Secondary cities offer less volatility and lower risk than ‘A’ cities

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Secondary office markets in Germany offer less volatility and lower risk than their ‘A’ city counterparts, according to a study published this month by DEMIRE and market researcher BulwienGesa.

According to the study, ‘Investment Opportunities in German Secondary Office Locations’, selected German ‘B, C and D’ locations offer higher potential yields on office investments than Germany’s ‘Big 7’s cities with the same risk profile or a lower one. Smaller cities also benefit from less volatility in the lettings market, coupled with higher net initial yields.

‘German institutional investors who used to invest in ‘A’ cities are starting to look more at ‘B’ and ‘C’ cities,’ said Sven Carstensen, head of Bulwiengesa AG’s Frankfurt branch. ‘The market has become pretty hot.’

Office employment is also rising steadily in smaller cities. An increase in office employment of more than 5% is forecast up to 2020 for nine out of 21 secondary cities that were included in the study with Leipzig set for an increase of as much as 9.4%.

While many international companies and large corporations have branches in A cities, around two-thirds of German employees work for small and medium-sized enterprises, whose locations are often far removed from the major cities,’ said Markus Drews, member of the board of German real estate group DEMIRE.

Around 2.9 million people currently work in offices in Germany’s ‘Big 7’. However, almost twice as many people - or 5.4m - work in B, C and D locations. The number of office workers in A cities has increased by 28% since 1999.

‘Over the same period, the cities in the other categories have experienced slightly lower but steady growth. Office employment increased by between 17% and 25% in all B, C and D locations analysed,’ added Drews.

Office yields in B cities are typically around 5.1% today, vs. sub-4% in A cities, according to the study. In C cities, yields hover around the 5.7% mark, which rises to 6.7% for D locations. Seven of the D locations investigated - Kassel, Koblenz, Flensburg, Göttingen, Bayreuth, Schwerin and Stralsund – and two C cities, Rostock and Wuppertal, achieved net initial yields of 6% or higher.

And yields in B cities are expected to keep their edge: Bulwiengesa forecasts office yields tightening slightly to around 5.14% in B cities by 2021, compared to 3.75% for A cities.

Investors with between €10m and €15m to invest can find ample opportunities in smaller cities, according to Carstensen of Bulwiengesa. ‘If you’re looking to acquire an office of between 3,000 sqm and 5,000 sqm, there are lots of possibilities, particularly in cities such as Bonn, where there are a number of big companies and where there is little volatility.’

Volatilty drops outside A cities

Volatility plays a much bigger role in A cities than in their smaller counterparts, according to the study. For example, the average vacancy rate in major cities rocketed from 3.1% to 10.7% between 2001 and 2004. However, the increase was much more moderate in smaller cities. The vacancy rate in B, C and D locations has been declining slowly but steadily since 2007, albeit starting from a low level.

‘The vacancy rate is very low overall in the C cities and many of those in category D as well,’ said Sven Carstensen, head of BulwienGesa AG’s Frankfurt branch. ‘For example, the vacancy rate in Freiburg (a C city) is 1.4%, and in Göttingen (a D city) it’s 2%,’ he added.

Interestingly, 60% of German office space is located outside major cities, according to the study. A markets account for 43.2% of the total, followed by B cities with 20.5%, C cities with 14.7% and D cities with 21.6%, according to Bulwiengesa.

In the study, Bulwiengesa conducted a detailed analysis of the office markets of 21 B, C and D location. For the purpose of the study, the cities were clustered together and compared to Germany’s ‘Big 7’.