German real estate is considered a safe haven by international investors. While many of them focus only on the so-called “Big Seven” cities Hamburg, Berlin, Dusseldorf, Cologne, Frankfurt, Stuttgart and Munich, they miss investment opportunities in Germany’s B- and C-class cities. However, properties in these cities may prove compelling investments.
Germany is internationally admired for its strong SME sector. Paradoxically, it requires a major effort to raise more awareness for these investment opportunities, because many foreign investors are simply unaware of the decentralised structure of the German real estate market. That is why they more or less ignore regions outside the metro regions of Munich, Hamburg, Berlin, and the financial centre of Frankfurt. However, the fortes of Germany’s middle-market structure could be adapted for a real estate investment strategy that is especially attractive for international investors who are interested in investment opportunities apart from the residential sector.
With its polycentric structure and its plethora of high-powered small and medium-sized enterprises, the German economy differs radically from that of many other European countries. This has implications for the real estate investment markets, and opens up opportunities outside the metropolises.
70 cities in Germany have populations of over 100,000 residents. Also, there are sound or indeed excellent infrastructure in places well away from centres like Berlin, Hamburg, Munich or the Rhine-Main region.
And Germany is not least dominated by mid-market companies. According to the Federal Statistical Office, the overwhelming majority of them (99.3 percent) or 2.5 million businesses qualified as small and medium-sized enterprises (SME) in 2014, and these account for nearly 33 percent of the annual economic turnover and for 44 percent of the gross investments. 60 percent of the jobs in Germany belong in the mid-market sector. The mid-market sector acts as guarantor of the economic stability that helped the country get through the most recent global economic crisis comparatively unscathed. Its ability to do so ties in with the often high equity ratios of mid-market companies which provide reserves during difficult times. Moreover, seven out of ten so-called hidden champions are based in Germany – a term which refers to entities that count among the top three in their respective market segment but are not listed and often known only to industry insiders.
Inversely, mid-market companies have a significance that is reflected in the weight their concerns have in Germany’s political discourse.
What would be the best way for real estate investors to benefit from the decentralised, middle-market structure of the German economy? The property inventory of the German mid-market sector is rarely professionally managed. Therefore, it presents attractive investment opportunities for market players with the right kind of market access and property know-how.
The share of family-owned businesses in the mid-market sector is close to 95 percent. And more than 80 percent of the properties in which German mid-market companies operate are owner-occupied. Here, opportunities to buy often present themselves when entrepreneurs are about to pass on their responsibilities to the next generation. Since the potential of these corporate properties is rarely exhausted, an active professional asset management can achieve income growth and appreciation, depending on the location and the property type.
This is all the more plausible because many mid-market companies are based in places other than the Big Seven, and thus in regions where yield rates are still higher than in the metropolises. This situation – a large number of outperforming companies in many different locations – is well suited for portfolio diversification by sector and region.
Mid-market companies are sought not just as sellers on a market plagued by short supply, but also as tenants. They are generally known for their reliable payment behaviour, tend to commit themselves to a property for longer terms, often pay higher rents as a result of specific requirements in the rented premises, are very credit-worthy and usually have good ratings.
A fine example of a German city defined by the mid-market sector and rarely on the radar of investors is Dortmund. Located at the east end of the Ruhr, it retains a strong industrial core that is rooted in the city’s history. In addition, the city has long positioned itself as a destination for the fast-growing technology and service sector.
Owning an office property in the eastern part of Dortmund, which has emerged as a dynamically growing IT location, can deliver distribution yields of up to eight percent.
The situation has analogies in other Class B cities in metro regions with sound fundamentals. Aiming for a tenant mix of German mid-market companies in dynamic and structurally sound locations is a great way to minimise cluster risks both on the property level and across portfolios. All in all, analysing opportunities aside from investments in “Big Seven” cities could thus pay off for investors.