Head to Germany's B- and C-cities for yield

It seems to have become a tradition now that REFIRE attends the usually lively "Expert Talk" organised at the Expo REAL in Munich by Engel & Völkers Investment Consulting. The session brings together a good cross-section of German real estate company bosses to mull over a specific theme and give a pulse reading of the state of the market.

This year the timely topic was "Property Boom – and No End in Sight?" - for German companies an appropriate challenge, given the run the market has enjoyed for the last seven years.

Felix von Saucken and Kai Wolfram, the two CEOs of Engel & Völkers Investment Consulting kicked the ball off by telling the audience that B- and C-locations and periphery regions of the biggest cities were now definitely in the cross-hairs of real estate investors.

Apart from the frothy prices in the top locations, part of the attraction of the secondary and tertiary markets is that there are scarcely any attractive portfolios being offered for sale, nothwithstanding the ongoing pressure to invest and both the low interest rates and lack of feasible investment alternatives, said the Engel & Volkers duo.

Most of the panel participants agreed that prices nationwide are still headed upwards due to the heavy demand, but that yields beyond 5% were no longer realistic (In Munich 2% is more likely). However, "if specific assets are sought out carefully enough, then investing in B- or C-locations need not be accompanied by higher risk", said Wolfram.

Thomas Hegel, CEO of Düsseldorf-based listed property company LEG Immobilien AG, said: "Basically it's still reasonable to invest in all German residential markets at the moment. In top locations like Munich or Berlin however, it's getting harder to justify long-term investment at current price levels.  There's better value to be found now outside some of the bigger cities."

Claudia Hoyer, the COO of listed TAG Immobilien AG, agreed. "There are better entry opportunities now outside the major urban markets, which are now currently trading at 20-times multiples or much more." Although her company had been able to buy residential assets at 8-12 times annual rent, she said that in bidding or tendering situations now it was common to see up to 25-time multiples, which should give pause for thought. She also said that TAG was achieving sustainable rent increases of more than 3% annually for its B- and C-location holdings.

Martin Eberhardt, CEO of Bouwfonds IM Deutschland, also sees the best opportunities in the so-called "Swarm cities", where young people flock for studies or job opportunities. "Despite rising prices, these are where the best opportunities are and where rents will continue to rise because of growing demand."

Lars Bergmann, CEO of Immovation AG, said "Investment in C-locations is becoming ever more interesting if you plan on achieving any sort of yield above and beyond just preserving your wealth." However, he warned that Germany would not be able to meet all investor demand, despite current enthusiasm for the market.

Francesco Fedele, CEO of the Stuttgart-based BF.direkt AG, a provider of mortgage finance, said "We're happy to support projects in C-locations, even if you have to look really carefully at the specific micro-location, since as a rule this is where yields are higher and more stable."

The panel discussed the current popularity of asset categories such as student accomodation or healthcare properties, which have become mainstream enough to no longer be considered 'niche' segments.

Hegel of LEG Immobilien said "The complexity of these assets is greater, which means higher admin costs – easier to underestimate, particularly when such assets are treated as part of a classical residential portfolio." He added that in mixed markets like his company's heartland of North Rhine-Westphalia, some rents have risen 15% while in other more depressed towns, they have fallen by nearly 5%. "Local micro-knowledge in our region is absolutely critical", he said.

The always outspoken Bergmann cautioned that, "These special types of property are by no means automatically more attractive investments. More than ever, it depends on the micro-location, with local factors such as demography, infrastructure and surrounding amenities playing a crucial role."

Eberhardt of Bouwfonds pointed out that the rise in 'student housing' was not just a factor of the increasing amounts of students, but also of the demand from singles for micro-apartments as part of a fundamental shift in housing preferences. Student accomodation generally has a 150 bps spread premium over classical housing, and helps to diversify a residential portfolio, with unchanged volatility.

The panellists discussed financing, with most agreeing that institutional investors operate with an average LTV of about 60%.

Bergmann said he saw many investors now stretching this to 75% at such low interest rates. Federle of BF.direkt AG points out that investors are increasingly availing of mezzanine capital or club deals, while on the bigger deals insurers and pension funds were encroaching more and more into the financing market as the banks recede. Despite this, he said, banks were still taking on more risk as they compete with rivals and were issuing loans not always justified by the commercial risk.

As several official studies have documented, the shortage of available properties, a lack of feasible alternatives and the low interest rate climate are all driving investors to take on bigger risks. As a final shot Bergmann of Immovation cautioned investors that with the market in potential bubble territory in certain regions, they need to take a more differentiated approach to the market than in the past to find risk-adequate investments.