Glowing German figures mask looming shift in capital flows

REFIRE had a meeting this week with the head of a sizeable German Family Office, whose fortune has been earned providing aspirational German consumers with the last word in reliable kitchen appliances over six upwardly mobile decades. The Family Office has been a prominent investor in direct and indirect real estate vehicles in Germany throughout that time, as well as occasionally taking advantage of the currency hedges and long-term dynamism of the London and US property markets.

Right now their focus has shifted entirely to the US, he confided. Why should they torture themselves to get a possible 4% in Germany, or less, when opportunities abound across the pond? A good question, indeed, and a worrying one, if his rationale proves to be typical of hundreds (or even thousands) of investors like him across Europe.

It’s not just that the latest prognosis from Germany’s five economic ‘wise men’ for economic growth in Germany for 2015 has just this week been downgraded to 1%, below the government’s own figure of 1.3% (which itself had been hurriedly amended down from 1.7%). It’s that several other studies reaching us suggest that the commercial real estate markets in Germany may have already succumbed to a trend change, after four years of steady recovery.

Dr Günter Vornholz, Professor of Real Estate Economics at the EBZ Business School in Bochum (and in his day job, the head of research at significant German lender Deutsche Hypo in Hanover) believes that commercial property values have been stagnating since the start of the year in the key commercial centres of Frankfurt, Munich and Berlin, rising slightly in Hamburg, and have already lost 5.7% of their value in Düsseldorf.

This would come as a rude shock to many investors who trust the figures from such rating agencies as Scope in Berlin (which we have reported on frequently in these pages) that German-only funds have performed markedly better in 2011-2013 than European-based funds, by a margin of 8.2%to 5.8%, according to Scope’s figures. But with the winds of change blowing from a different direction, investors are asking themselves how they should position themselves now.

We’ve been here before, of course. However, we’re now witnessing a six-year slide from nearly US$1.60 to our current $1.25 to the euro, with ever-decreasing peaks, stable troughs, and a trend of returning to oscillate around the $1.35 mark. Currency speculators, though, are now clearly bearish on the euro, with doom-mongers from some of the biggest banks betting on the currencies even reaching parity again in the near future.

The effects of this weakening euro are, of course, a mixed blessing. It should boost eurozone exports – and indeed Germany’s exports did hit a new high last month, amid mounting gloom about Wolfgang Schäuble’s commitment to a ‘black zero’ or a balanced domestic budget by 2020. The positive currency effect was much more pronounced for Eurozone members – like Ireland – the bulk of whose trade is with non-eurozone members, such as the UK and the US. Irish exports of goods and services have boomed, while the rest of Europe (most particularly Finland) is bearing the brunt of a stagnant European economy and the loss of markets caused by Russian sanctions.

In Europe-US relations though, the last few months have seen the US market gaining in momentum – inflation is up, quantitative easing has been trimmed back, unemployment is down to 6.5%, and the Fed is getting ready to raise interest rates. In stagnating Europe we have practically negative interest rates, the ECB is preparing to pump billions into banks to counter looming deflation, and the euro has lost 9% against the dollar since the summer.

Worse, still – foreign investment into German commercial real estate, at more than €5bn in the first quarter, shrivelled to €3.5bn in the third quarter – with the Americans cutting back to a mere €600m in the period after kicking off in the January to March quarter with €2.1bn.

It can only be hoped that they don’t go the whole hog and start throwing ballast overboard, fearful of an even further fall in the value of the euro. Certainly old hands like Cologne-based Jamestown, an initiator of US-only closed-end funds with a superb track record under the wily eye of veteran Christoph Kahl, are licking their chops at the prospect of getting another marvellous run in America’s most dynamic commercial cities. Jamestown and others are already scooping up funds from German instituitons and private individuals for US investment, effectively starting with a new broom and new business models, having timed their last run almost to perfection.

Should the pendulum swing sharply in favour of the US, a weakening euro will make German real estate more attractive to long-term oriented Asian investors, who can enter the market at higher initial yields than are currently available. Korean, Singaporean, Taiwanese and Chinese funds are already scoping out the German market, and each month brings news of new, sizeable transactions. The Asian outbound investment story will have a long way to run, US attractions notwithstanding, and in Germany we’re only at the beginning.