Even rising prices on the property investment market cannot compensate for product shortages

Subdued start to the year owing to the absence of large portfolio transactions

April 03, 2019

FRANKFURT, 3rd April 2019 - Negative interest rates are back it seems. For the first time since 2016, returns on 10-year government bonds have fallen into the red again, shattering the hopes of banks, savers and bond investors for a return to normality. The European Central Bank (ECB) has at least recently made it increasingly clear that a change in interest rate policy would be delayed should the economy deteriorate further. “In fact, during the boom years the ECB — at least from Germany’s perspective - missed the opportunity to raise interest rates at an early stage, thereby depriving itself of an essential tool that would have enabled it to counteract slowing economic momentum or even a recession,” said Timo Tschammler, CEO of JLL Germany. Tschammler added: “Given the reduced growth prospects in most European countries, an increase in interest rates is off the table, at least for 2019. These developments also mean that the underlying conditions have changed again for the German real estate investment market. While an end to yield compression and the prospect of rising yields was being discussed only around nine months ago, this scenario is now no longer relevant.”

Although it appears too early to argue that “two is the new three” with regard to prime yields, the renewed decline in returns on government bonds creates new scope for a further drop in property yields. “That assertion is supported by three fundamental developments,” said Timo Tschammler:

  •   “The continuing strong demand for space, which so far appears relatively immune to the weakness of the economy and provides a basis for further increases in rental prices.
  •   The global investment demand for property remains at a high level and could even increase further in the next few years in line with the general trend. German government bonds with a volume of around €150 billion and yields of more than 3% are due to expire by 2021. When the capital is reinvested, investors will have to decide whether to invest in bonds again despite the continuing low returns or redeploy their capital in alternative investments — which includes property.
  • Adequate investment products will remain in short supply for the short and medium term. In principle this applies to all asset classes, but particularly concerns office properties. In this sector, in 2015-2018 the number of transactions fell by 23% while the transaction volume increased. As things stand, a significant increase in fungible properties for sale is not on the horizon. This imbalance between supply and demand is therefore likely to further drive up prices.” 

The transaction volume* fell by almost a quarter year-on-year owing to the absence of large portfolio deals

The German investment market began 2019 with the realisation that things cannot always keep rising. Moreover, even higher prices cannot compensate for the shortage of products in every quarter. Including the Living* asset class, property with a value of almost €15.3 billion was sold in the period from January to March, representing a 22% decline compared to the same period of 2018. Property used exclusively for commercial purposes accounted for €11.3 billion.

“The absence of large portfolio sales in the first quarter was largely responsible for the overall reduction in the transaction volume. Only around €4.2 billon was registered, which was 43% less than in Q1 2018,” said Helge Scheunemann, Head of Research at JLL Germany. The two largest portfolio transactions in the recent quarter concerned the acquisition of more than 2,800 residential units by Deutsche Wohnen from Akelius as well as the sale of 34 industrial properties with a volume of €260 million by a British fund manager.

“Investment interest remains intact, however. In addition, numerous and sometimes larger properties and portfolios are currently in the process of being sold, which means we are still moving towards a total annual volume of about €70 billion,” said Timo Tschammler. The number of transactions has fallen year on year, but by a much lower rate of 12% compared to the decline in the volume. As a consequence, the average transaction size is smaller at about €38 million per transaction.

Berlin significantly increases its dominant position – office property remains in strong demand

In the first quarter it was noticeable that the investment volume was weaker in the Big 7 compared to the overall market. Only Berlin stood out here. The total transaction volume (including Living) in the German capital increased by more than a third to almost €4 billion, accounting for 46% of the transaction volume for all Big 7 markets. This excellent result was primarily owing to 11 transactions in the three-digit-million range. Otherwise, the property strongholds experienced what in some cases were significant declines compared to the same quarter of the previous year, ranging from minus 8% in Stuttgart to minus 76% in Munich. 

Aggregated across all Big 7 cities, the transaction volume (including Living) fell by 23% to €8.6 billion. Property used exclusively for commercial purposes in the seven property strongholds accounted for €6.0 billion, corresponding to a 29% decline.

Around 44% of the total German volume of €15.3 billion was invested outside the Big 7, and this also represented a sharp decrease of 20% in a 12-month comparison. “Despite these declines in the transaction volumes, we maintain that the losses in the major cities are in no way owing to diminishing demand. We expect to see a pick-up in market activity over the course of the year,” said Tschammler.

