Shift in weighting to residential as German volumes exceed €100bn

Surprisingly, given the ongoing difficulties presented by the seemingly never-ending coronavirus crisis, transaction volume on the German real estate investment market is expected to total between €105bn and €110bn for 2021, including residential, equivalent to an increase of about 30% over 2020. This is actually a record, topping the value of €91.8bn in the pre-pandemic year of 2019.

However, it's important to look at the more salient aspects of these figures, including the momentum that has developed over the second half of this year. Corporate takeovers alone will account for more than €30 billion this year, including the merger of Vonovia and Deutsche Wohnen. 

For this reason, among others, the figures reflect a further shift in the weighting of market share towards residential. As Helge Scheunemann, veteran head of market research at JLL Deutschland puts it, "As a rather defensive asset class, all properties in which there is a bed were in demand in 2021 - to put it in general terms. Only hotels are an exception here. By the end of the year, the share of living is expected to be more than half of the volume, meaning that more than €50 billion will have flowed into this property usage." 

Hotel properties were - and still are - the asset class most affected by the negative impact of the pandemic - reflected in declining transaction volumes on the investment market, and likely to make up only 2% of the market. This will be the same as last year, equalling its lowest share of the past ten years. 

Scheunemann says the big question at the moment is how inflation will play out. "We're looking at a combination of unprecedented factors, which creates great uncertainties in the further course of the economy: the hoped-for end of a pandemic, global supply and production bottlenecks, catch-up effects of the demand side as well as stimulation of the economy by the ECB's monetary and financial policy." 

While real estate is often viewed as offering a form of blanket protection against inflation. However, that very much depends on the right combination of numerous individual factors - including the time of entry, financing volume and structure, location, letting structure, lease conditions and the investment objectives. At the very least, JLL expects the probability of a rise in interest rates to be low in view of the current sovereign debt in the eurozone, with the ECB hoping to avoid putting the brakes on the upswing.

JLL points to the ongoing capital pressure from investors. "Over the next four years, government bonds with a total volume of almost one trillion euros will mature. Even if interest rates rise by then, part of this capital will be reinvested in real estate," says Scheunemann.

Further trends are emerging, which will pose new challenges for asset management, and lead to new ways of calculating returns. These include the further diversification of investor portfolios to avoid cluster risks, such as the promotion of 'neighbourhood development' or 'Quartiersentwicklung', incorporating users' basic needs of working, living, shopping and leisure. That's certainly the buzzword that's been widely circulating, as investors figure out what they're going to do, given the uncertainty of office demand.

Another trend we can't escape is ESG, which dominates all discussion these days. As Scheunemann says, the perception has reversed - "It's no longer about paying a green premium - but rather about extracting a price discount for non-sustainable properties." A new cohort of investors will now only buy properties for their portfolios that are taxonomy-compliant according to Articles 8 and 9 of the Disclosure Regulation. "At the same time, investors will try to clean up their portfolios, i.e. sell properties that do not comply with the taxonomy. Such properties should actually be traded at a discount, but in view of the current enormous demand, the theory has yet to be proven in practice," says Scheunemann.

It also remains to be seen who will buy the non-taxonomy-conforming properties, when actually everyone is looking for sustainable properties. Financing for such "brown assets" will be more difficult in the future, and JLL expects banks to demand a clear plan as a basis for financing that clearly shows a road-map to a sustainable building.

Obviously, then, the only way forward in many cases is redevelopment and refurbishment. "We expect the share of office renovations and refurbishments in the total new construction pipeline in the Big 7 to increase to 24% next year, and to almost 30% by 2024. By comparison, the 10-year average between 2011 to 2020 was 18%," says Scheunemann. Traditional offices are increasingly being displaced by "green" offices and flexible leasing concepts, and the bulk of future demand will increasingly focus primarily on these concepts. Adds Scheunemann, "It is clear that this transformation cannot be achieved through new construction alone. Building refurbishments and upgrades will be the real challenge for owners."