ROUNDTABLE: The resurgence of Germany


Barclays Capital
Corestate Capital
GREAT German Real Estate Advisory Team
Special Situations Realty Partners III
Tishman Speyer

Re-engineering German growth

The German economy is growing again and opportunity abounds, but participants in PERE’s Germany roundtable  say no one is getting carried away – yet. Robin Marriott

Maybe it is because German nationals are conservative by nature or because they have survived economic shocks before or because they are simply wary of past mistakes, but local real estate players remain restrained over the country’s remarkable economic strength at the moment.

To be sure, there is plenty of reason for cheer. The German Council of Economic Experts recently announced that the German economy will have expanded by 3.7 percent in 2010, and it is forecasting 2.2 percent growth for 2011. That is even further ahead of estimates provided by Chancellor Angela Merkel’s government. Basically, the economic recovery, which had stalled in the winter of 2009, is strengthening in Germany, and the country is set to outstrip the growth of its major European rivals – namely, the UK (1.2 percent), France (1.4 percent), Italy (0.9 percent) and certainly Spain (-0.4 percent).

It is against that backdrop that PERE met with five leading real estate professionals early in November at Frankfurt’s Villa Kennedy Hotel, located in a peaceful corner of the city away from the hustle and bustle of its bankers and high-rise offices. The cast included Matthias Hünlein, managing director at Tishman Speyer; Ralf Kind, director in the real estate investment banking team of Barclays Capital; Michael Schleich, managing director of GREAT German Real Estate Advisory Team; Collin Schmitz-Valckenberg, member of the board of directors for Orlando Real Estate’s Special Situations Realty Partners III; and Ralph Winter, founder of Corestate Capital.

It is amazing to compare Germany with even a year ago. If you look at exports, they are high. However, they are still something like 10 percent below where they were before the global crisis, so there is a way to go.

Collin Schmitz-Valckenberg

Despite signs of economic growth, the participants in PERE’s inaugural German roundtable are not yet getting ahead of themselves, particularly as that growth has not filtered through meaningfully to the local real estate markets. Instead, they are focusing on a raft of issues from local investor demand for core assets to the availability of bank finance to how Germany’s surprisingly small public real estate sector is ripe for change. 

Indeed, the way the ice is broken among our participants is indicative of the current sentiment among Germans. One of the participants cracks a joke about the expensive-looking breakfast, which is only touched after the roundtable ends, again demonstrating the conservative German ethic of work first. After all, outside in the real world of Germany’s towns and cities, the average Herr und Frau Schmidt are not living it up with five-star breakfasts just yet. Instead, they are coping with post-global shock austerity.

A note of caution

Given the economic performance Germany is enjoying, it may seem logical that the roundtablers would be enthusiast about the prospects for Germany’s real estate markets. They are, just not in the same way as perhaps real estate professionals from different parts of the world might be.

As Tishman Speyer’s Hünlein points out, part of the cautious German psyche has to do with a focus on savings and not getting too carried away by positive indicators. “If you look at our history, Germany has gone through a number of difficult situations where people had to rebuild wealth,” he notes. In other words, although the economic rebound looks positive at face value, it is clearly early days in terms of talking about major positive effects on the country’s property markets.

Indeed, Schmitz-Valckenberg points out that it is German exports that are having the major positive effect, a segment that generally is not associated with real estate. “The export boom is technology, the production industry and so on, but the whole domestic sector is lagging behind exports,” he says. “And even though unemployment is falling, this has not filtered down yet.”
In other words, the macro situation is ahead of the mood, encapsulates Corestate’s Winter. “We have every reason to feel great about the current position, but it is still like there is a cautious, careful approach to spending and investing,” he says. “People in general are risk averse.”

This is something all our roundtablers can agree on, and it is how most Germans see their current situation. “For me, it is unexpected how Germany is coming out of the global recession,” adds Winter.

While Schleich believes the facts about economic resurgence are there for all to see, one shouldn’t get carried away. “It is amazing to compare Germany with even a year ago,” he says. “If you look at exports, they are high. However, they are still something like 10 percent below where they were before the global crisis, so there is a way to go.”

The only banker in the room, Barclays Capital’s Kind, is keen to underline the cautious approach. He notes that there is still high volatility in the financial markets, which is a function of the global economic environment, and cautions that, although real estate companies currently are trying to raise as much capital as they can, this should not be taken as a clear sign of bullishness and an indicator that an avalanche of investment will take place.

