Suffering, by knowing the numbers...

It’s six years ago almost to the day since REFIRE first tuned in to the legendary real estate investor Sam Zell giving his views on the European real estate markets – and particularly Germany’s.

On that day, the large conference room in Frankfurt’s Congress Centre was half-empty, as the line-up of mainly American speakers had seemingly failed to make much of an impact on the up-and-coming young Turks of the still somewhat sheltered German real estate industry, despite the fact that several of the Americans present were among the leading luminaries of the real estate industry across the water.

Waxing effusively about how his company planned to pour billions into Germany, Morgan Stanley’s global head of real estate John Carrafiell defended his strategy of paying top dollar for prestige properties with up to 50% vacancy rates, on the grounds that this was a unique opportunity to buy quality properties at below replacement costs. A couple of senior German bankers, perhaps a little dizzy from their recent rapid ascent to global real estate prominence, weighed in with affirmations about the golden future of which Germany was only at the beginning.

Sam Zell was having none of it. The man who had single-handedly floated three major real estate companies on the New York Stock Exchange, and was the single biggest owner of office properties in the US after the federal government, was sceptical of the investment banker’s plans to funnel billions of other people’s money into the sector. Growth, he said, growth was always the key to real estate. You buy real estate to participate in the real underlying economic growth in an economy. You can tinker with valuations as much as you want, he growled, but ultimately he couldn’t see the conditions around him in Europe to support a major commitment into commercial real estate. The antagonists agreed to disagree.

Within weeks, Zell had sold his Equity Office Properties group to Blackstone for $39bn, at what later proved to be the top of the market. It took a further three years for Carrafiell and his team to finish skinning their hapless investors, who lost record amounts, and are still licking their wounds from the experience long after the Morgan Stanley team moved on to pastures new.

‘The Gravedancer’, as Sam Zell is known, was back in Berlin recently as one of the keynote speakers at the EPRA annual conference. And no, he’s no more bullish now on the prospects for Europe than he was then. He’s had his setbacks in the meantime – like losing $300m in his ill-fated venture into newspaper ownership with the Tribune Group, which might hurt a bit, but for him the money is just chump change. As always, his plain-talking analysis and sprinkling of anecdotes was both insightful and entertaining.

Zell likes to describe his business philosophy as something like “suffering, by knowing the numbers”. On Europe, he says, he’s trying hard, but he still just can’t understand it. Growth, or the lack of it, is still Europe’s biggest problem. Spain, Greece - for him, the numbers just don’t stack up. He was heading to Ireland, he said, not necessarily to write cheques but because he felt sure that whatever was happening in Ireland would have significance for the rest of Europe.

Could he offer us any crumbs of comfort? Does Europe have anything positive to offer to American investors right now? Oh, sure, there’s plenty of things. There’s the wine, the cheese, the castles...

Well, perhaps there’s a little more, for those who take a very localised view. For example, a new survey here in Germany commissioned by WGF AG and carried out by property research group BulwienGesa shows a sharp rise in the number of project developments in Germany’s seven largest cities, up 37% on last year. Not surprisingly, the bulk of these are residential projects, reflecting the dynamics on the housing market, followed at some distance by office and hotel developments.

The figures also reflect the rapidly waning significance in Germany of the openended and closed-ended funds sectors, which previously sucked up so much of the available resources for real estate investment. but have of late been suffering a severe battering. After years of stagnation in residential development, largely due to low rents and a surplus of accommodation, which gave investors little incentive to construct new, fairly-priced housing, planning offices are responding by loosening restrictions on the number of permits issued. The market is responding. Permits issued this year to build new rental accommodation rose in July by 38.2% year-on- year, according to data from Germany’s main construction industry federation.

The new supply is still well below market demand, which, barring any major government intervention, should ensure a steady stream of construction for the next few years. At current low interest rates, we can reasonably expect that private investors, family offices, occupational pension funds and other institutionals will start shifting their resources away from the classical property funds - and more unneeded commercial assets – and putting them where the market may finally reward them with an adequate return. That’s surely something of which the sceptical Gravedancer would also approve.