Top Picks: Where is capital headed in 2019?

Demand for real estate in Germany is expected to be buoyant next year, despite a sharp uptick in prices. As the investment landscape continues to shift, some of Europe’s biggest players tell REFIRE what they are betting on in Germany next year – and why.

‘Big 7’ continue to shine

Despite concerns over pricing, Germany’s ‘Big 7’ cities will continue to attract the big bucks next year. One investor who is continuing to bet big on Germany is European fund manager AEW Europe.

‘Compared to some European markets, there’s a breadth and depth of investment capital in Germany; it’s more diverse, there are less mergers between pension funds, for example,’ AEW’s CEO in Europe, Rob Wilkinson, told REFIRE. ‘2017 was one of our best years in terms of capital raising in Germany. We might raise less this year but that’s because we’ve been more focused on deploying capital. Our EVI fund (Europe Value Investors) has just completed its fund raising above target and our City Office Germany fund also had its final closing. We expect to raise circa €400m of equity from German investors in 2018, bringing our total equity raised since 2014 to more than €1.5b. We’d like to double the equity we’ve raised from German investors over the next three-to-four years. ‘

AEW Europe raised €410m of equity for EVI and may launch a successor fund which could, potentially, be slightly bigger, according to Wilkinson: ‘Overall, we’re targeting a broad range of assets in Germany. There’s not an asset class we wouldn’t consider, even retail. Our City Retail Fund has invested across a number of European markets but has yet to invest in Germany. The only problem is that high street retail in Germany has become extremely expensive, although we’d like to source more opportunities for this fund next year - up to €200m. We’d also like to invest between €300m and €400m on behalf of our Logistis fund next year, as well as around €200m in core offices and another €200m in core plus/value-add offices. We could also invest between €50m and €100m in resi, which means we could invest over €1b in total in Germany next year.’

Other investors will also continue to focus on Germany’s ‘Big 7’ next year. ‘German continues to be a major area of focus for us,’ said Joseph de Leo, a senior partner at real estate private equity group Benson Elliot in London. ‘Our strategy in 2019 is to invest more in Berlin and Frankfurt, two local markets with interesting dynamics. Our priorities are residential assets and offices but we’ve very opportunistic, so we’ll also look at micro living and serviced apartments. For offices, we’re only really looking at the ‘Big 7’, although we’ll consider resi across Germany.’

Focus in ‘Big 7’ is shifting

However, investor focus within the ‘Big 7’ is evolving, ‘Next year will still be a year of chasing yields but I’m getting more cautious about Germany due to current pricing and whether it can deliver the expected growth,’ said Gunnar Herm, head of real estate research and strategy in Europe at UBS Global Asset Management. ‘In the Big 7, I think we’ll look more at secondary locations in those cities rather than prime locations, such as smaller sub-markets in eastern Berlin, thereby tapping into the growing population there. We’re least likely to invest in prime next year; we’re more interested in core plus and value-add.’

Other investors are taking a similar approach.‘We’re looking at more peripheral locations in the ‘Big 7’, or what we call the ‘affordable office strategy’ - we don’t go into B or C cities for offices,’ said Sebastiano Ferrante, head of Germany and Italy at PGIM Real Estate. ‘Germany and France are two of our major markets. In Germany, we’re interested in value-add and core plus offices; vacancy rates are at an all-time low. Prime is highly priced. The Omniturm in Frankfurt (still under construction) is going for a 50% premium over the Opernturm in Frankfurt that sold a couple of years ago, which is a massive difference. And it’s not the only one. We’re interested in offices where old lease agreements are in place because you can increase the rent.’

PGIM Real Estate invested between €200m and €250m in Germany this year and would like to invest another €500m over the next 24 months, according to Ferrante. It is active in the residential sector, moving out of the ‘Big 7’ into university cities or cities with strong local economies, such as Wiesbaden or Heidelberg. ‘We like forward residential transactions in commuter locations, so from Duisburg to Düsseldorf, for example. We’re also moving into serviced residences, including micro apartments. We’re interested in the intersection between classic residential and accommodation services, such as co-living,’ he added.

For Annette Kröger CEO of North & Central Europe at Allianz Real Estate, ‘Germany is a piece of the overall puzzle’: ‘We look for opportunities on a global scale. As we’re a long-term investor, we follow long-term trends,’ she said. ‘We have €11b of AUM in Germany today. Next year, we’ll continue to look for office investments in the ‘Big 5’, particularly in Munich and Berlin. We’re interested both in CBDs and in quality micro-locations, such as central sub-markets. However, pricing is ambitious these days. We like to do forward deals, to enter early on. We’ll manage to core as well. We invested around €500m in Germany this year. Next year, we’d like to invest between €700m and €1b in North & Central Europe, most of which will be in Germany.’