Much of this increased fundraising effort can be attributed to the historically low interest rate environment, explains Kind. “In the back of their minds, corporate treasurers are thinking that the overall macro-economic outlook, the level of indebtedness and expected inflation means that the central banks will probably need to raise interest rates at some point, which would change the picture entirely,” he says. “What the property companies are doing is therefore a little bit opportunistic at the moment.”

Lessons learned

Nevertheless, there is excitement in the room in terms of real estate investing in Germany. After all, our participants all have Germany and Central European-focused businesses, and they say that deals are taking place. But before that can be discussed, Germany’s recent past needs to be addressed as it holds contemporary lessons. 

Indeed, everyone in the room vividly remembers the amazing months in 2004, 2005 and 2006 going into 2007 when Germany’s real estate market was on fire. Many investors felt Germany was the next economic growth story and that its real estate was somehow ‘under-priced’. Players from clearly overheated markets such as the UK were looking towards Germany as their next playpen. It seemed almost exotic and untapped to the British, and certainly to Americans.

Investors including large US opportunistic funds sensed not only big opportunities in commercial property but in residential property as well. Part of the reason was that German municipal authorities were selling off vast housing companies and portfolios. Foreign investors bought these multi-billion portfolios with cheap bank loans that were syndicated or securitised. The strategy was often predicated on modernising these portfolios, achieving a multiple of the original investment by either raising rents or privatisation, that is selling them to Germans that hitherto rented.

The play, however, was a limited success. It proved difficult to raise rents, and it turned out that Germans were not so interested in owning their home. When the credit crunch hit, many foreign firms still had big debts attached to these portfolios and their lending banks were stuck with large loans on their balance sheet. Banks and investors alike got burned.

“If you look at the facts, it was absolutely astonishing,” says Schmitz-Valckenberg. “The volume of transactions didn’t treble, it almost quadrupled. The traditional share of 25 percent foreign investment went up to 75 percent. They took a different view of the market than domestic players that had operated here for years.”

If the lending environment freed up more, one would see more firms coming into the value-added, opportunistic end. After all, one cannot achieve opportunistic returns on 60 percent loan-to-value ratios.

Ralph Winter, Corestate Capital 

Not that domestic players have stepped back. Their investment volume rose as well. Where investors such as German open-ended funds competed against highly leveraged foreign players for the same assets, those open-ended funds have invariably run into trouble today. Even though open-ended funds took on limited debt, the depreciation of assets has hurt the open-ended industry in general, with three such funds liquidating in 2010 and many responding to investors’ wishes to pull out their money by temporarily halting redemptions.   

Importantly, points out Schmitz-Valckenberg, foreign investors that bought aggressively didn’t have teams on the ground, so those opportunistic deals that required some asset management didn’t work out well. “They didn’t have the capacity to understand what was happening in the markets they bought in,” he adds.

This means that, for the past two years, plenty of foreign firms have been sitting on investments in which their equity is worth zero. The lending partners to these firms haven’t acted because they haven’t been forced to or because they didn’t have the resources to take a write-down. Now, some of those banks are backed by their respective governments and the investments are getting refinanced. Step by step, these things are slowly being worked out.

Demand is back

Things have changed dramatically since those debt-gorging days. For the past 24 months, everyone has been looking for stable assets financed by low levels of debt. That means achieving 20 percent-plus returns isn’t all that possible in Germany.

According to the roundtablers, the current ‘play’ is more about investing in special situations, where one has to “work like hell”. Indeed, this is precisely what our experts are doing in their businesses, as they discuss later.

For foreign investors, however, the fact that Germany ended up being a place of pain in the last cycle prompts the question of how those investors see Germany today. The roundtablers note that some foreign players have established offices in Germany and continue to have a focus on the country, while others that dipped into Germany opportunistically have seen how complicated the market is.

I would say that, instead of having a ‘pure’ German approach, investors are taking a more European or international approach.

Matthias Hünlein, Tishman Speyer

Indeed, Germany is not as simple as the UK, which has London, or France, which has Paris. Instead, the market is made up of six very different real estate locations with intricacies, foibles and contrasting dynamics. “You really need to understand these different markets,” says Schmitz-Valckenberg.

As a global player, Tishman Speyer is a good firm to expand upon the issue, and the answer from Hünlein is a qualified yes. “My impression is they draw the line between main markets in the Eurozone, which Germany is part of, and secondary or non-Eurozone markets,” he says. “I would say that, instead of having a ‘pure’ German approach, investors are taking a more European or international approach.”

