Property underpinned by Asian, North American demand in 2016

The Berlin rating agency Scope sees a further strong year ahead in 2016 for German real estate, as investors pursue higher yields than they can get with government bonds. In particular, German big cities are likely to be the focus of investors, with further yield compression expected.

Again, as in 2015, investors will continue to seek higher risk, including investing in niche property segments or in foreign markets such as southern Europe, as well as investing in more project development, the rating agency forecasts in its Alternative Investments Outlook 2016 report.

According to the Scope researchers, "the vehicle of choice for investing in real estate will continue to be the open and closed end fund structures". Open ended funds benefit from potential upward revaluation and being able to reinvest selectively. "We expect to see strong inflows into the sector from private and institutional investors in 2016, says Scope.

Both types of funds have been strongly in favour of this year among German investors, with Spezialfonds having attracted more than €3 billion in new capital in the first three quarters of this year. Open-ended mutual funds attracted even more at €4.2 billion, according to the German funds association BVI.

Funds managers can view such strong inflows as a burden if they're not able to invest fairly quickly, either directly in real estate or in paying down loans. Keeping the funds in liquid form brings little or no yield – whereas, according to Scope, open-ended funds can expect average yields of 2.5% next year, with a range of between 1.5% to 5%.

Among open-ended funds, Scope sees the continued ongoing creation of new individual products for institutional investors, particularly those created to target specific regions or asset categories such as hotel, retail or logistics properties - or even more specifically, in medical properties, nursing homes, or other niche asset categories.

Given the continued spread between real estate and 10 year government bonds, real estate will remain attractive, say the researchers. Office investments are still likely to show a spread of between 200 and 400 basis points over the risk-free option of bonds.

Closed end funds are experiencing more mixed results, with several funds having benefited from rising asset values, to the satisfaction of existing investors. But there are plenty of examples of low-diversified or single asset funds which have disappointed investors because of high vacancy rates or poor locations. Many investors have completely lost confidence in the closed end model.

Given the current high level of asset prices, new fund initiation of open-ended mutual funds will be tougher next year says Scope. With investors yield expectations' still often at the 5% mark, new fund issues are likely to be targeted at nursing homes, secondary locations, and foreign markets such as the USA and southern Europe.

Yield expectations for closed-end funds are put at between 5.5% and 7% per annum, but from mixed-risk office assets i.e. those with many diverse tenants and or at least three properties, 3.5% to 4.5% is the more likely yield – and for residential funds Scope puts returns of between 3% and 4% in what is likely to be a more difficult environment.

Despite all this, Scope still sees investments in top properties in the best locations as representing good value, providing good fungability even in tough times.

Given the continued and rising demand from Asia and North America investors, real estate, along with renewable energy, should still prove to be the most popular alternative investment option next year, concludes the report.