“No one ever got fired for buying IBM,” goes one of the most famous marketing slogans of all time. It might be an exaggeration to suggest that no one ever got fired for buying German real estate, but at least at the moment it would only be a slight one.
That is because the UK’s vote to leave the EU has added the olive-on-a-stick to a cocktail of potentially toxic fears and uncertainties that include the increasing stridency of right wing populist politicians across the continent, Greece’s struggles with its debt burden, the region’s ongoing refugee crisis and the heightened threat of mass terror attacks.
Even within the safe haven of Europe that mix is prompting investors to look for sanctuary in markets that offer a high degree of stability, and none of the big real estate markets have a stronger reputation for stability than Germany.
Demand is at an all-time high. The German market saw over €50 billion of commercial real estate deals last year and the only factor that could prevent it from reaching that figure again in 2016 is a scarcity of core property.
For investment managers that is both an opportunity and a burden. Capital is abundant, but assets are scarce and expensive. PERE gathered together three managers for this year’s German roundtable discussion at the offices of Corestate Capital in Frankfurt’s Tower 185 skyscraper: Corestate managing director Tobias Gollnest; Matthias Leube, head of asset management and transactions at AXA Investment Managers, Real Assets in Germany and Marcus Mack, fund manager at TH Real Estate. They were joined by Benjamin Friedrich, senior vice president at advisory and investment group Macquarie Capital.
Their task: to identify the strategies that will enable them to capture value on behalf of private equity investors in what is currently one of the hottest real estate markets in the world.
Germany now the safest haven
We are in early September and the Brexit vote is still very fresh in everyone’s minds. The participants spend the early part of the discussion analyzing the effect on European and German real estate markets.
Macquarie Capital’s Friedrich argues that once equity markets recovered from their initial Brexit-induced wobble the referendum result benefited the real estate asset class in Germany: “The Brexit decision created uncertainty about the economic and political situation as regards the EU’s relationship with the UK and it has increased demand for secure investment products,” he says.
“In the last three months, we have seen the listed real estate market, particularly the residential companies, significantly outperform the market – Vonovia shares increased by around 15 percent, Deutsche Wohnen by around 18 percent, LEG Immobilien by around 10 percent. Meanwhile, the DAX 30 share index increased by approximately 5 percent, which shows that investors’ interest in German real estate has further strengthened.”
Vonovia, the largest German listed residential property company, demonstrated its continued appetite for expansion at the beginning of September by agreeing to buy smaller Austrian rival Conwert for €2.9 billion, offering a 24 percent premium to the six-month weighted average price.
AXA IM Real Assets’ Leube agrees that an increased desire for low-risk investments has played to Germany’s strengths as an investment destination within Europe: “The German market in the EU is very stable both from an economic point of view and also from a political standpoint.”
He argues that the safe haven effect has coincided with the increasing maturity of German real estate markets, particularly Berlin, to exert a powerful pull on global capital: “In previous years, why were London and Paris so attractive? International investors are prepared to pay a premium because these markets are super-liquid even in the down times. When they looked at German cities they were probably less liquid. But now Berlin is becoming an internationally-approved liquid market with enough opportunity for continuous transactions and, because of this, it attracts a lot of international capital prepared to pay a premium just to move into this market.”
Meanwhile, anxiety over the economic impact of Brexit has contributed to keeping monetary policy loose and interest rates low. As a consequence, borrowing has become even cheaper, says Corestate’s Gollnest: “The Brexit vote has pushed down interest rates by another 10 to 15 basis points, which is good for us because we are a leveraged buyer. We seek 70 to 75 percent leverage, so, on the one hand we benefit, but on the other side, we have to pay higher prices.”
Frankfurt to benefit?
If financial sector companies choose to move jobs out of London to other European cities in the wake of the Brexit vote, Frankfurt, as the epicenter of the German banking industry, is one of the destinations that has been suggested as a possible beneficiary.
