German real estate prices increasingly deemed ‘unacceptable’

German real estate prices are increasingly being deemed ‘unacceptable’, over growing fears that a bubble could be lurking around the corner in some sub-sectors, according to fund manager Universal-Investment’s Investor Survey 2019, published this month.

According to the institutional investors surveyed – with combined total assets of around €202.4bn –prices in core locations are particularly unacceptable, with almost 30% in agreement, up from just 8.2% last year. However, 76.5% of investors surveyed believe that European real estate prices are over-priced but still acceptable, up from 70% last year. Interestingly, investors across Europe no longer see opportunities to buy at low prices.

‘Yes, German real estate is expensive but if you compare it to other major markets, it’s in the range,’ said Michael Windoffer, head of real estate cross border lending at Hamburg Commercial Bank. ‘Of course investors become cautious and wonder whether they should lock in a cap rate of 2.9% for a few years.’

Fears of real estate bubble growing

According to 70.6% of investors surveyed the risk of a real estate bubble in some European markets is very real, with 23.5% citing the risk as being irrespective of the location. Less than 6% of respondents have no fear of real estate markets overheating.

Nearly 90% of respondents expect an initial net return on new investments Germany's Top 7 of less than 3.5%, with more than 40% saying that they expect net returns of less than 3%. And, until now, the current distribution yield had been the key performance parameter for two-thirds to three-quarters of investors surveyed. However, this year, just 47.1% of investors view this as the main return indicator. The expected return on current cash flow has fallen yet again and now stands at 3.41%, down from 3.96% last year. The total return has become a more important performance indicator for 41.1% of investors, up from 9.1% last year.

‘With the current return on a property continuing to decelerate, investors are evidently gearing their focus more to the future and, based on a longer-term investment horizon, are increasingly relying on their properties appreciating in value,’ said Stefan Rockel, managing director of Universal-Investment.

Surge in demand for residential assets

There has been a big uptick in interest in Germany’s residential sector, with almost one in four investments (23%) being made in the residential sector, up from 14.1% a year ago. However, offices remain the most popular choice, with 53% of investors saying they plan to invest in offices, broadly in line with last year. In a further sign that the retail sector is suffering, just 8% of investors are interested in investing in the retail sector, down from 12.3% last year.  Interest in hotels has also dipped to 6% down from 7.7% last year.

Investors turn their sights to new markets

Investors are not limiting themselves to the German market. While 54% of institutional investors continue to focus on Germany, this marks a sharp drop on the 70.2% who did so last year. Interest in North America is up, albeit from a tiny 0.8% last year to 4% this year. Demand for the rest of Europe has also increased to 31% from 28.2% last year. Interest is also rising sharply in the Asia Pacific region, now at 9%, up from less than 1% last year. Interest in BRICS markets is still muted, rising to just 1% this year following two years of no interest.

Some investors moving up risk curve

Predictably, as yields tighten, some investors are going further up the risk curve, with 70.8% of investors saying they rely on core plus as well as core assets. Almost 60% of investors expressed an interest in value-add assets, which barely featured last year.

‘Due to the yield squeeze on real estate markets, returns on top properties in prime locations are evidently no longer enough,’ said Rockel. ’We believe this to be a reason why institutional investors are giving preference to core plus,’ he added.