The public face of Germany
Foreign capital, evaluating the prospects for property investment in
Germany, is finding appeal in the emergence of IPOs as an exit strategy.
By Robin Marriott
As the shadow cast by the Eurozone crisis recedes, German real estate investment looks set for its day in the sun. Europe’s biggest economy also is its strongest, with low euro exchange rates and easy global monetary policy having generated an export-led boom. Some areas of the country are experiencing virtually full employment, and the International Monetary Fund forecasts steady economic growth of 1.3 percent in 2014. Even consumer spending is up in what is traditionally a nation of savers.
For international investors, however, Germany has never been an easy market to master. Many lost money on German real estate following the global financial crisis of 2008. With at least seven major cities – Berlin, Hamburg, Munich, Cologne, Frankfurt, Stuttgart and Dusseldorf – and many smaller sub-markets, each with its own distinctive characteristics, local knowledge is at a premium.
That has not prevented foreign capital from flooding into the country over recent months. In June, German-listed property company IVG Immobilien, which is struggling to refinance its debt, put together a club deal of South Korean institutions to buy the Gallileo office tower in Frankfurt through a sale-leaseback from Commerzbank for around €250 million (see Foreign invasion, page 56). One month later, New York-based Cerberus Capital Management snapped up the Phoenix portfolio of nine shopping centers from Wells Fargo and a second unconnected portfolio of 10 German retail centers out of administration.
What Cerberus does next may serve to illustrate a second interesting trend following the noticeable flood of foreign capital: it is reported to be preparing a €2 billion initial public offering of its German retail property investments. Meanwhile, Morgan Stanley Real Estate Investing also is rumoured to be working up to its own retail property IPO. In July, Germany’s largest residential landlord, Deutsche Annington, showed that the strategy has potential by launching its own share offering.
Steffen Ricken, the new managing director at Corestate Capital, welcomes the move towards private equity firms using the capital markets in Germany. “It’s a good sign of how Germany has come to the surface of international capital because, once the capital market opens up, everyone realizes that is a good way to buy into Germany,” he says. “Investors need an exit route, and the capital markets are a very attractive way to exit your assets.”
Ricken adds that there also is a lively mergers and acquisitions market in the German residential sector as investors build up large portfolios, which possibly could lead to continued IPO activity. More residential platforms have come to the surface, with the battle for growth and critical mass further fuelling M&A activity.
There have been plenty of examples, with one of the most talked-about transactions arriving in April. That is when a consortium of insurers, pension plans and savings banks led by investment manager Patrizia acquired a €2.5 billion portfolio consisting of 32,000 apartments in Bavaria from GBW, the listed housing subsidiary of regional bank Bayern LB.
Sebastiano Ferrante, head of Germany at Pramerica Real Estate International, hopes that this is the beginning of the large-scale development of the German listed sector. He notes that Germany has an underdeveloped listed sector, partly because the big German open-ended funds had filled that niche in the market. Now, with open-ended funds in decline and many in liquidation following the financial crisis, property shares are growing in popularity as a way to place capital in the market.
Ferrante points to the potential retail IPOs as an example of this tendency and anticipates the creation of office-focused listed companies as well. “We are missing REITs,” he says. “Although it’s not our primary business focus, I think it’s something that Germany needs because people want to have long income and they want to invest into a specific sector in Germany – and that needs big vehicles that are professionally managed. I hope we are seeing a development in that direction because it will give the German market another strong fundamental, which is good because it will attract a lot of international capital that cannot invest directly into funds.”
Ricken says the US, as the biggest and most-liquid global real estate market, shows the way with its wide variety of REITs. “It is bound to come,” he predicts. “Once you have a fully functional private real estate market, you need a listed market.”
Ferrante adds a slight caveat, though. “We now have to see how solid and deep this market is and whether it can deliver a story beyond ‘We just conglomerated a big portfolio’,” he says. “That is part of the story, but it’s not enough.”
The Asian influx
Stuart Reid, a partner at Rockspring Property Investment Managers, for which Germany is the second-most important market after the UK, believes that the perception of the country among international investors has changed markedly in the past year thanks to the stabilization of the euro. Indeed, all of the managers around the table credited European Central Bank president Mario Draghi’s pledge that he would do “whatever it takes” to save the Eurozone from collapse with creating a calmer atmosphere.
“Euroland as a whole has come back into focus for international investors,” says Reid. “If you’re looking at region, Germany is 30 percent of the economy so you have to look at Germany. In addition, French politics are not looking so supportive of business, therefore Germany stands out.”
Reid continues: “The changes have been dramatic. Raising equity for Germany and Europe just 12 to 18 months ago was extremely hard work. I’m not saying it is easy now, but there are significant amounts of money available.” Indeed, he will be hoping that investors like the Germany retail story as the firm goes about reopening its German Retail Box Fund to fresh equity investments.
