German banks treading gingerly as the party gathers steam

If there was some doubt at the end of last year whether Germany could continue to hold investors’ attention,given emerging opportunities in nascent neighbouring economies, those doubts have been dispelled – as hungry buyers are rating Germany an even better bet than they did last year.

The figures are astonishing. Despite the cloud hanging over the residential sector in the form of the looming Mietpreisbremse, or rental cap, investor thirst for German residential remains unslaked. The logistics sector has seen more turnover this past quarter than at any time in the past ten years, and is up nearly 70% on the same quarter last year, with the areas around Berlin, Düsseldorf, Frankfurt, Hamburg and Munich profiting disproportionally, with super-sized facilities ever more in demand.

If last year investors were mumbling about starting to look at Germany’s secondary cities to meet their yield expectations, Germany’s twenty or so B-cities are no longer exotic territory for yield-hungry investors. The recent €300m acquisition by US investor Apollo of TAG’s non-residential assets included several office buildings in cities like Mannheim and Nüremberg. Many similar deals are currently being transacted.

German banks, reticent about backing any deals throughout the crisis years that weren’t watertight, blue-chip ‘core’ assets in the safest CBD locations, are following their clients into the provinces – and are showing themselves increasingly flexible on the definition of ‘core’. According to broker JLL, ‘core’ offices in the top seven cities were yielding 5.2% in 2011 – as against 4.5% today. With ever fewer such assets available, what’s not to like about yields of 5.8% in Hanover, 5.9% in Essen, 6.0% in Wiesbaden, 6.2% in Mainz, and a host of other at- tractive cities such as Münster, Mannheim, Leipzig or Dresden?

The argument against investing in Germany’s provincial cities has always run along the lines of the “uncertainty of exit” several years hence. The concern was always, who would be there to buy the asset when you need to move on and out? At least in the biggest cities, it was thought, there would always be another buyer coming along, persuaded by centrality and location. An exit was assured, the only issue was the timing.

Recent discussions with senior bankers have only emphasised to us at REFIRE how the issues of refurbishment and sustainability play an ever-larger role in the decision of their banks to finance an asset. Bank margins are again under pressure, with the return of several financing banks into the fray, not to mention competition from alternative providers. As many have recently found to their cost, ‘core’ assets can quickly become “broken-core” assets if, despite their location, the tenant moves to a property better-suited to his needs after ten years. The lucky investors, who’ve been enjoying stable returns for nine years, may just find themselves perched on the edge of a cliff.

A cursory walk around the business district of Frankfurt these days – to take just one German city as an example - will show how quickly many modern offices become obsolete. The entire city centre seems to be one big building site, with one ‘core’ property after another beingcarted away in dump trucks.

Conservative banks such as Deutsche Hypo and Helaba ARE actively financing. It’s not as if they’re curbing lending but it’s noticeable how circumspect they have become, both as to the assets or projects they will finance, and with whom they choose to do business. As the upswing continues, and interest rates remain – for Germans, at least – at such a low level, the demand for German real estate will scarcely abate. Last year Germany’s Pfandbrief-issuing banks increased new lending on commercial property by 10% to €53bn, while lending on residential investment rose 8% to €48.2bn. This year’s start suggests we’re in for another bumper year.

An (unlikely) rise in interest rates might send some of the new debt capital providers running for the hills, but in the meantime, the larger banks are following their favoured clients into cities they may not have, eh, visited for some time. It’s not outside their comfort zone, but the bankers are not considering these times ‘normal’, either. In other words, there’s too much money about, determined to buy bricks and mortar. On the plus side, if the new deals involve refurbishments, or non-core assets in secondary cities, the banks can trouser margins of 150 to 200 basis points, and more than compensate for the shift away from ‘core’.

Andreas Pohl, CEO at the Hanover-based Deutsche Hypo Bank, offered some useful insights into bank thinking at a small press briefing in Frankfurt last week. Lending will, of course, always remain his bank’s core business, he stressed, although all the banks are conscious of the constraints they’re up against in the coming years with the new equity capital requirements. However, real in-depth knowledge of local German real estate markets, and acute sensitivity to lucrative project development or refurbishment opportunities in those local markets, is what will differentiate the bank winners from the losers. As a cautious banker, he finds himself sniffing the air more frequently these days, like waiting for a shift in the wind, he said, while all around people are starting to party again like it’s 2007...

As an interesting aside, he commented that he detected a higher quotient recently of flaky – not to say outright dubious - propositions being submitted to his bank for financing consideration. Again, doubtless a function of the pressures investors are under to shift their funds into something – anything – involving real assets, or incur the wrath of their masters. Should we be surprised, then, that Bob Dylan is touring around Germany this summer? We can already hear him crooning “When will they ever learn...?”