German office capital values seen peaking in 2018 - Study

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A report published last week by Capital Economics suggests that German office capital values are likely to peak in 2018, although the report concludes that after rising steadily for years, a sharp correction seems unlikely.

An earlier report in 2016 noted that office capital values in Berlin, Frankfurt, Hamburg and Munich had risen by between 30% and 65% since 2010, and that, at the time, even though prime yields were already well below previous lows, valuations did not look excessively stretched against a basket of alternative assets.

Since then, values have indeed continued to rise – in the case of Berlin, surging by almost 30% last year alone - to stand 140% above their 2007 peak. Capital values in Munich and Hamburg are 80% to 90% higher than in 2007, while Frankfurt is up by 60%.

The study notes that a key driver in the rapid appreciation of office values has been the steep decline in yields, as investors search for returns in our low interest rate environment. German office assets have also been bid up by rental growth expectations, on account of strong employment growth and ever tighter availability.

Still, it’s really only in Berlin that actual rental growth has made a significant contribution to rising capital values, the study points out, adding about 12% per year to capital growth between 2015 and 2017. In contrast, rental growth was only about 3% on average in Munich, and not even that in Frankfurt and Hamburg.

The Capital Economics researchers believe have now reached the bottom, and they expect the rate of rental growth to ease. As a result, they are forecasting capital appreciation to slow sharply between now and the end of the year. With the European Central Bank looking to end it QE programme and interest rates maybe starting to rise next year, the researchers think we will have seen a peak in capital values in 2018.

Berlin is singled out as the city with the biggest risks, given its large development pipeline which could put prime rents under pressure, and drag down capital values. But overall, although yields are seen shifting out again from 2019, the fall in capital values by end 2020 should be around 6% lower than the end of this year, avoiding an abrupt downward correction across the market as a whole.