Meanwhile, AEW Europe is seeing institutional clients, including French investors, put capital to work in the country. The pan-European firm employs 10 people in its German office, which is one of nine across Europe.
Gereon Kohlgrüber, AEW’s head of investment in Germany, notes that he is seeing a lot of money coming into Germany from the USA, Asia and Australia. “A lot of investors want to avoid risk,” he says. “It’s not easy to create many opportunities in Germany, but you have stable income and most investors currently like low volatility and high liquidity. If you take the 10 largest European markets, number one is Paris, number two is London and then you have Munich, Frankfurt, Berlin and Hamburg. Those four together are bigger than Paris and, by investing in Germany, you can diversify from a portfolio standpoint.”
Still, Kohlgrüber also notes that German investors increasingly focus on the fund structure through which they invest. “We have done a lot work around this to provide investors a fund structure that is more suitable to their needs, rather than the standard self-investment fund structures we see all the time,” he says.
Ricken suggests that a third factor, in addition to the improving economic outlook and the desire among investors to avoid risk, is the excess of liquidity as capital exits the sovereign bond market and looks around for another home. “Real assets – real estate and infrastructure – have come into focus in the past few years,” he says. “In the last 12 months, Asian capital has poured in.”
International capital certainly is important to Pramerica, which has a particularly strong base among domestic institutional investors, representing some 40 German limited partners. Over the next year, Ferrante aims to bring more capital into the business from international institutions, agreeing that capturing an influx of Asian money will be vital.
For some, however, getting to grips with the German market will represent a steep learning curve. “There are a few that have been in the market and are relatively sophisticated, but most of them need to be educated in-depth about Germany,” Ferrante reflects.
Grasping the opportunities
All of the roundtable participants agree that Germany is not a country where investors can make quick and easy money. “The forecast is for growth over the next five years, but this doesn’t mean that Germany has a quick growth expectation on rents and values from the occupier market,” says Ferrante. “Liquidity will push up prices, but we don’t believe the occupier market will change. It always will be a low rental growth environment in Germany.”
Ferrante suggests that some American investors still are seeking higher yields than the German market is likely to offer. “They are looking to Europe and Germany and saying, ‘There must be distress. I want value-added returns.’ This is an expectation that I think is difficult to meet,” he says.
At this point, Reid throws out a hypothetical question. “Do you think it is possible to make opportunistic returns in Germany?” he asks. The consensus seems to be that it is possible to pick off select investments, but also difficult.
“We sold an asset in Berlin [at the end of August] where we had to restructure the asset, but it took two years and a lot of hard work to renegotiate and extend the lease and invest into the asset,” Kohlgrüber explains. “It is only then that you can make the returns. In Germany, the key is to focus deeper on the various submarkets. Markets like Berlin, Frankfurt or Munich have many different sub-markets and require someone on the ground who is a specialist to achieve the business plan.”
Ferrante says Pramerica has been successful in creating opportunistic returns on specific investment strategies with specialist partners for different asset classes like residential, logistics or retail. He argues that the best opportunities are to be found in illiquid property types such as logistics assets with less than 10 years to run on the tenant’s lease. Such property is trading at yields of 2 percent to 3 percent above those for long-let assets, he explains, identifying retail parks where tenants have five to six years left on their lease as another area of
Reid and his firm know the latter property type intimately. Since 2006, Rockspring has operated its aptly-named German Retail Box Fund, which currently has $640 million in assets under management. “The fund has outperformed INREV total net returns since 2009 by 40 percent, and we have opened that fund up again until December to a small number of investors – some are current investors re-upping and some are new –
because we see an opportunity,” he says.
The investors that make high returns are those that know the assets and the tenants well, Reid argues. “I don’t worry about buying a three- or four-year unexpired lease term because we know the tenants and have done our detailed homework, including tenant meetings and interviews, so I know he’s going to renew his lease,” he says. “Across our portfolio, we have a 96 percent roll-over of leases on expiry. You have to focus on that detail, then you can pick out opportunities every now and again.”
On the other hand, Ricken believes the residential market is becoming increasingly interesting to investors. “Right now, residential offers interesting opportunities,” he says. “However, the number of opportunities is limited, especially in the distressed sectors.”
To make the best returns, Kohlgrüber advises investing in residential properties in specific locations rather than trying to manage a portfolio scattered across Germany. Management is best left to local specialists who understand regulations such as the Mietspiegel, a German system of rent control. “We have roughly 2,500 residential units in Berlin, which we are managing with a partner,” he says. “Apart from a few prime spots, there is no over-pricing.”
Generally speaking, Kohlgrüber feels that some investors remain anti-risk across asset classes. “Much has been said about the prime secondary gap in property yields, and this still remains a relevant indicator of how risk-averse some investors have become if a property does not have a long lease in place, regardless of the other underlying qualities,” he says.
