Tier II office markets in the spotlight

Selective investments in Tier II office markets in Germany could be the way forward, given how tightly priced the ‘Big 7’ cities have become, according to Iryna Pylypchuk’s report ‘German Offices – What now?’ published by Fidelity International this month.

Fidelity has introduced a Real Estate Investment Market Opportunity Score Matrix to quantify the relative attractiveness of European real estate investment markets and sectors, taking into account current pricing and projected investment returns. Its methodology draws together standardised data on economic, demographic, investment and occupier market liquidity and depth, drivers of performance and real estate market fundamentals at a geographic and sector level to create an ‘Opportunity Score’.

Tier I and II scores fall in the range of between -1.0 and 5.0 - the higher the score, the stronger the fundamentals. A Tier I or II score of 2.5 and above signifies robustness of a given measure to merit a good investment opportunity. The final Market Opportunity Score is expressed as a score between 0.0 and 5.0.

According to Fidelity’s Index, Berlin, Hamburg and Munich are the top-performing markets for existing investors, generating a Market Opportunity Score of 4.2, 4.1 and 4.3, respectively. Fidelity expects Berlin to deliver the strongest returns on existing investments of the 21 markets covered, forecasting an annual average return in 2017 and 2018 of 10.1%, compared to 9.6% for Munich and 7.5% for Hamburg.

However, Tier II locations are gaining ground. Leipzig, which has a Market Opportunity Score of 3.2, is edging close to Tier 1 average results and exceeds the Tier 2 average of 2.4. The attraction of Leipzig is that it shares several ‘Berlin characteristics’, notably the third lowest rental levels across the 14 Tier II markets, coupled with exceptional rental growth of 21.3% between 2007 and 2015, which is nearly three times the Tier II average of 8.3%.

Also storming the charts are two other Tier II markets, Hannover and Nuremberg. Despite Nuremberg’s weak supply fundamentals, due largely to its vacancy rate of 8%, its demographics and unemployment scores show very strong results. Subsequently, it scores 2.6. Hannover, on the other hand, benefits from yield compression in excess of the Tier II average and robust supply fundamentals, thereby generating a score of 2.7.