With regard to the asset classes, there was virtually no change in the relative shares compared to 2018. Investors continued to focus on office property, which accounted for a 38% share. “The fact that investors are also increasingly adding alternative products to their portfolio mix is reflected by the development of the Living asset class,” said Tschammler. The share of this asset class increased to 29% in the first quarter, compared to 27% in 2018 as a whole. As well as traditional residential portfolios, investors also still have student accommodation as well as care and retirement homes in their sights.

Despite the numerous negative headlines about retail real estate, the share of this asset class has stabilised at 13%. Some buyers for shopping centres also emerged in the current quarter: eight transactions were registered in this segment, which was only three fewer than the combined figure for the last two quarters of 2018. “The repositioning process in the retail segment is in full swing, and portfolio owners and operators are now exploring how digital experiences and shopping worlds can be integrated into their centres. However, in view of declining frequencies and rising e-commerce revenue shares, sometimes lengthy and above all cost-intensive restructuring measures are required. The situation is quite different for retail warehouses. Their share of the total retail volume amounts to almost 44%, which attests to the continuing strong interest in retail warehouses, retail parks and supermarkets. Investors particularly regard property used for food retail as an attractive product that is largely resistant to online trade,” said Helge Scheunemann.

The ratio of German and foreign investors shifted towards domestic buyers in the recent quarter. In the first three months, foreign buyers accounted for only a third of the volume compared to 67% for German investors. Foreign investors are particularly interested in large-volume property investments. “Since sales and due diligence processes generally take longer here, the first quarter can only provide a temporary view of events. As the year progresses, the share of foreign investors should increase again. This is also indicated by the fact that investors from the two traditionally largest countries of origin, the UK and the USA, expanded their net property assets in Germany during the first quarter,” said Timo Tschammler

Has the potential for yield compression been exhausted?

Whenever real estate players think that yields have reached the bottom, the market tells them otherwise. Indeed, with the clear refusal of the ECB to raise interest rates this year, the underlying data has fundamentally changed again. As a result of the weakening economy and the flight of investors to safe havens such as German government bonds, returns fell to levels that had seemed to be a thing of the past. “The persistently low interest rate means that investors who want or must rely on predictable and stable returns have virtually no alternative to investing in bricks and mortar,” said Tschammler. And this lack of alternative options is especially evident from the development of yields in the office asset class. The average office prime yield for the seven strongholds fell slightly again by 5 basis points to 3.06% compared to the previous quarter, and by 20 points in a 12-month comparison. “It is harder than ever to provide an accurate forecast for the rest of the year because of the level that has already been reached. From today’s perspective, we believe there is scope for a further 10 basis points in each of the Big 7 cities, so that the average prime yield for all cities would then amount to 2.96% by the end of 2019,” said Scheunemann.

Top properties in sub-markets outside the prime locations have also experienced a similar development. These properties have benefited from the supply shortage in the prime areas and the actions taken by investor to compensate for this situation. The yield compression has also continued here, and the aggregated yield has fallen to its lowest level in ten years at 3.41%. The gap between this and the prime yield is now only 35 basis points.

“The continuing yield compression in the first quarter combined with further rental price growth of 12.9% year on year resulted in a further significant appreciation in peak office values,” said Timo Tschammler.

Following a lull in the previous two quarters, the first quarter again saw some movement in prime yields for logistics properties with ten-year leases in prime locations. Aggregated across the logistics regions in the Big 7, the average yield fell by 10 basis points to 4.00% and is expected to decline further to 3.75% by the end of the year. “In the logistics segment, we are increasingly seeing single-asset transactions in the upper double-digit million range with much longer lease periods of up to 20 years. These products are already being traded for returns of well below 4%,” said Tschammler.

In the retail property segment, yields reflect the current demand for specialist retail products. Yields for both retail parks and specialist retail stores fell by 10 basis points on a quarterly basis to 4.40% and 5.10% respectively. Prime yields for shopping centres and central commercial buildings were unchanged at 4.10% and 2.87% respectively and are not expected to move before the end of the year.


* includes office, retail, logistics and industrial property, hotels, land, special properties and Living with multi-family houses and residential portfolios with at least 10 units and 75% residential use, sale of company shares with the acquisition of a controlling majority (without initial public offerings), apartment blocks, student accommodation, retirement and care homes and clinics.