Yesterday's market

Though firms continue to flock to Germany, is the best already past?

On November 9th several dozen representatives of the global property and finance industries gathered in the ballroom of the Ritz Carlton Hotel in Berlin. Their purpose: attendance at the second annual German Distressed Property conference hosted by PACT. Their discovery: since last year, both the conference and the German market have become substantially more crowded.

The story is by now a familiar one. In recent years, Germany, once the economic powerhouse of Europe, has suffered from slow growth, recession and soaring unemployment. One result of this sluggishness has been visible in the country's housing market: while most Western countries have seen housing prices inflate to the point that no middle-class dinner party is complete without talk of a bubble, in Germany prices have barely moved. Another is that German corporations and public bodies, in an attempt to stave off financial difficulties, have been forced to free up capital for investment—and for historic reasons, most conveniently own large chunks of (often residential) property. Meanwhile the country's banks have been looking to unload an estimated €300 billion of non-performing loans off their balance sheets.

The upshot is that US and UK financial players have been piling into the market, buying property assets at fire-sale prices. All they have to do, so the theory goes, is a touch of clever management before splitting large housing portfolios into smaller units, selling individual apartments to tenants or just waiting for the introduction of German REITs to inflate prices.

While a motley crew of private equity firms, hedge funds, real estate buyers and banks has already entered the market, a growing number continue to come: more than one delegate in Berlin confessed to being under pressure from investors to increase their exposure to Germany.

But if the conference showcased the rising enthusiasm for the market, it also provided reasons for caution, particularly to those who don't yet have a foot in the door. Dr. Ralf Pampel, managing director with private bank B. Metzler GmbH, presented figures which highlighted the higher prices that increased competition has created. In 2002, portfolios changed hands for between €375 and €775 per square meter, or eight to 12 times their rent rolls. By this year, prices had climbed to between €750 and €1000 per square meter, and properties have been bought for up to 18 times their rental value. Moreover, 2005 was the first time in years that the bottom end of the price range, which had been declining since 1998, actually increased (see chart).

This is not to say that German residential deals have suddenly become unprofitable. In fact the market is just doing what markets are supposed to do: as competition among buyers has increased, so too have the expectations of sellers.

Earlier this year, the sector saw its first exit by a financial buyer. After acquiring the HPE Haubau Group five years ago, Peabody Funds had successfully sold 2,400 units to existing tenants before selling the remaining 4,500 unit portfolio to GE Commercial Finance Real Estate. Although details of the deal were not disclosed, Pampel suggested that the sale “can be interpreted as a signal that they've reached their return expectations.”

Nevertheless it's striking that the sector's first exit was a sale to another real estate player. However clever GE's business plan, for Peabody to receive those higher returns, the new owner probably paid a higher unit price than the last one did.

As suggested by the crowds at the Ritz-Carlton, the rock bottom prices that buyers have been enjoying could soon join lederhosen and the Berlin Wall in the annals of history. Suddenly Germany doesn't look so distressed after all.