Financial sector companies might move part of their operations to Frankfurt and technology firms to Berlin, says Friedrich, but not for some time yet: “Convincing people to come over to Germany might not be easy, given existing operations, infrastructure and lease contracts in place – also social factors have to be taken into consideration when relocating operations abroad. With respect to new investment decisions, banks might be cautious towards the UK and likely to allocate capital to other cities where they already have operations in place.”
He adds that if London’s status as a financial center declines Frankfurt may not be the winner: “Zurich is a bigger stock market than Frankfurt.” Indeed, continental Europe may not benefit as much as some expect: “Trade is happening all over the world, so there might be a shift away from London and Frankfurt to other financial centers like Zurich or Dubai.”
Leube dismisses the prospect of a business exodus from London as “a lot of speculation.” He adds: “It depends on what happens with EU financial passporting. That will determine whether business will spread out from London. We will see what the outcome is over the next 12 to 24 months.”
It is monetary rather than political policy that is having the most pronounced effect on the real estate market, however. EU interest rates remain at a historic low of 0 percent. Meanwhile, Germany has become the second G7 nation after Japan to issue 10-year bonds with a negative yield. The forces driving equity investors towards core property as a stable, comparatively high-yielding asset class are more powerful than ever and the weight of money seeking a home in the sector is driving prices ever higher.
“There is a lot of money in the market and that has brought yields under pressure. Probably we will see even more price increases until year end,” says TH Real Estate’s Mack. “For 2016 and 2017, there might be a further downward yield shift before it flattens or goes up again, but for now there is still so much money in the market and so much pressure and there is no alternative.”
Prime yields for office and retail property in Munich, Germany’s most expensive market, have compressed to around 3.4 percent, but prices will continue to rise in the big cities, predicts Leube: “We are going to see the yield shift of the last two to three months continue in the last quarter. You can see that people are pushing hard to get their money allocated and it is astonishing what kind of prices can be achieved with core-plus properties in this environment.”
Not only is the market becoming more expensive, it is also more crowded: “Most investors are focusing on core investments and that is also our main type of investment. It’s harder to find assets because everybody wants to invest into core,” says Mack.
Demand is coming from a diverse range of geographies and investor types, observes Leube. “We will see more international capital. We will also see typical German capital investment in Germany because this is where the very conservative institutional investors feel most happy. A lot of pension funds and insurance companies are trying to increase their real estate proportions.”
Friedrich has noticed the same trend: “The insurance groups and pension funds are increasingly facing a mismatch of assets and liabilities, given negative government bond rates and their obligation to invest in secure investments. They are allocating more capital into real estate, through direct investment, investments through managers or real estate debt.”
Meanwhile, bank financing is cheaper than ever. Friedrich cites the example of the recent refinancing by Deutsche Pfandbriefbank of two office buildings in Stuttgart and Hamburg for Schroder European REIT at a 0.85 percent interest rate. “Being below one percent is a phenomenon of creditors being able to get hold of negative swap rates and getting that priced into their margin. Not all banks are passing on negative swap rates and you have to be one of the bigger market participants to get this though, but we will increasingly see this while swap rates stay negative,” he predicts.
High prices, many buyers, cheap finance: it all adds up to an overriding question: “If you have liquidity in your fund where do you invest it?” asks Leube. “That is clearly one of the pressures you have as a fund manager or investor. What do you do with your liquidity?”
Finding investment niches
For Mack this is a pressing matter. He is aiming to acquire €300 million of real estate for the retail property funds that he manages over the coming year. “We need to find the right properties for the right price,” he says. However, as a manager of mainly conservative capital, TH Real Estate is prepared to shell out for the right assets. “Our investors so far tend to go down the returns curve rather than up the risk curve.”
This is not an easy market in which to make the sort of attractive risk-adjusted returns that Corestate targets. “I don’t see interest rates going up and most of the distressed properties have been sold already in the last eight or nine years, which means we will have to deal with this environment where prices will stay high and find investment niches,” says Gollnest.
Since selling off its residential property portfolio last year, Corestate has focused on two such niches: Micro-apartments; and high street retail in the smaller German cities. The former is a development play targeting young professionals and students who want to rent small, affordable homes on a short-term basis.
