In our most recent column here we took the liberty of letting off some steam about the current obsession with socalled ‘core’ investing – generally taken to mean the acquisition of a prime office property in a top location, rented out on a lengthy lease to a blue-chip tenant with impeccable financial and professional credentials. The assumption is that this is the embodiment of ‘safe’ investing in turbulent economic times – an assumption bolstered by the evident amount of competitors vying to get their hands on the same assets.
I’m afraid we just can’t help it, but every time we look out from the 42nd floor of a Frankfurt office tower across a landscape of glass-and-concrete palaces stretching to the sky, we can’t help wondering how much money has been collectively lost by hopeful investors on these superb edifices. We’re big admirers of Frankfurt’s thrusting skyline make no mistake about it and invariably feel a flutter of local pride at the first glimpse of the shimmering metropolis in the distance when descending down the A5 autobahn from the north, a good 30km outside the city.
Even now, with nearly a fifth of all the city’s office space lying vacant, the cranes on Frankfurt’s skyline testify to the arrival of yet more magnificent office space halfway to the clouds, and further enrichment for the optical profile of Germany’s banking and financial powerhouse. We love it. Those that work in these buildings seem to love it too, and employers – judging by their willingness to sign on the dotted line for space in these coveted towers – obviously love it as well, and provide the rationale for the developers to keep on buildin’.
In Berlin last week we listened to Dr. Stefan Bone-Winkel talking about his idea of Core. Bone-Winkel is the CEO of BEOS AG, a specialist fund manager and investor in mixed-use industrial properties – which buys, upgrades and adapts old warehousing and manufacturing premises for the needs of mediumsized companies. BEOS’s recent funds have been several times over-subscribed, so the company is doing something right.
Bone-Winkel’s thesis – in a nutshell - is that Core is a concept that is determined by the tenant, and not the investor or the project developer. ‘Core’ is an asset that offers its tenant few other options as to where they can go for the purposes of running their particular business. Understanding those businesses, and why they need to be in certain locations, is what Bone-Winkel’s business is about, and why his company’s ‘core’ locations in cities throughout Germany might be unrecognisable to many who have a different understanding of the word.
o illustrate his point, Bone-Winkel highlighted the fate of the well-known office building in Taunusanlage 11 in Frankfurt’s business district, known as T11 - a not untypical example. The property was built in 1972, and was the home of Chase Manhattan bank until being gutted and completely renovated in 1992. It’s now a shell again, and awaits the arrival of new tenants in 2013 following total revitalisation at a cost of untold millions.
The property, in its time, was the only German office property commanding more than DM 100 per square metre per month, or €50.00 in its euro equivalent. Bear in mind that the highest rents in the most luxurious offices in Frankfurt these days barely reach €35.00 per square metre – and that’s absolute tops. Most office properties would be lucky to see €25.00 these days – well below the rents on ten-year rental agreements signed long ago during the dotcom era. Using other examples, Bone-Winkel concluded that Frankfurt’s so-called core properties are worth not much more than 30-50% of their purchase prices in 1993, a mere twenty years ago. In many cases, such as T11, the building itself is effectively worthless, although the location may have some value. The life of a modern downtown office building in a metropolis like Frankfurt is twenty years. At which point the owners can start again. That’s the new reality.
Bone-Winkel’s key point is that assumptions of seamless lease extensions or the arrival of new tenants following the expiration of the current contract are, in most cases, invalid or grossly optimistic. The kind of tenants traditionally considered core, or blue-chip, are precisely those described these days as ‘rental nomads’, who are always ready to move on to the latest, most modern, most prestigious office space. The evidence is there; the professional services firms – the Ernst & Youngs, the KPMGs, the PriceWaterhouseCoopers – not to mention big employers like Deutsche Börse with their tailor-made headquarters - all have moved in the last couple of years in Frankfurt to the latest, poshest space, leaving swathes of empty, practically unlettable office space behind them in their wake.
Indeed it’s true - Frankfurt is littered with custom-built office space for its onetime tenants, who did a runner once freed of their contractual obligations. That’s the nature of the game, say the project developers. And so it is. Still, we shouldn’t be surprised when it turns out that most investors in closed-end funds get a rude awakening when their investment falls off a cliff when it comes time for the repayment of capital. Or why the German property funds industry has earned itself such a grubby reputation in recent years. Still, more of the same, we expect, in 2013. Happy Christmas to all our readers.
