To B or not to B? That is the question.

Attending as many real estate gatherings throughout Germany as we do, here at REFIRE we frequently find ourselves thrust into debates about the merits (or lack thereof) of investments in office property outside the core investment locations in Germany. The classical arguments always point to the uncertainty of an exit, the lack of potential new tenants, and the greater liquidity and visibility available to investors in Germany’s Big Seven cities.

(For the record, our own experience is that, if the big property adviser groups don’t have an office or representation there, they tend to promulgate the view that there is a lack of adequate research to support an investment decision. Not surprising.)

A recent study by Düsseldorf-based advisory group DIWG provides a useful contribution to the debate about the merits of Germany’s lesser-ranked cities, or B-locations, as worthy of serious investor consideration.

The producer of the study is DIWG (Deutsche Immobilien Wirtschafts Gesellschaft), which was founded in 2011 after a schism in top management of the then Apollo Asset Management led to Horst Jaletzky and Marc Seeger branching out on their own with a number of mandates. DIWG now has more than 2bn in assets under management, and a total of 70 staff, of whom 20 are full-time involved in valuations.

A recent study by their research team, entitled “German Commercial Real Estate: Comparing A and B sites” concludes that over time, office investments in A-locations are more volatile and crisis-prone than B-locations.

“A comparison of A and B-locations shows that B-locations are gaining more and more 1A qualities and are significantly less volatile then the top 7 sites, even if the absolute key figures for take-up rates and top-end rents are low in comparison”, says Marc Seeger.

The study used as a measurement basis the traditional big seven cities of Berlin, Düsseldorf, Frankfurt, Hamburg, Cologne, Munich and Stuttgart as the A-locations; the 11 cities used for comparison as B-locations were Bonn, Bochum, Dortmund, Dresden, Duisburg, Essen, Hanover, Leipzig, Mannheim, Nuremberg and Wiesbaden.

The DIWG study compared the performance of the top 7 to the 11 B-locations in the areas of space take-up, vacancy, vacancy rate, and prime rent. It also calculated the relationship between the volume of vacancies at the end of each year and annual turnover in the same period. The study covers the period from 2000 to 2012.

During the period under review, Germany's top seven locations reached an average annual turnover of around 417,000 m². The range of variance was a significant 216,000 m² or about 68%, as the minimum average was about 319,000 m² and the maximum average was 535,000 m². The variance in B-locations, however, is only 38,000 m² with average annual take-up of 74,000 m². The variance of the B-locations is thus proportionally similar in absolute terms, but in real terms is much lower due to the lower sales volume.

Vacancy rates in the A and B locations had a similar average vacancy rate of 7.8% and 7.6%, respectively, although the variance in the A-locations was 215% compared to 56% in the B-locations. Significantly, the vacancy rate in the top German cities rose over the period from an average of 3.1% to 8.1%, while it decreased in the B-locations from 8% to 6.2%.

The (frequently-abused) indicator of top rents showed that while prime rents in A-locations have fallen by about 10%, they have risen in the B-locations by just over 4%.

On another key indicator, the ratio between vacancies and annual sales volume, the study showed the A-locations to be better with an average ratio of 1 to 2.5, meaning 2.5 m² of vacancy to 1 m² of sales area. The B-locations came in at an average of 3.0, although the B-locations include two cities in eastern Germany - Dresden and Leipzig - which have exceptionally high vacancies and only moderate rental sales. Leaving these two cities aside, the ratio in the B-locations would be 1 to 1.7, and hence better than in the A-locations, says the study.

Using DIWG’ own proprietary ranking system combined with the accepted Prognos AG’s Future Atlas, which ranks cities’ future economic potential, Munich and Hamburg topped the list of the A-cities for overall investment value. Of the B-cities, the highest scores went to Bonn and Nuremberg, followed by Bochum, Duisburg and Leipzig.

The take-home message of the study? Investment choices are choices of risk-class. Risk-averse investors should definitely avoid investing in Frankfurt. Investment risk-takers, however, will find regular investment opportunities in Frankfurt. Many of today’s B-locations have the potential to be classified among the A-cities, and likewise some A-cities are destined to lose that top classification. The full study can be found at www.diwg.de.