Debt and distress
One anticipated source of opportunities that has failed to materialize on any great scale is the chance to buy distressed assets, particularly via the debt. “Everyone was producing charts last year of how much real estate was due to come onto the market because of distressed debt,” says Ricken. “Banks were going to offload them onto the market, but they didn’t. Or they did, but not on a large scale because the cash flow is still there and the debts are still in play. You have to create your own opportunities by real estate expertise.”
Reid counsels patience. At the top of the market in 2006 and 2007, the total volume of real estate traded in Germany doubled from its long-term average of €20 billion to €25 billion, he notes. Much of the additional spending was by foreign investors, backed by foreign banks lending on six- or seven-year terms.
“I think there is a lot of unwinding of that boom period that will happen,” Reid reasons. “The opportunity for those of us with equity is to find owners without a core business in Germany anymore and that want to go back home.” He calls these opportunities ‘right property, wrong owner’.
Reid argues that, once the bank has written down the loan sufficiently, there is an opportunity in such cases to acquire good assets from exiting foreign owners, often where the debt side also is exiting non-core business. Of course, that is provided that one is prepared to put in the work to check that the property fundamentals are right and structure the deal.
“The last four deals we have done in Germany amounting to around €125 million have been with four foreign owners and their four foreign banks, which were not here pre-2006 and now are exiting the country,” Reid emphasizes.
Ferrante agrees that expectations of when distressed assets would return to the market were overly optimistic. He believes that some of the foreign banks are now ready to stop “kicking the can down the road” and address the problem of distressed properties sitting on their loan books. However, he stresses that different banks are taking different approaches. Some prefer to take ownership and manage the property themselves, while others still are paralysed by their inability to take write-downs.
“We have two very large debt funds we have raised from the UK – one preferred equity and one mezzanine – and together they are almost £1 billion,” Ferrante says. “Somewhat surprisingly, our deal pipeline is pretty strong, but it’s not always about buying the asset or buying the loan. It is sometimes better to be part of the refinancing structure rather than being on the equity side and buying out of distressed situations.”
In another respect, the roundtable participants are largely satisfied with the performance of the banks. Finance generally is agreed to be easier to come by and on better terms than one year ago.
“The first question with financing is who is the borrower,” says Reid. “Six to eight years ago, anybody could borrow and anybody did – and the banks lost a lot of money. Today, you need equity of 30 percent to 40 percent, as well as a track record and proven asset management capability with a local team, before debt becomes available. Well, Rockspring has the asset management track record in Germany, and we have found the margins coming down as the competition between banks increases.”
Valuation and regulation
Two other topics that generate lively discussion are the German system of valuation and recently introduced European regulations on alternative investment funds.
Reid raises the question of whether property in German special funds is over-valued because values arrived at under the methodology mandated by German law may differ from the market price. “I find that valuation is something that people are shy to talk about in Germany,” he says. “For me, valuation is not a methodology; it is what somebody pays.”
Ferrante contends that there is always some room for interpretation in any valuation. Is the fair value the one that can be realized in the depths of a downturn or what is achievable when the market recovers?
The subject leads the participants on to a discussion of the value of the assets remaining in the German open-ended funds, some of which have sold many of their best properties in order to meet investor demand for redemptions. Reid says he is concerned about the true value of the €20 billion of assets remaining in open-ended funds yet to be fully liquidated.
Ferrante counters that much of that property may be held in German funds but it is located outside Germany and that the gap between book and market value of German properties will be far less than that for properties located in weaker European economies. “Those funds that are in liquidation were massively invested outside of Germany,” he says, adding that the biggest discrepancies in values are in Italy, Spain and the Netherlands. “Everybody with assets in those markets has problems. Only €4 billion to €4.5 billion of that €20 billion is in Germany,” he notes, stressing that this is a point he continually has to make to global investors.
Meanwhile, Ricken sees potential opportunities arising as a stricter regulatory regime for alternative fund managers threatens smaller fund management businesses. The Alternative Investment Fund Managers directive came into force on July 22, and firms must comply by the same date next year, including applying for a license. “Regulation will shake the market next year,” he says. “We will see a lot of consolidation.”
Ferrante agrees: “We will see a lot of closed-ended fund managers just disappearing, especially those that are under-managed with no governance at all. It should improve professionalism and make the sector more institutional.”
Looking to the future
The roundtable participants conclude the discussion by setting out their priorities for the coming months. Unsurprisingly, all are keen to diversify their investor base by capturing some of the international institutional capital coming into the German market. Meanwhile, both Pramerica and AEW will seek to trade on their strong base of German institutional clients by offering them a conduit through which to invest abroad.