Winter draws on the past to address the issue. He talks about how investors from the US retrenched amid the Great Recession, but that some are now finding that there aren’t necessarily a large numbers of deals occurring back home in the US. At the same time, some investors need to diversify or continue to diversify into different countries rather than keeping all their eggs in one basket.

Indeed, Corestate is speaking with investors from the US that are interested in Germany and have capital to invest in opportunistic or value-added strategies, such as Corestate’s. “I am completely confident that this will continue,” Winter says. “They learned their lessons, now they are asking: ‘Do you have the right people on the ground?’”

Core, core and more core

There may be mixed messages over what international investors think about Germany, but when it comes to domestic LPs, the picture is very clear indeed: they want core assets. This isn’t a different story compared to other parts of the world, where institutional investors also are seeking the comfort of less risky assets in prime locations. It is just that, somehow by nature, German institutional investors are even more conservative.

In a recent study by INREV, Schleich points out that 70 percent of investors were indeed looking for core product. Further, a large percentage of investors are looking to sell their value-added, opportunistic holdings to recycle into core. It is an undeniable trend.

During PERE’s whirlwind tour of Frankfurt the day before the roundtable, a host of other firms were adamant about the same thing – core is the hot commodity in Germany. One firm was even raising a core fund specifically because German institutional investors had asked it to.

People like secure, reliable, real income streams, and those people seeking core product in Germany are mainly interested in cash-on-cash fixed returns. If you can offer them five or 5.5 percent returns, they are very interested, particularly if the tenant is a strong one with a long lease attached to its occupation.

Barclays Capitals' Ralf Kind

BarCap’s Kind isn’t surprised by the fact that core property is a commodity of choice for many, given a lack of clearly superior alternatives available to investors. He rightly points out that, in Europe, the alternatives such as bonds and equities hardly merit much excitement. “There is significant volatility in equities and bond yields are low, but in real estate there is relative stability,” he argues. “People like secure, reliable, real income streams, and those people seeking core product in Germany are mainly interested in cash-on-cash fixed returns. If you can offer them five or 5.5 percent returns, they are very interested, particularly if the tenant is a strong one with a long lease attached to its occupation.”

Of course, as previously confirmed by our participants, there is not that much core real estate to buy at the moment. That begs the question whether German LPs and property investors will eventually move up the risk spectrum to seek more yield.
Hünlein suspects not, suggesting that none of the institutional investors are under such pressure that they have to invest in value-added or opportunistic strategies. “They will not get punished for not investing up the risk curve,” he adds.
Then again, Schmitz-Valckenberg believes an example of a firm going up the risk spectrum already may have presented itself. In August, the real estate arm of German insurance giant Allianz acquired about 80 assets in parts of southern Germany from supermarket group Aldi in a sale-leaseback transaction.

“Would you have imagined an insurance company buying that three years ago?” asks Schmitz-Valckenberg. “It is clearly not the usual focus of an insurance company to buy such a product; it is not a core deal.”

GREAT’s Schleich approaches the question of whether investors will go up the risk curve in a slightly different way. He believes that many investors are under pressure in the sense that they have to invest a certain amount of money, but they may not find it in their main geographical focus areas. “Instead, they have to leave the top seven cities and go to locations like Munster, Konstanz or Heidelberg,” he says. “They have to move and weaken their regulations a little.” 

Show me the money

Real estate investors – whether they be domestic or international – may be more interested today in buying less risky assets than they were before the credit crunch. But apart from the lack of assets to buy, there is another impediment to investing successfully.

What is still lacking, the roundtablers say, is bank financing, especially for deals in the €1 billion-plus bracket, though banks are writing bigger cheques now than at the start of the year. At the start of the year, banks seemed able and willing to loan €50 million to €70 million. Today, that primary loan is more like €100 million to €150 million.

Winter says: “If the lending environment freed up more, one would see more firms coming into the value-added, opportunistic end. After all, one cannot achieve opportunistic returns on 60 percent loan-to-value ratios.”

At this point, BarCap’s  Kind cites the absence of the commercial mortgage-backed securities market as a major hindrance. Between 2003 and 2007, CMBS as a financing mechanism was working with astonishing results. Obviously, that stopped in 2007, and many banks were “captured by the situation”, referring to those banks where large CMBS loan pools ready to be securitised were instead left with them on their balance sheets. “Clearly, banks still need to chew through those assets on the balance sheet,” he says.

