Europe’s tower of strength

The German market continues to offer reassuring solidity for investors in increasingly uncertain times, writes Stuart Watson

Frankfurt’s Tower 185 was an apt venue for this year’s PERE Germany roundtable. The German financial center’s fourth-tallest skyscraper was a clear beneficiary of the demand for Europe’s booming real estate investment market when it was snapped up in November 2017 for €775 million. The hotly contested transaction also highlighted why, for some investors, Germany has eclipsed the UK as the European market of choice. The new owner, Deka Immobilien, cited a Brexit-inspired exodus of bankers from the City of London as a factor in its decision to acquire the building.

However, demand for assets has fueled rocketing prices in the big German cities, so investors are being forced to weigh up whether such a hot market is the place to be at what is widely thought to be the end of an unusually long market cycle. Those deliberations are taking place against a background of rising anxiety over the possible breakout of a Trump-inspired trade war, as well as fears over contagion from the economic crisis in Turkey.

Considering these issues and mulling over the most effective private real estate strategies for Germany on a humid summer afternoon in Frankfurt are five investment management professionals: Michael Bütter, chief executive of hosts Corestate; Gil Bar, managing director for estate at Aviva Investors in Germany; Nic Fox, partner and head of Middle Europe at Europa Capital; Carolina von Groddeck, managing director for Germany at Savills Investment Management; and Bernd Haggenmüller, managing director of real estate at Ardian.

Sudden disruption

The discussion begins with a consideration of where the German market should sit in investors’ portfolios in the light of recent international developments. Ardian’s Haggenmüller says the current sense of unease is familiar to anyone investing in the European market over the past decade: “What’s characteristic to this cycle is that since it started in 2010 there has always been a risk to worry about. Greece was a big issue. Then there was the possible collapse of the eurozone, the French elections, and now, possibly, a trade war. People remain prudent – with some exceptions – they are always aware something can go wrong.”

“This sudden disruption is possibly indicative of the kind of thing that could spoil the party. People are watchful,” muses Fox from Europa Capital. However, he sees no sign that the powerful positive sentiment surrounding the real estate sector is changing: “There is almost unending capital wanting to be allocated to real estate, across all risk strategies and it is seeing a pretty attractive picture of steady economic growth in Europe.”

Aviva Investors views the risks to the macro environment as “lukewarm,” according to Bar. “Fear is a constitutional part of every human being. So the question is, are these concerns probability or reality? Are the tariffs and the trade war a real and imminent worldwide economic problem? As it stands today, I believe not.”

He argues that the biggest risk to the sector is a rise in bond yields. But even then, the impact will not be immediate. “The data shows there is a limited amount of correlation between bonds and real estate, and there is a significant time lag, somewhere between a year and two years,” he argues.

Corestate’s Bütter is not worried about interest rate rises in the short-term, either: “At the moment, we still have a gap between real estate yields and bond yields of 2 percent. That is very attractive. I don’t see the European Central Bank raising interest rates quickly. They have announced a first little step in 2019 and that will probably be 0.25 percent.”

But whether or not a full-scale trade war breaks out, tariffs could still have some negative effects, says von Groddeck from Savills Investment Management: “The disruption to international trade could make a difference to the underlying economy of states and therefore the occupier market. That is what I see coming out of that disruption in the short to mid-term.”

Low base of drama

Even if there is an unexpected shock and a correction in the real estate market as a whole, Germany will still look comparatively enticing to investors, suggests Bütter: “This is a safe harbor market with a stable economy and occupier base, and good assets. It is still one of the best markets for real estate and given the impact of Brexit on the UK it will remain a very attractive location within Europe. That gives me confidence that we will see a period of very strong yields here. Money needs to be deployed. Find me a better place to deploy capital than German residential.”

“Germany is a safe harbor market with a stable economy and occupier base, and given the impact of Brexit on the UK it will remain a very attractive location within Europe”

-Michael Bütter

Last summer, Germany was on the brink of a general election. Angela Merkel’s position looked weak and the nationalist right appeared to be gaining ground. There were fears in some quarters that Germany’s vaunted political and economic stability could be under threat. A year later, those worries have proven groundless, argues Haggenmüller. “Don’t forget that German politics starts from a very low base of drama,” he quips. “It is more exciting than it has been, but that doesn’t mean it is shaking up the current structure.” He points out that GDP growth was a steady 0.5 percent in the second quarter of 2018, with aggregate growth of 2 percent a year expected going forwards.

Meanwhile, development has been limited, observes Bar: “The supply risk in Germany is low in most areas. The regulatory environment makes it difficult to develop at significant scale and, in many places, there are few building plots available.”

“The overall political agenda hasn’t changed and is still focused on stability, and the underlying economic data bears that out,” says von Groddeck. “We have record low unemployment and the outlook is positive for the next few years. In the medium-term, there could be changes, but Germany is a powerhouse in the middle of Europe and if we don’t cope then the whole industry has challenges to face.”