Allianz Real Estate is also targeting student housing and micro-living/multi-family models like the ones in the US, which it will invest in on a global basis, according to Kröger.

AXA Investment Managers – Real Assets is also moving away from ‘dry, prime investments’, Sven Krumpholz, head of Germany at the group, told REFIRE. ‘We’re very nimble in looking for opportunities outside the ‘Big 7’,’ he said. ‘There’s a scarcity of land, so it’s a good idea to increase the density of cities. At the moment, we’re more focused on value-add opportunities as well as asset classes that are often below the radar of other investors due to the local operational expertise required to invest in them, such as healthcare. Through scale, we can create value for our investors. We are also looking at traditional asset classes, so I don’t want to exclude anything, but we are particularly interested in residential, healthcare and logistics.’ (He declined to comment on how much AXA invested in Germany this year.)

German logistics still hot

Logistics has also not lost its allure. Last month (October), affiliates of Blackstone Real Estate Partners VIII completed the acquisition of US industrial REIT Gramercy Property Trust for around $7.6b. Its European arm, Gramercy Europe, will continue to focus on logistics next year: ‘Out strategy evolves all the time,’ said Gramercy Europe’s CEO, Alistair Calvert. ‘We’ll continue to focus on Germany, the Netherlands, France and Spain. ‘We’d like to invest between €500m and €600m in European logistics next year and I’d like as much of that as possible to be in Germany.’

Gramercy also plans to do more development next year, likely with local partners in Germany, he said.

However, logistics are not the only assets on the cards. ‘We’ll continue to have focused funds but we might launch a new fund next year that isn’t logistics-focused,’ Calvert said. (He declined to give further details.)

UBS is also targeting urban logistics but ‘not big box logistics’, Herm said. ‘Some department stores and retail parks are failing. They’re located in residential areas, which means the sites could provide last mile delivery services instead.’

Blended business models gaining traction

For Henri Vuong, director of research and market information at INREV, blended business models will gain traction next year: ‘The lines between investors and investment managers have become blurred, especially for big companies who have been investing on their own behalf and are now offering that service to other investors.’ she said. ‘However, raising capital is going to become increasingly competitive; it will become more challenging. You have to be innovative and inspirational to raise capital in this climate and stand out from the crowd.’

Social impact investing moving out of the shadows

Another rapidly growing trend is social impact investing, according to Vuong: ‘Corporations are now more socially aware,’ she said. ‘The term ‘social impact investing’ is in vogue, which is a good thing if it helps urbanise communities that are run down etc. It’s more of a value-add play for investors who are chasing returns, so it kills two birds with one stone.’

Ferrante agrees: ‘Social impact investing is becoming more important – investors are asking for it,’ he said. ‘It’s a big theme because it impacts on all institutional investors who have to show both internally and externally what they are doing on that front. If they were to invest 1% to 2% of their total allocation to it, it would be a lot. Our US strategy is investing in affordable housing and transformative redevelopment, including in ‘disrupted’ cities in the Midwest. We just don’t have any standards for it yet here in Germany.’

Krumpholz is taking a similar approach:‘Social impact investing is one of our big themes when we look for new opportunities,’ he said. ‘It’s return-driven but if the asset has a purpose, it also benefits the community. More and more investors want to invest responsibly – there is clear market demand.’

Conclusions

Germany has seen a significant inflow of capital – around €60bn of commercial real estate deals are expected to be transacted this year – and that is not about to change, said de Leo: ‘It’s the safe haven of Europe. I think we will continue to see an influx of capital. Yields may have reached all-time lows but, to counter that, Germany has strong fundamentals, including strong rental growth.’

For Ferrante, the biggest challenges in Germany are ‘pricing, liquidity and the lack of investable products, particularly in logistics’: ’Compared to these challenges, financing is relatively easier to obtain, as is the deal execution. Regulation will probably increase, which may make it harder to invest in the residential sector,’ he said.

The key challenge for Kröger is getting access to deals early on: ‘The challenges in Germany are that there are a lot of funds available and a lot of competition out there. Vacancies are decreasing on the occupier side and there’s a lot of liquidity in the investment market, which should remain stable going forward.’

A good feel for how the market will likely develop is also crucial, according to Krumpholz: ‘It’s important to have an idea as to how the market will develop as it depends a lot on micro markets. There is no guarantee that the market will move at the pace that you expect it to. I don’t know if we’re at the top but I know we’re not at the bottom.’