Major exit stress for trading developers in office projects

The outlook for new German office development remains surrounded by gloom, with the negative trend in declining office project development volumes in Germany's A-cities that started in 2021 set to continue right through 2023, attendees at a recent press briefing at Berlin communications consultancy RUECKERCONSULT heard.

The speakers were Reinhold Knodel, the CEO of Pandion AG; Roland Köppe, head of project development for Berlin at Becken Development GmbH; Fabio Carrozza, managing director of BF.real estate finance GmbH; and Alexander Fieback, head of Berlin office at researchers bulwiengesa AG.

The whole development sector is clearly in deep trouble, attendees heard, with rising interest rates, the sharp decline in investor interest and the ongoing uncertainty surrounding remote working meaning that a lot less buildings are now in trading developers' pipelines.

Presenting the developers' perspective, Reinhold Knödel of the Cologne-based family-owned developer Pandion AG put it thus: "The industry is currently under great pressure. Both on the financing side and on the demand side, the market environment has changed radically within a very short period of time. Purchase prices have fallen by a factor of about six annual net rental incomes. On the other hand, there are also prospective rent increases due to the indexation of the contracts. But it will take time to make up the difference and arrive at an arithmetically equal purchase price. Meanwhile, the transaction markets are at rock bottom. We expect this situation to continue until next year. This is because interest rates will continue to rise and investors will buy low-risk bonds rather than further increase the already high share of real estate in their portfolios."

"Project development is once again proving to be a volatile business," added Knodel. "At the moment, hardly any new projects are being initiated, but are only being completed where already started. Speculative new construction is practically non-existent. In the medium term, all this will lead to a shortage of supply of modern office space in city centre locations. At the same time, rising top rents and barely declining letting turnover signal a continuing high demand for high-quality space. Centrality and quality of the workplace remain important criteria in the battle for skilled workers and therefore many companies cannot afford to be frugal."

Another developer, Roland Köppe of Becken Development, which is primarily a trader-developer, building with a view to an immediate sale to an investor, added his perspective. Becken is a big player, is solidly capitalised and has a strong pipeline, so can weather some storms and sit out the current crisis, without having to sell its developments at just any price. Still, "Investors' willingness to pay is declining sharply due to the interest rate environment. If you are not forced to sell below cost of production, you can hold projects in inventory for the time being via inventory financing," said Köppe, adding: "We only make new acquisitions if the projects make real economic sense under current conditions. Market players with less equity capital will have to cut back considerably."

Köppe, like Knödel, also tried to find reasons to be optimistic. "Nonetheless, outstanding projects always enjoy stable demand. This is because the attractiveness of space for employees is still the top priority on the tenant side."

Fabio Carrozza gave us the financier's perspective. "Certainly the mood among real estate financiers is currently negative. However, what we're seeing is that market participants expect some easing of the interest rate situation towards the end of the year. Therefore, project developers are trying to buy time with bridge financing and are taking the properties off the market for the time being until conditions improve. Given these expectations, bridge financing makes perfect sense."

These new realities are reflected in in Carrozza's own BF.Quarterly Barometer for Q1 2023, which we track closely here at REFIRE. "Margins have increased significantly over the past two years. Whereas they were just below 240 basis points in Q1 2021, they are currently around 340 basis points. The steep rise shows the banks' increased risk awareness. The banks are remunerating themselves for the higher risk. In return, the average loan-to-costs (LTCs) fell from around 73 percent to about 69 percent. Again, financiers are more cautious than they were a year or two ago."

Alexander Fieback of market researchers bulwiengesa AG confirmed that the very best projects were still enjoying stable demand, as tenants continued to give high priority to the well-being of employees. "Good locations and good quality remain in demand and rising rents in top properties continue to enable adequate development business. More peripheral locations are increasingly under pressure, unless the micro-location has attractive special features, for example in terms of gastronomy or accessibility. "