Europa Capital has recently begun to pursue a core strategy beyond its presence in the value-add space, and Germany is one of the obvious markets in which to acquire assets. “Germany is in the wonderful position of being the market of choice among core investors right now, particularly compared with Brexit-threatened UK, with which it vies as the top market,” says Fox. Still, he adds, a strategy focused solely on German core property would be unlikely to pay dividends at the moment. “There may not be too many prizes for investing in core in Germany at the pricing that currently prevails. You are buying at the highest rents we have seen for a while and the lowest yields we have ever seen. That could go only one way. It will be very difficult to produce performance without diversifying, or by buying into a rental growth story.”

Pressure on fees

The participants observe that capital flows into the German market are becoming ever more diverse. “We were overwhelmingly North American capital 20 years ago,” says Europa Capital’s Fox. “Now that makes up about half of our investor base; the rest is European, Middle Eastern, Australian and Japanese money for investments in value-add strategies and real estate debt.”

Meanwhile, Haggenmüller has observed a surge in interest from Asian investors: “In general, there is a mega-trend toward Asia. Across the world every second dollar that will be invested over the next 10-15 years will come from there.”

More diverse capital sources mean managers need to provide a greater range of investment vehicles to accommodate them. In July, Corestate launched a RAIF fund to accommodate a broader range of smaller investors. Bütter says: “The RAIF is the most professional way to collect capital these days. We have licenses in all relevant jurisdictions and we can arrange various structures in order to collect money. For instance, we do a retail fund for small investors and a club deal structure for ultra-high net worth money. We are also seeking to continue to grow our institutional investor base, however.”

Domestic investors are often more comfortable with German-regulated fund structures, says von Groddeck, but for other capital it is useful to be able to offer Luxembourg or Italian-regulated vehicles: “You need to be open to and able to supply those structures if you want to cater for different types of investors and equity.”

Aviva’s Bar adds that institutional investors are working with a shrinking pool of asset managers. “It doesn’t have to be the big ones; they also like to work with smaller, specialized firms, and transparency and communication with their managers are highly important to them,” he says. “The other trend we see is that if you don’t have a thematic or value creation proposal, or both, there is enormous pressure on fees. The big challenge is to show not only that you can solve a problem for them, but also that you have a special solution tailored to that investor.”

Stunning growth

While the immediate future for the German real estate market looks assured, the long-term picture provides more cause for concern. “The massive demographic changes that will happen over the next 30 years should concern investors, as well as potentially providing them with an opportunity,” says Bar.

“The massive demographic changes that will happen over the next 30 years should concern investors, as well as potentially providing them with an opportunity.”

– Gil Bar

“The population is aging. Munich is probably the one exception, but in all the other major German cities there is a significant decrease in the working age population. The housing product in Germany needs to adapt to the demand from a population that is going to live longer. The nature of the urban space in Germany will change.”

“That feeds back into the immigration debate,” says Fox. “Assuming Germans aren’t going to produce double the number of children, that requires more immigration, a super-controversial issue that nearly brought Angela Merkel down and might yet.”

Von Groddeck observes there has been a slight, but significant increase in the birth rate, which together with immigration, may yet ameliorate Germany’s demographic problem. She also questions whether demographic changes will impact the major cities. “Are we talking about the top five to seven conurbations or Germany as a whole? Rural areas will lose inhabitants, but those larger cities will grow, and a lot of smaller cities have seen increases in population too.”

That’s an argument taken up by Haggenmüller and deployed to justify Ardian’s strategy of investing in first-tier German cities, in spite of the expense that entails. “Although the population of the country may not be growing overall, we have cities that have seen a stunning growth rate over the last couple of years, and that will continue,” he said. “That creates opportunities for investment in housing and offices. It is the reason why we are investing in the big cities – they are growing at twice the rate of the country overall. If the growth rate is 2 percent for the country, it is 4 percent and more for the big cities.”

Meanwhile, Corestate is also seeking to take advantage of long-term demographic trends by investing in urban micro-living concepts. “The trend of older people leaving the cities seems to have reversed,” says Bütter. “You need more space in the cities for them and for younger people – and students, too – and the space within the city boundaries is limited. So modern residential forms need to emerge, like micro-living and co-living.”

Polycentric market

The discussion turns to the challenge of sourcing investments and driving returns in a competitive and expensive market. Bütter suggests it is possible to find attractive assets in second-tier German cities as long as a manager has a strong network of local contacts. “You also need an investor base willing to take on more risk, and get in earlier through routes like development. We are buying assets on our own balance sheet so we can act quickly and then bundling them and selling them on again. We co-invest as a way to mitigate the sentiment of the risk for our investors.”

The polycentric nature of the German market, with prosperity scattered across many cities rather than just concentrated in the capital, provides opportunities for core investors, argues von Groddeck: “There are still pockets in Germany where you can invest into core property in very good locations and still get rental growth, so even core investors can add a little value. International investors in Germany want duration of income and you can find that still if you are willing to go into the top 20 cities rather than just the top seven.”