Incoming Basel III regulations requiring stronger capital adequacy levels will not help banks make loans either. This is especially true for German lenders because a lot of their equity is considered ‘hybrid’ – a form of capital that is not really pure equity but that traditionally has been viewed close enough to equity for it to count towards a bank’s Tier One capital ratio. Hybrid capital will be outlawed by Basel III.

Indeed, Kind feels that banks continue to remain selective in terms of property lending, adding that he doesn’t see CMBS coming back in Europe anytime soon, the way it has in the US. Therefore, in order to finance larger property deals, a borrower would need a consortium of underwriting banks that need to agree on one term sheet, which he considers “a project in itself.”
Still, for the right situation, a bank is happy to “step up to the plate” and underwrite transactions on a sole basis, Kind notes. This was demonstrated by the public takeover of Vienna-based ECO Business Immobilien, where Barclays Capital acted as sole financial advisor and financing bank on the acquisition, he says.

Public market  

Apart from buying core property, BarCap’s Kind senses that investors are looking at another opportunity in Germany. This one has its genesis in Germany’s surprisingly constrained publicly listed real estate sector, which he estimates at around €6 billion in terms of market capitalisation for the 10 largest listed companies.

Given the large size and strength of the German economy and its real estate market, there is a mismatch with the relatively small listed sector. International investors are keen to deploy long-term capital to the German listed sector, but it still lacks companies with sufficient size and liquidity.

In addition, according to Kind, a number of parties are actively seeking positions – including minority stakes – in property companies that might ultimately get brought to market via an initial public offering. Investors that made their move into Germany before the crisis are increasingly looking to the public markets for an exit.

Meanwhile, open-ended funds are going through a phase of dramatic change, with institutional investors looking for new products to invest their capital in. Who knows? Some of those struggling open-ended funds might be recycled and transformed into REITs.

“People are expecting a structural change in the marketplace – a move from a non-listed sector into the listed sector,” Kind sums up. 

Certainly, this will not happen overnight. Let’s not forget, Germany has never been a fan of ‘disintermediation’. It is a country that historically relied on banks for funding, and it likes a high degree of regulation in order for investors to feel more secure.

Nevertheless, Kind knows from a number of roadshows that Barclays Capital is running across Europe that there is “good money” actively looking at Germany. In other words, the German listed sector has to catch up a little bit, but this could be a huge opportunity for investors, not to mention banks like BarCap that can facilitate the process.

Turning over rocks

If any of the discussion sounds like the roundtablers are not excited about the opportunities in Germany, that would be the wrong assumption. After all, Orlando’s special situations fund has dry powder, as does Corestate and Tishman Speyer.

We can always find buyers for good assets in good locations, but for anything else it is difficult to find buyers

GREAT's Michael Schleich

Meanwhile, Barclays Capital has executed a number of transactions this year and is working on additional mandates in Germany.
“We see a number of deals in the opportunistic sector that are attractive again,” says Schmitz-Valckenberg. The firm has been quiet on the acquisition front for the past two years, but it is about to close three transactions. He believes it is possible to increase the valuations of offices and retail properties through redevelopment, refurbishments, elevating rents and so on.

With a 30-person real estate advisory team, GREAT has visibility on all kinds of deals, helping clients perform due diligence on assets and portfolios, providing asset management services and selling assets as well. “There are deals to execute,” says Schleich. “We can always find buyers for good assets in good locations, but for anything else it is difficult to find buyers.”
Corestate has been focusing on what Winter calls “special situations,” which typically involves instances where equity in an investment has been “washed out” or where an investor lacked asset management and property expertise. “In general, I am very optimistic about the next 12 to 24 months because of Germany’s strong economy and because foreign investors are interested,” he says.

Tishman Speyer has exerted a lot of effort stabilising value-added projects and then bringing them to market to be sold, Hünlein says, adding that it has sold a number of assets in recent months. At the same time, it does have capital to invest in Germany, where it is scouting new deals.  

Despite the perseverance of local investors like our roundtablers, what happens next in Germany is likely to be influenced to an extent by global investors. As evidence, look no further than the acquisition of the Sony Centre in Berlin by South Korea’s National Pension Service for around €570 million in May.

Perhaps over the next five or 10 years, it will not be the US that drives the market in Germany, but these upcoming stars from Asia and beyond. More than likely, these new investors will need help navigating the complexities of the market. The dynamic is set up nicely as a perfect, powerful cocktail of huge global investors looking to mix with local expertise, which is is where our roundtable participants are likely to play a role.