vdp
vdp Immobilien-Forum 2023
The annual real estate forum of the Association of German Pfandbrief Banks (VdP) kicked off with CEO Jens Tolckmitt getting straight to the point - office real estate is facing into severe headwinds, with high energy prices, working from home, interest rates, an 'overambitious' ESG agenda, a wave of insolvencies among project developers, a lack of price visibility and investor resistance, and a crushing bureaucracy - to name just a few.
Jens Tolckmitt, CEO, vdp
The thrust of the event this year was to assess the immediate prospects for the beleaguered office market.
The event, attended by REFIRE, was a hybrid gathering of about 230 attendees both present and online, in the covered centre courtyard of the FAZ building in Berlin-Mitte. Tolckmitt addressed the current fashionable description of Germany as 'the sick man of Europe', making it clear that he does NOT subscribe to that view. He nonetheless sees little prospect of a turnaround in the office sector much before mid-2024, although he pointed to a glimmer of hope in recent rental developments which could indicate a willingness of the market to gradually spring back to life.
The VdP's own market specialist Hildegard Höhlich sees further downward price corrections, despite the nominal benefit of rising yields and rising rents in part of the office market. She sees the influence of ESG considerations as not yet being fully priced-in, as companies go about comprehensively reviewing their likely future office needs. No simple matter, with many having great difficulty in pinning down the level of their likely activity and personnel needs.
"We saw a decline of around 80% in the first half of the year," Höhlich noted on transaction levels. The main reason is the fact that the property interest rate for office properties is now above the current yield of ten-year bonds for the first time in more than a decade since the beginning of 2023. "The question is what risk premium investors will demand over Bunds," she said. There is also a high degree of uncertainty about how the tenant market will develop, what consequences can be expected from the use of home offices, and what the impact of the increased vacancy rate will be.
These office vacancy rates are noticeably beginning to rise, particularly among weaker grades of property, leading to a widening in the gap between rents and purchase prices in the good and not-so-good locations. But the prices for office properties overall are headed downwards over the coming months, she made clear. The home office trend alone, she said, would reduce the demand for office space by between 10% and 25% over the coming years.
"Unless occupancy rates are high enough, it won't be possible to finance every project," said Höhlich. There will be less completions in the medium term, although the vacancy rate is still likely to increase. Projects already under construction are largely pre-leased and won't add to the overall vacancy rate. But many existing properties won't meet demand from an enery point of view, or in terms of require modern office communications. Unless the property is really ESG-compliant, neither investors nor banks will want to engage with it.
With the peak in completions is likely to be reached in 2024, top offices in top locations will thus continue to fare well. Not so much for B- and C-locations, though. So, not much optimism there.
There followed a lively panel discussion, moderated by the ever well-informed Michael Fabricius of Die Welt, which probed how existing legislation was hindering office recovery.
The panellists - Sven Carstensen of researcher Bulwiengesa, Maria Teresa Dreo-Tempsch, board member at Berlin Hyp, Jochen Schenk, CEO at fund manager Real I.S. and vice-president at lobby group ZIA, and Frank Müller-Rosentritt, FDP member of the Bundestag - all agreed that the current ESG regulation is ill-adapted for achieving the German govenrment's goal of ensuring climate neutrality by 2045. The regulatory focus is too heavily weighted on energy-optimised new building, while the big effort has to go into energy optimising of existing buildings.
Jochen Schenk described how older properties in peripheral locations without good public transport connections and a high requirement for refurbishment were facing a difficult future. "Just how are we going to get to CE2 neutrality?", he asked. The definition of 'core' properties would have to be redefined. New construction standards are setting lofty goals, but this does little for existing properties if investor money all flows into new-build construction - with the taxonomy therefore becoming an instrument for the misallocation of capital. This won't help reduce the CO2 footprint of the real estate industry, he stressed. Any transformation would be doomed to fail without a major expansion of 'green' energy, and this would also take longer than expected. More emphasis was required, he said, in promoting the transformation of previously 'brown' properties into 'green' properties.
The other panellists agreed there were too many inconsistencies within the various ESG regulations, collectively not leading to a reduction in CO2 emissions. The EU taxonomy encourages a misallocation of capital without achieving its energy-reducing goals, it is too overambitious, and it generates too many conflicts between ESG target and their affordability.
Berlin Hyp board director Maria Teresa Dreo-Tempsch said it is clear now that a certain amount of office stock is now just no longer needed. The emphasis should be on trying to find ways to convert it to other uses. The goal has to be to be to transform the existing stock into green, modern real estate. For the office market, the single biggest challenge now was ESG, she said.
The big difficulty here, said Frank Müller-Rosentritt, FDP Bundestag member and banking specialist, is how complicated it is for medium-sized companies to even keep track of the numerous ESG regulations. And even then, particularly in provincial regions, how likely is it that energetic conversion can EVER be worth it, given the low level of office rents prevailing, he asked.
And yes, there really ARE significant differences between Germany's Top 7 cities and regional towns, where more than 70% of office space is located, with Sven Carstensen, of researchers Bulwiengesa, bemoaning the preponderance of studies and data on only the biggest cities, neglecting the B- and C-cities where the situation is certainly no easier. Carstensen gave the figure of €1,000 per sqm as a rule of thumb for the energetic refurbishment of an office. Completely unrealistic for many properties to get refinanced at that rate for inclusion in funds, the panellists agreed, and rendering them no longer practicable. Schenk added that it was also conceivable that certain legal restrictions on use, as applied in the Netherlands, could also soon come into effect here.
The key point, made by Carstensen and Müller-Rosentritt, about the top cities and the rest is that energy optimisation measures that might just about make sense in the top cities due to the high level of prevailing rents are simply unfeasible outside these bigger cities, where office rents can be as low as €8.00 per sqm per month.
While yields may be rising, as Tolckmitt indicated, that's because multiples are plunging. Long gone are the days of the pre-Ukraine invasion, with the near-quadrupling of financing costs in little more than a year. Capital market interest rates now exceed office property yields for the first time since 2011. Aggregate office yields in the top segment have risen from about 2.6% to just under 3.8% now, reflecting the fall in multiples from 38 to 26 now, a fall of a third. The VdP's Höhlich expects yields to hit 4% before the end of the year, implying further falls in the multiple. For office property owners, there sure wasn't a lot of positive news to take away from an otherwise engaging and informative morning.