Haggenmüller takes a different tack, arguing that buying in secondary locations in first-tier cities offers the best opportunity of harnessing rental growth. “We are in a market with supply constraints and very positive rental dynamics ahead of us,” he says. “Those rental dynamics usually happen in the city centers where you see prime rents rising quicker and earlier, then at a later stage the wave moves on to the ‘B’ locations in the same cities.”

“We are in a market with supply constraints and very positive rental dynamics ahead of us”

-Bernd Haggenmüller

Fox agrees that for value-add strategies the larger cities offer liquidity, a crucial factor for investors seeking a swift exit. “If you have to get out then liquidity is everything and you always find more liquidity in bigger markets through ups and downs. That is why, for most sectors, we focus on the big cities,” he says. “The exception is the last-mile logistics sector, and, even then, we buy assets around the big conurbations.”

For long-term income-driven investors, Bar argues a thematic approach to investing yields the best results: “Through these thematic funds you are able to grasp and capture rental growth over the medium or long term because you are buying assets where people want to work, live, play and learn. We also see asset management opportunities in those areas because buildings change use much quicker than they did before while the location still remains attractive.”

Unearthing the best investment opportunities will remain a challenge for investors in Germany, but, with a stable domestic environment and deep reservoir of available capital, the roundtablers predict another favorable year ahead for the central European powerhouse.

Gil Bar

Managing director, German real estate,
Aviva Investors

Bar is managing director of the German platform of Aviva Investors, the investment management arm of Europe’s third-largest insurer. The firm is one of Europe’s largest managers of real assets with £37 billion ($48 billion; €42 billion) in total under management. Bar leads a 17-strong team based in Frankfurt focused on pan-European core and core-plus strategies, which manages around €2 billion of assets. Last year the firm launched a continental long lease strategy fund which has invested over €135 million.


Michael Bütter

Chief executive, Corestate Capital

Bütter joined Frankfurt-listed investment manager Corestate in 2016 as a senior advisor and became CEO in May this year. The company, which employs 600 people and manages €22 billion of real estate assets, concentrates on Germany as its key market, but also invests in other territories, including Poland, Spain and the Benelux countries across sectors including residential, micro-living, offices and real estate mezzanine debt across a full range of risk profiles from core to opportunistic.

Nic Fox

Partner, head of middle Europe, Europa Capital

Fox is a partner and member of the investment committee at Europa Capital, a London-based boutique investment manager that sits within the $28 billion Japanese-owned Mitsubishi Estate. Europa Capital manages €3 billion of European real estate and has carried out around €1 billion of transactions in Germany to date. Its activity has been principally confined to the value-add space, but the company is now also committed to investing in the core and core-plus space in Germany and Paris.

Carolina von Groddeck

Managing director, Germany,
Savills Investment Management

Von Groddeck has headed the German team at London-headquartered Savills Investment Management since the beginning of this year. From its 18 offices with 280 employees in Europe and Asia-Pacific the firm has around €17 billion of assets under management. It focuses mainly on the office, retail and logistics sectors, as well as on core and core-plus strategies with some value-add investments.

Bernd Haggenmüller

Managing director, real estate, Ardian

Haggenmüller leads the German real estate team at Ardian. The firm is the largest private equity investment house in Europe with around €70 billion of assets under management, but is comparatively new to the real estate sector, where it has so far built up a €1.3 billion portfolio in Germany, France and Italy. Ardian closed its first European real estate fund in the spring, having raised equity capital of around €740 million, and is now planning a second such vehicle.

The end of capital growth?

Yield compression continued in some German cities in the first half of this year, with cap rates reaching record levels. Have prices finally reached their peak?

Carolina von Groddeck: Capital growth is a pocket thing. I don’t know if it is a trend that yields are still shifting, but on certain properties, you are really surprised by the prices because the competition is so fierce. Without incorporating expectations on rental growth it is difficult to make those prices work. However, these enormous prices are not always being paid – that is a new trend. The expectations of the brokers are not being met in certain transactions.

Nic Fox: Some of the yields being paid here are eye-watering, but there is rental growth and that is what investors are banking on. Yields in Germany have always moved within a smaller band and at a lower level than in the rest of Europe, but this is still a record low, hence one ought to be watchful. History has shown there will be disruption, markets will correct, and rents will go down.

Michael Bütter: There is a lot of Asian money flowing into central Europe looking not only for real assets but also for real estate debt. The party is not over yet and there is still a lot of demand out there.

Bernd Haggenmüller: My bet for the last three years was that cap rate compression is over and I was always wrong, but I think this year we are really coming to the bottom of cap rates. The driver for growth now is rental value. With investors buying at very low yields and paying very high prices per square meter there is a pressure on landlords to push rents up. Of course, you can only do that if there is scarcity of supply, which at the moment we have.