Secondary cities offer better prospects than ‘Top 7’ office markets

Secondary cities in Germany offer better prospects that the ‘Top 7’ office markets, according to a survey published this month by Bulwiengesa and DEMIRE Deutsche Mittelstand Real Estate.

The survey, ‘Office Real Estate Market: Investment Opportunities in Secondary Locations’, compares 31 second tier cities in Germany with their ‘Big 7’ counterparts, such as Berlin and Munich.

The elevated return potential in secondary cities manifests itself most conspicuously in higher net initial yields of between 4.1% in Bonn and 7% in Stralsund and Chemnitz. In ‘Top 7’ cities, however, net initial yields are just 3.2% on average. Moreover, more stable incomes in secondary cities are reflected in less volatile rents. Bonn and Dortmund, for example, are characterized by a very low spread of rents, which reduces the threat of market-driven rental corrections. Conversely, big cities such as Berlin and Munich show larger fluctuations in their rent averages.

In the survey, which examines the return potentials (net initial yields) and earnings risk (volatility of office rents), Bonn, Dortmund, Koblenz and Essen came top. By contrast, Berlin, Munich and Hamburg and Leipzig fared the worst. Only one Class A city, Düsseldorf, made the Top 10 in terms of its risk-return ratio.

‘Due to the better chances for returns in second-tier cities and the absence of investment opportunities in Class A cities, market players are increasingly committing themselves in second-tier cities,’ said Sven Carstensen, head of the Frankfurt branch of Bulwiengesa.

Last year, approximately €27.5b was invested outside Germany’s metropolises, of which around €15b was in second-tier cities. ‘While rising demand will push the net initial yields in the secondary locations down to historic lows aswell, the yield spread between these markets and Class A cities is still considerable, at 2 percentage points,’ Carstensen added.

Office tenants in second tier cities less likely to relocate

Office tenants in second-tier cities are also less likely to relocate, according to the study. ‘The survey findings also confirm our first-hand experiences in the market,’ said Ralf Kind, CEO of DEMIRE. ‘We benefit from a strong tenant loyalty in our properties. The tenancy in second-tier cities is dominated by mid-market companies, and these tend to remain loyal to their respective place of business.’

Higher level of pre-lets in secondary cities

Unlike in Class A markets, where the share of un-let floor space is typically around 40% at the start of a given project, new developments in secondary locations are more likely to be aligned with demand, with a high percentage of pre-lets.

And because new schemes in second-tier cities are rarely speculative, they are more likely to reflect local demand. In Ingolstadt, for example, 24% of office stock is less than 10 years old, compared to 14% in Ulm and Darmstadt and 13% in Kempten. In ‘Top 7’ cities, this figure is typically less than 10%, although growth has been much higher in cities such as Berlin, where office development soared by 26% last year, according to Bulwiengesa. In terms of absolute new-build figures, the highest completion rates were in the second-tier cities of Essen, Bremen, Dortmund, Münster, Bonn and Mannheim, according to Bulwiengesa. (ssk)