The attraction of the latter is a higher return without a significant increase in risk, argues Gollnest: “We believe if you buy a unit let to a well-known retail chain in a small or medium sized city then you have pretty much the same risk profile as you do in Munich, but in Munich you buy at a yield of 3 percent-plus and in these cities it is 6 percent-plus.”
Investing in niche markets or secondary German cities to find better risk adjusted returns can work for some investors, but only with the right local partners, argues Friedrich: “We recommend that international investors without their own operations on the ground partner with experienced local managers. By doing so, investors can broaden their market access and earn better risk adjusted returns. That is one of our key focuses at Macquarie, finding experienced, best in class managers who we are partnering with international capital.”
An increasing number of investors are considering alternative asset classes. Mack says: “In Germany we concentrate primarily on core asset classes – retail and logistics – but there are interesting investments in the alternative areas as well. That is something we might look at in the future.”
AXA IM Real Assets invests, on behalf of its clients, in alternative sectors including healthcare and data centers: “We are working along the risk spectrum and across asset classes and geographies trying to find value,” says Leube. “Prices in Germany are getting close to the level in Switzerland. Trying to find value through standard agent processes is particularly difficult. We want to do more development – building our own core product. We have started our first development in Munich and we are looking at two more in Berlin.”
German pension funds and insurance companies still prefer to focus on mainstream asset classes, says Friedrich. However, they have recently become more flexible about the type of investment structures they will contemplate: “We are hearing that many groups are now also considering joint venture and club structures in addition to their classical fund products.”
It is a market in which buyers are torn between seeking out defensive positions and taking on more risk in order to secure deals. Gollnest observes a flight to core: “One challenge all of us have is investors are looking more diligently at the quality of assets. I don’t see large portfolio deals where you package up three strong assets with seven weak ones. It is very difficult to get finance for a property that suffers from vacancy or weak quality,” he says.
Leube, on the other hand has seen buyers which are increasingly willing to settle for something a little less than perfect: “A lot of people want quality, but they don’t get quality and because there is so much competition they start to compromise on risk. They even compromise on location. They sometimes forget that this cash flow is generated in a location that at re-gearing you might have a problem,” he warns.
Will the conditions that have made the German real estate market such a magnet for capital continue for the foreseeable future? There appears to be no reason to think not, says Gollnest, but you never know: “My big question mark is for what reason it could end? In 2007, I had never heard the word sub-prime. I don’t see any large crisis at the moment, but there will be one at some point in time.”
Leube shares that sentiment: “If you have been in the sector for a while you have this feeling that something has got to change at some point in time,” he says. More immediate concerns occupy most of his thoughts, however. “Being active in the market the worrying thing is how to find the right investments that provide value for investors. Even if you ask agents they say they have never seen anything like this pricing.”
That problem will continue to be the one that consumes investors’ waking hours in these currently exceptional market conditions. That is, unless this unexpected event that these roundtablers expect should come to pass and shake the foundations of Europe's supposedly last remaining safe haven.
Senior vice president
Friedrich is a senior vice president at Macquarie Capital, which comprises the corporate advisory, equity, debt and private capital markets businesses of Australian financial services company Macquarie Group, as well as undertaking principal investing. He joined the firm in 2011. Friedrich has more than 10 years’ experience in real estate investment banking and corporate finance and has worked on more than 20 transactions with a total value of more than €10 billion.
Corestate Capital Group
Gollnest leads the commercial real estate business of Corestate Capital. The real estate investment manager is based in Luxembourg, and focuses on Germany, Austria and Switzerland where it has undertaken €5.6 billion of transactions and manages assets worth around €2.1 billion. Gollnest has more than 15 years of experience in property transactions, financing and real estate investment banking.
Head of asset management and transactions, AXA Investment Managers – Real Assets in Germany
Leube is responsible for all acquisitions, disposals, asset management and development activity for the firm in the country. Based in Cologne, he leads a team that manages German property with a value of around €5 billion.
TH Real Estate
With over eight years of real estate experience, Mack is responsible for the investment and fund management of several German retail funds for investment management company TH Real Estate. He is also the fund manager of the German Retail Income Fund, a retail