willing to pay €40 per sqm? We are some seeing some speculative development now. The office vacancy rate is 5.5% but I don’t think Frankfurt will hit the zero vacancy rate we see in Munich,’ Kullmann said.

Bumper year for resi

In Frankfurt, there were €1.3bn of resi deals in 2018, which jumped to €2.4bn of deals in 2019, an increase of approx. 90%, the best year since 2013, according to Michael Bender, senior team leader of residential investment at JLL Germany.

‘This year, I expect to see another increase,’ he said. ‘This is because there is a lot of liquidity in the market and funds such as Aberdeen, Commerz Real and DWS are trying to invest in multi-family via forward deals. Forward funding deals actually accounted for around 30% of the total last year.’

The trickiest part is to find plots upon which to build. Initial yields for forward funded schemes in the centre of Frankfurt have a multiplier of 30 or 31, which falls to 27/28 in locations such as Offenbach, Mainz or Wiesbaden, according to Bender.

There are also some sizeable projects underway, including 160 Park View, which is being developed by Hines and RFR. It comprises two towers: one will be a hotel and the other will be condos (129 in total, ranging from 53 sqm to 330 sqm across 26 floors) in Frankfurt’s Westend. Construction is underway and it is due to be completed by the end of 2022.

‘Another interesting project is GEG’s redevelopment of Union Tower. It’s being converted from an office into a condo tower right on the Main. It’s a very cool location,’ Bender said.

In December, Bosch&Buderus sold a portfolio of 1,000 resi units in Wetzlar, Lollar near Frankfurt, to Nassauische Heimstätte. JLL advised Bosch&Buderus. The sale price has not been disclosed.

Retail market still struggling

There were €261.48m of retail deals in Frankfurt last year, compared to €177.64m in 2018, according to CBRE.

However, Frankfurt’s retail market continues to struggle, according to Lütgering: ‘Retail is really tough because investors struggle to value retail because they don’t know what’s happening with rents, although Goethe Str. has some of the top rents in Germany, at around €250 per sqm.’

Family offices used to be able to charge very high rents on the lower two floors but now tenants are only interested in taking ground floor space,’ according to Kullmann. ‘Landlords will just not be able to charge high rents on the first and second floors. I think some retail space could be converted to offices.’

For Linsin, ‘food-anchored retail is still leading the way’: ‘Retail parks are quite popular. Retail is still an interesting asset class but investors look very carefully,’ he said. (ssk)