All four participants identify the potential for growth in their separate account business for institutional clients. “The ones that can afford it are going towards single client accounts rather than with 10 others in a fund,” says Ferrante. “One account that they control with a global mandate, and global diversification with one manager.”
Pramerica will press ahead with further sector-specific investment strategies. “We have concrete plans about a residential strategy outside of Germany and a retail strategy in Southern Europe,” says Ferrante. “Some German LPs are ready to look into Southern Europe again. They are saying those markets are totally illiquid, so we feel there is a good opportunity to do something now.”
AEW’s Kohlgrüber says his firm, which maintains offices in Warsaw, Prague, Budapest and Bucharest, sees Central Europe as a growth location for investment by managed core funds. “Poland is coming back,” he says. “It’s not a hot market, but the Polish economy is doing pretty well.”
Kohlgrüber also suggests that value-added approaches will emerge. “We have noticed an increased appetite for more value-added strategies focusing on creating core real estate,” he says. “It’s a strategy we are actively pursuing, and we are well placed to add value through the more than 90 local asset managers we have in Europe.”
In addition to reopening the German Retail Box Fund, Rockspring is concentrating on acquisitions for TransEuropean V, its latest value-added fund that had a final closing nine months ago with €353 million in equity. Around 45 percent of that equity has been invested in seven deals, with two to date in Germany, and Reid is looking for another two or three acquisitions in Germany in the retail, office or logistics sectors.
Corestate is considering a change in strategy in the coming months. “Our client base so far is private and mostly based in Switzerland,” says Ricken. “Corestate is contemplating diversifying this platform, going to a broader funding base – meaning international investors and institutional capital – and, at the same time, we want to diversify the risk/return profile. We traditionally were opportunistic and are now moving towards value-added and core assets.” He adds that Corestate is going to recruit a bigger team to implement its new strategy.
In the context of today’s German economy, with exports and job growth high and living standards rising, it seems scarcely credible that the country was regarded as the “sick man of
Europe” as recently as 2004. In the years since the financial crash, it has become a comparative safe haven within a mixed European picture. While it may never be a high growth market, investors prepared to stick with Germany in the long term will reap the rewards.
Asian investors discover German real estate
The sale and leaseback of Frankfurt’s Gallileo office tower in June demonstrates the growing appetite for German property from foreign investors, particular those from Asia. German listed property company IVG Immobilien arranged the club deal on behalf of a number of unnamed South Korean institutional investors, while former owner Commerzbank has taken out a lease on the 430,000-square-foot tower for an unspecified number of years. The price was not revealed, but it is believed to be around €250 million.
Completed in 2004, the 38-story office block is located in the center of Frankfurt on the corner of Gallusanlage and Kaiserstrasse, close to Frankfurt’s central railway station and the banking district. The building, together with the nearby Silberturm, served as the headquarters of Dresdner Bank from 2008 until Commerzbank acquired Dresdner later that same year. Gallileo was retained by the new owner, while Silberturm was let to Deutsche Bahn in 2009.
IVG, which acted as investment, asset and fund manager for the club deal, has invested around €1.3 billion in such transactions since the beginning of 2012. Following the deal, the firm said it would seek to raise additional equity in Asia and other international markets for investment in German and European properties.
IVG in crisis
A certain German development may be to blame for the firm’s current predicament
IVG Immobilien, arguably the best known and most important German property company for most of the last two decades, stands on the brink of collapse. On August 20, the firm announced that it would file for court protection to reorganize €3.2 billion of debt after negotiations with its principal creditors failed.
IVG holds around €4 billion of real estate on its balance sheet and manages €15 billion of property assets for private and institutional clients, including a fund that owns a half-share of the Gherkin tower in the City of London. However, the collapse of its share price from around €35 in 2007 to 8 cents in August 2013 has slashed its market value to less than €17 million.
IVG’s highest-profile disaster was the development of the Squaire, a 2.2 million-square-foot office and hotel scheme built above railway lines near Frankfurt’s airport. The project’s budget spiralled from an estimated €660 million when development began in 2007 to its final cost of €1.3 billion.
The Squaire is a very dramatic symbol of the crisis at IVG, but it’s not the source of the default, according to some market participants. After Lehman Brothers collapsed, the listed real estate sector suffered. While some listed companies in the UK restructured their balance sheets, IVG is said to have missed the opportunity to do that. In other words, they say IVG doesn’t represent the market and is instead an individual, ring-fenced problem.
However, Ferrante is concerned about the negative effect that the IVG crisis could have on sentiment surrounding the launch of new German listed property companies and REITs. “I am a little bit worried that IVG will have an effect on other IPO stories,” he says. “I have been saying to people, ‘IVG was a specific situation.’ You wouldn’t expect an IPO coming out of the market now to put on such a high level of leverage.”