The latest data on investment volumes is showing that we are approaching record levels of international capital being deployed into the German real estate market. Current estimates from real estate services firm DTZ suggest that 50 percent of capital is now originating from international sources, compared to the 2007 peak of 55 percent. So, much like the industry chatter on prime yields, the question begs – is history repeating itself?
In my view, unlike in 2007, the international capital that is now flowing into German real estate is driven by long-term allocation goals. A much larger share of it is core and core-plus money, targeting Germany for its merits as a comparative economic safe haven at the core of the Eurozone, with low volatility and relatively low capital values. Therefore, it looks like capital will remain invested here for the foreseeable future.
But this change in the character of international investment in Germany is not without complications. It means, of course, that there is more capital chasing an already limited pipeline of core assets. The obvious result of this will be further yield compression, which we have already seen in 2015 – the average yield compression for the first half of the year was 40 basis points, according to CBRE.
Additionally, I believe we have reached somewhat of a Catch-22 situation. The institutional investors we are seeing moving into the market this time around are already underweight in German real estate, but are also structurally limited on core assets because of this new long-term holding trend – they can neither sell nor buy, as the market for the kind of assets they want has become so illiquid.
But what about the operational impact on the German market itself? Are there any benefits to be gained?
Reflecting back on the start of my career in the late 1990s, investment banks and opportunity funds were landing in Germany for the first big sale and leaseback transactions, like Morgan Stanley Real Estate Funds’ acquisition of the Deutsche Telekom portfolio (Project Millennium) in 2000, for a total of around €550 million. This was, perhaps, the first time the German market had seen an influx of substantial foreign capital. At that time, the commentary from the US opportunity funds focused on rents and how prime yields were expected to remain at around 5 percent for decades. Germany wasn’t viewed as an exciting market, so the only way these funds could see making money was on the price going in.
At that point, foreign capital wasn’t in competition with the local investors, which weren’t focused on the yield play on long-term income that big sale-and-leaseback transactions provided. In fact, German institutional investors often provided the exit route for the opportunity funds.
This relationship changed with the collapse of Lehman Brothers in 2008. Foreign opportunistic capital had been pumped up by excessive leverage and was outbidding any German interests on the vast majority of deals between 2006 and early 2008. Furthermore, through the cycle, German institutions had now become the vendors as prices were pushed higher than their value estimates. Indeed, a portion of German institutional investors look back at that period with a hint of a smile, as they took the opportunity to offload some of their lesser-performing assets.
Fast-forward to 2015, and the arrival of long-term core capital into Germany from abroad, along with the resulting competition for core assets, raises the question of whether all of this foreign interest is bad news for the local institutional market.
In my view, it isn’t. In fact, there are two major opportunities that could help to completely transform Germany into a gateway real estate market like London, Paris and New York.
Firstly, unlike the aforementioned cities, Germany doesn’t currently have a large listed real estate sector. The exception, of course, is the listed residential entities that have been a huge success in attracting foreign capital and together have established a new industry, despite the efforts of legislators to prevent it. The commercial property sector is ripe for a similar move.
Secondly, to date, German fund managers haven’t been at the forefront of global capital raises and German platforms haven’t established themselves as partners of choice for global institutions. There has been some movement in this direction by firms like ECE Real Estate Partners, but not on a large scale like our US and UK counterparts.
The incoming flow of international capital, in search of more secure, long-term investment opportunities, could create the environment for the maturation of the German real estate investment market by expanding the universe of products and structures, and transforming Germany into a global real estate player.