Germany – investors like commercial property and multi-family dwellings even if they come at a price

Property investors have had plenty to worry about in the last few years. The flats constructed in the wake of the reunification boom in Germany resulted in high vacancy rates and a sharp fall in rents. Soon afterwards, the office property markets crashed when the new market bubble burst and following 9/11, as it became virtually impossible to let space in the office towers constructed during the years of the dot com hype. Some of the shopping centres built in the 1990s also turned out to be simply too much of a good thing in view of stagnant retail sales. Today, the situation is much brighter with regard to commercial property, although not all locations are flourishing. Structurally weak regions with a high level of migration from the area are not necessarily doing well. Among the clear winners are central German property markets in the country’s seven biggest cities – Berlin, Düsseldorf, Frankfurt, Hamburg, Cologne, Munich and Stuttgart. These buyers’ markets have developed into sellers’ markets.

Why are these seven cities experiencing such a favourable trend? Easy international access is key, making the cities an attractive location for both domestic and foreign companies. It has meant a sharp increase in employment. In combination with the urbanisation trend, which started approximately at the turn of the millennium, the influx of new inhabitants has significantly increased, with the corresponding growth in the population of these cities. The rising number of inhabitants and strong labour market benefit consumption. This is further boosted by an ongoing sharp rise in the number of shopping tourists from Germany and abroad, many of whom with strong purchasing power.

The above brief outline describes the developments which have led to a high demand for flats, office space and retail premises, whereby the latter are only sought-after in shopping centres with a substantial footfall and city centre shopping streets. Accordingly, all three market segments have seen a sharp increase in rents. Top rents have risen the most for retail space. Within 10 years, they climbed by more than 50% to an average EUR 300 per square metre. Rent for flats has also increased sharply. Following an increase of around 40%, tenants now pay EUR 13 per square metre on average when they first move in and as much as EUR 18 per square metre of prime space – that is rent excluding heating and other bills. In Munich, rents are EUR 4 to EUR 5 higher. Growth in rents was somewhat more modest for prime office space, which rose by around 20% to EUR 27 per square metre at present. Although the dynamic growth in rents has now decelerated slightly at a relatively high level after the sharp increase, at 2% to 3% the rate of increase continues to be considerable. Growth in rent for retail space, in particular, does however seem to be coming to an end.

While the huge number of cranes in major cities make it difficult to believe, the rapid increase in rents has partly been caused by short supply in the market as well as the high level of demand. For many years, construction of new flats and commercial space had not kept pace with growing demand. This was probably partly due to the fact that investors stayed away from the German property market for a while based on bitter previous experiences. Supply in the office property market was comparatively extensive. Vacancy rates, which in some cases were considerable, were reduced over a period of several years. However, meanwhile, office space has also become scarce. In Berlin, Munich and Stuttgart, the vacancy rate is decreasing in the direction of 3%. Consequently, it is becoming increasingly difficult for those looking for space to find larger premises in the desired location. The vacancy rate is highest in Frankfurt. This means that there is a reserve should banks decide to relocate jobs from the Thames to the River Main.

The high level of investor interest for the seven cities is not just based on the strong trend in the rental market. Facing low interest rates, investors often need to invest large amounts. This is more difficult in less prominent locations, because they practically offer no properties of three-digit million value. In addition, the big cities score highly in terms of significant and more liquid markets as well as good future prospects. However, the high level of investor demand has pushed up purchase prices, noticeably depressing the initial rental yield achievable. While the digit before the decimal point often was the figure five ten years ago, today it frequently is no more than three. Although this still sounds like a lot compared with zero for the 10y Bund yield, the risk profile of German government bonds cannot be compared with that of high-rise office buildings and shopping centres. Commercial property in the big cities are therefore on course for exaggeration, similar to the housing markets of those cities. At the same time, the risk of a correction is increasing. Yet, in view of the pressure to invest, this is unlikely to stop buyers. Fortunately, the risk of a bubble is not as significant as in previous boom cycles. Today’s loan-to-value ratios are more conservative, and many investors have substantial amounts of their own funds.

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