Study highlights higher yield potential for German offices in B-cities

Office properties in secondary German locations could show higher yield potential than in the biggest commercial centres, according to a new study carried out by listed property company DEMIRE and market researchers Bulwiengesa.

The study (the fourth annual edition) examined 35 secondary cities in economically strong regions throughout Germany., and concludes that secondary locations continue to offer higher yield potential compared to the German A-cities Berlin, Hamburg, Munich, Frankfurt, Düsseldorf, Cologne and Stuttgart (A-cities). However, the excess yield declines due to rising purchase factors. In addition, secondaries also showed a comparatively high resilience during the Corona pandemic. 

DEMIRE and Bulwiengesa attribute this, among other things, to the economic structure of secondaries, which are characterised by small and medium-sized companies which are highly relevant as tenants, as well as being less dependent on international tenants. Secondary locations mostly appeal to public tenants or medium-sized companies with a strong regional orientation, and public sector tenants have proven very resilient through the pandemic. 

Another factor is that, with ticket sizes being generally much lower in the secondaries, many international investors tend to ignore them, concentrating only on the bigger cities where the perception of liquidity is greater.

In nearly all these secondary cases, the number of office employees has risen in recent years, leading to a decline in vacancies and rising rents. In contrast to A-cities, which has dampened a lot of new project development, construction in the majority of secondary locations is demand-driven, with very little office space being built speculatively.

The study showed an average vacancy rate of 4.2% across all the secondaries examined - a figure kept low by low building activity but dynamic demand for office space over the past ten years. The study examined the secondaries in respect of their yield stability and the achievable yield, concluding that secondary locations have higher yield potential than the A-cities, where the spread has narrowed. 

For example, the range of achievable net initial yields in the secondaries extends from 3.5% in Freiburg im Breisgau to 5.9% in Chemnitz. In A-cities a level of between 2.I6% (Berlin) and 3.1% (Cologne and Stuttgart) is currently being achieved.

Average rents have almost universally risen in secondary cities over the past ten years, ranging from about 4% in Darmstadt to almost 50% in Leipzig.

Ingo Hartlief, CEO of DEMIRE, which has long focused on prime locations in secondary cities (the so-called ABBA approach) said the study underscores the strength and potential of secondaries. "With our clear focus on secondary locations we see ourselves well positioned. Especially in economically uncertain times, the stability of our portfolio has proven to be a key advantage. For further portfolio development, we are also consistently focusing on secondaries, in which we feel at home."

DEMIRE's portfolio is mainly office properties with a blend of retail, hotel and logistics, and (at 30th September 2021) consisted of 67 assets with lettable space totalling about 1 million sqm. including the its share of the recently-acquired Cielo property in Frankfurt. The company's market value exceeds €1.6 billion. After a spate of disposals of management-intensive units or those with little further value-added possibilities, the company's average WALT was 4.8 years, and its vacancy rate was 10.2%.

As we reported in REFIRE in November, DEMIRE now looks as if it's going to be the next listed company to be swallowed up by private equity. DEMIRE has always had a very small free float, with majority shareholders the US investment group Apollo and Wecken & Cie. controlling 91% of the €1.6bn company.

The two major shareholders have already initiated a structured selling process, and have said that they do not plan a public listing of their holdings, preferring to sell their entire shareholding to another investor, "capable of supporting DEMIRE in the next growth and value creation phase". The top management at DEMIRE said they support the decision of the major shareholders.