The German property market has turned into a favourite haunt of international investors in recent years. While prices have also risen strongly in Germany, the market is still considered cheap by comparison since the country’s economic strength coupled with its diverse business community that includes a strong SME sector create attractive risk/return profiles for property investments in Germany. That is true particularly outside pre-eminent markets like Berlin, Hamburg or Munich. NAS Invest’s managing director Nikolai Dëus-von Homeyer describes the benefits of property investing in Germany and explains how it can contribute to portfolio diversification.
Today’s low interest rate environment and the amount of cash in the market benefits real estate more than most other asset classes. Properties are in fact one of the select few that still offer investors attractive returns. True to the motto “real estate de-risks”, many investors also look beyond solid returns, seeking a safe haven for their portfolio Adding core properties – which are indeed very low-risk assets in prime locations of the world’s A-grade cities – is an effective way of portfolio diversification and risk mitigation. This argument resonates with many investors particularly in the light of political uncertainty. As a result, huge amounts of money flowed into property investments last year. According to JLL, the property agent, global transaction volumes in commercial properties reached USD 464 billion over the first nine months of 2017, exceeding the long-term average by about 23 percent. The lion‘s share went into core properties across the 25 largest “global gateway cities” including New York, Tokyo or – Brexit or no – London. These markets absorbed almost half of the invested capital in the first half of 2017 alone with the huge demand only hampered by the generally scarce supply of core properties.
Europe’s major cities account for a sizeable share of the global property investment volume. The continuing economic recovery in the old world together with the ECB’s loose monetary policy increasingly attracts international investors particularly from North America and Asia to Europe’s leading markets. Real estate investments offer a compelling yield spread of three to four percent over most European government bonds. Beyond London and Paris, international investors flocked particularly to German cities like Berlin, Frankfurt and Munich in 2017, while global capital also flowed into the property investment markets in Amsterdam and the Nordic metropolises like Copenhagen and Stockholm. Spain for its part enjoyed a comeback to Europe’s property arena in 2017 on the back of positive macroeconomic fundamentals. It seems as if international investors were spoilt for choice in Europe.
This rosy picture is somewhat marred by ever increasing prices and yield compression on the back of the flight to quality. Since 2013, prices for commercial properties in major European property markets have increased by 30 to 40 percent. The German property market has not been spared: properties on Berlin’s Kuhdamm now sell for 30 to 40 times the annual net rent exclusive of heating, lighting and other service charges. While still relatively cheap compared to London and Paris, this level is barely tolerable for many investors as the yield pick-up versus bonds quickly becomes negligible at these multiples and the average top rent across the “Big 7” has by now surpassed the magic three percent threshold.
In all this, international investors frequently overlook a market that offers significantly better return opportunities than Europe’s prime spots and carries only minimal risk: attractive locations in Germany’s grade B, C and D cities. In contrast to centralist countries like France or the UK where business is mostly clustered in the capitals Paris and London, Germany has a polycentric business landscape with a strong core of small to mid-sized companies. The country‘s smaller conurbations as well as its regional hotspots and mid-sized urban centres like Freiburg, Wiesbaden or Dortmund are home to the “German Mittelstand”. Recent figures by the KfW’s SME-Panel 2017 make it quite clear that small and mid-sized companies (SMEs) are at the heart of Germany’s economic success: over 70 percent of the country’s working population is employed in the SME sector that has greatly contributed to the strong job creation in recent years. In 2016, SMEs outpaced the wider German economy, growing revenues by 3.9 percent. This trend is set to continue: according to the “SME Diagnostics” study of the German Sparkassen- und Giroverband, a sizeable majority of SMEs anticipates a similarly positive or even better economic outcome in the years ahead.
The prosperity and stability of the SMEs benefits particularly the office letting markets in Germany’s secondary office locations. The research firm bulwiengesa found that grade-B cities enjoy similar – and in some sectors including technology, telecommunications and manufacturing even significantly higher – growth rates than Germany‘s major office markets while offering higher returns than office strongholds like Frankfurt at net initial yields of between five and six percent. Properties in these cities can frequently be snapped up at multiples of just 12 to 18 times the annual net rent exclusive of heating, lighting and other service charges.
The focus on SME properties and locations also enables investors to optimise risks at stable cash flows. For one, property investments can be diversified across sectors and, from a geographic point of view, across different structurally strong locations, which minimises concentration risks. For another, SMEs are high credit-quality tenants with strong ratings and excellent creditworthiness. They also frequently sign long-term leases. Investors should also not underestimate the fact that over 80% of all SME properties are still family owned. Here, active asset management via buy options and professional management offers attractive yield and value-add opportunities – provided that the asset manager has the right know-how to deal with the often fragmented properties that frequently have multi-tenant structures.
That tends to be a sticking point since most international investors, funds and asset managers lack sufficient expertise. The SME treasure trove can only be exploited with on-site resources for comprehensive asset management and a true understanding of all local factors because the German second tier cities may offer greater opportunities than the country’s “Big 7”, yet not all locations have ideal risk/return profiles. This is where specialist third-party asset managers can give property investors access to strong B-, C- and D-grade locations via various fund products including the German Special AIF or Luxembourg-based investment structures. To this day, international property investors stand to benefit greatly from expert insight into the structure of Germany’s SME sector and its return opportunities.
As a property investor and investment manager with a historically proven track record, NAS Invest sources, structures and manages real estate investments in the role of General Partner and Sponsor for its co-investing institutional and semi-institutional clients. Via its offices in Berlin, Frankfurt, Copenhagen, Luxembourg and Zurich, the main investment focus for NAS Invest lies in commercial real estate opportunities located in the most rapidly developing cities and metropolitan areas in Germany and Northern Europe.
More information may be found at: www.nas-invest.com