Commercial investment market bids farewell to 2018 with a record transaction volume
FRANKFURT, 4th January 2019 – A politically and economically turbulent year has finally come to an end. The political power blocs are on a collision course, both from a geopolitical and economic standpoint. “The U.S. President Donald Trump has taken less than two years to shake the very foundations of the world order. Trade wars or the threat of trade wars, the termination of international pacts such as the Paris agreement on climate change and the Iran nuclear deal, and the U.S. withdrawal from the bilateral INF treaty with Russia concerning the destruction of all medium- and short-range land-based missiles are all instruments of this destabilising policy,” said Timo Tschammler, CEO of JLL Germany. He added: “Politicians and their ego trips currently represent the biggest risk for the global economy, and Donald Trump is not alone in this regard. For instance, collaborations among the major economies, such as those that took place during the financial crisis, can no longer be taken for granted.”
Rather than coming closer together, the countries of the world are moving away from one another. As a prime example, the United Kingdom, once a model of economic pragmatism, is heading towards a disorderly exit from the EU because the Conservative Party under Prime Minister Theresa May is being torn apart by clashes between “Leavers” and “Remainers”. Even the vote of no-confidence that was recently won by May provides only a limited basis for hope. Italy, which is also still a G7 country, is now governed by populists who are proving difficult to assess. Even state bankruptcy cannot be ruled out. Many other examples could be added to the list.
“All things considered, it’s a rather bleak scenario that is further blighted by the enormous debt burden of the global economy. According to figures from the International Monetary Fund, the global debt of countries, companies and private households has shot up from 179% to 225% of economic output since 2007. And much of the growth experienced by industrialised countries since the financial crisis is owing to this increased debt, not to sustainable factors such as productivity growth. For example, debt and even more debt have fuelled the significant growth spurt that the USA is currently experiencing,” pointed out Timo Tschammler. He added: "What does all this mean for the real estate industry? Looking back over 2018, it can at least be said that so far neither the modest rise in interest rates nor intrinsic aspects of the real estate market, such as an excessive increase in the supply of space or imprudent behaviour of the market players themselves, have signalled a turning point in the cycle.”
Given the political background described above, many investors see their salvation in the property asset class: “And there are good reasons why this trend will continue in 2019 and demand for real estate will remain high. Aside from the lack of alternative options, more and more investors are choosing to increase their real estate investment ratios. Numerous pension funds and insurance companies are under immense pressure to invest capital, and even small changes in their investment strategy have enormous quantitative effects on the real estate market,” said Tschammler. He added: “Looking ahead to the new year, the most serious threats to the German real estate market are a possible tightening of global trade restrictions and a disorderly Brexit. Then even the still healthy economic situation in Germany could be affected. It remains to be seen whether the ECB will increase interest rates again, or whether it will find itself in a situation that it wishes to counter with monetary policy measures to support the EU economy. In the latter case, a rise in interest rate would be put on hold.”
New record achieved in 2018: commercial transaction volume amounts to more than €60 billion
The upturn on the investment market continued throughout 2018 and has now entered its tenth year in 2019. In view of the market’s buoyancy during the last three months of the year and the realisation of some large-volume transactions, it is fair to say that 2018 stood out as an exceptional investment year. Apart from the mega-transactions, some other noteworthy activities also contributed towards this development.
The transaction volume has been rising steadily since 2010, and 2018 proved to be another record year at least in the commercial real estate market. This market segment accounted for a transaction volume of €60.3 billion, which has tripled since 2010 and increased by 6% compared to 2017. Including the “living” use class (residential portfolios, micro-apartments and care homes), the total transaction volume amounted to €79 billion. However, the overall figure still fell below the previous high of €80.3 billion that was achieved in 2015.
Timo Tschammler: “Where are we going in the current year? Despite current geopolitical ncertainties, demand for real estate will remain high in 2019. A transaction volume for commercial real estate of up to €55 billion appears to be achievable in 2019. For the entire investment market, including “Living”, the volume is expected to reach about €70 billion, which would be around 10% lower than in 2018.”
The Big 7 cities consolidate their dominant position – project developments attract high level of interest from investors
It's clear that investors are still primarily interested in the Big 7 cities, and this situation was further reinforced in the last quarter of the year. In 2018, Berlin, Düsseldorf, Frankfurt, Hamburg, Cologne, Munich and Stuttgart accounted for well over half of the total transaction volume (€46 billion of €79 billion). The dominance of the most sought-after asset class, office real estate, is of particular significance. Here, around 80% on average has been invested in property in the Big 7 over the past few years (since 2012). And in Frankfurt, the commercial property investment volume managed to break through the €10 billion barrier following the completion of a number of large-volume office transactions at the end of the quarter. Including residential real estate, the Main metropolis recorded a transaction volume of €11.6 billion, representing a significant increase of 49% compared to 2017. Stuttgart experienced even stronger growth, with a 56% increase in the total transaction volume to €2.5 billion.
“The high level of interest in the established markets is primarily owing to the strong lettings market, which provides a fundamental basis for investments as well as the prospect of further rent increases following refurbishments or the renting out of vacancies in a property,” said Helge Scheunemann, Head of Research at JLL Germany. He added: “In the face of diminishing yield compression, rental growth in particular is ecoming increasingly important as a way of generating added value. This is also why value-add properties with short remaining leases, or properties with vacancies, are currently in demand. Here, it is more likely that higher rents can be enforced through the signing of new contracts. Non-core sub-markets and CBDs in the Big 7 are the preferred choice for office investors looking to invest, ahead of smaller and therefore riskier markets in terms of potential re-letting opportunities. In addition, significantly higher rents can be selectively realised here than in the prime locations.”
Office property remains the most popular asset class. Office properties alone accounted for approx. 37% of the total transaction volume including the “Living” asset class. From January to the end of December, around €29 billion was invested in office real estate. Residential properties with their various subcategories are ranked in second place. “Living”, which brackets together nursing and healthcare properties, student housing and multi-family units — that is, the typical investment in residential portfolios – has become of particular importance for the German market (with a share of 27% in the past year) and has long established itself as an alternative use class for investors. This includes those that have previously invested almost exclusively in the traditional asset classes of offices or retail.
Thus alternative products were in greater demand during 2018, as well as project developments and investments in unfinished properties. In terms of individual transactions, these accounted for 20% of the transaction volume. “The trend is towards continued rising demand due to the shortage of existing properties in both the investment and letting markets, especially in central city locations. Numerous office or residential construction projects are currently let before completion, thus reducing the risk of such investments,” said Scheunemann.
After office and residential real estate, retail property is in third place in terms of investor interest. At the end of 2018, this asset class accounted for about 13% of the volume. While only a few years ago retail property enjoyed almost level pegging with office property, the transaction volume in this segment continued to decline in 2018, falling by a further 9% compared to 2017 to reach €10.5 billion. And the situation would have looked even worse were it not for the billion-euro Signa department store transaction in the third quarter. “At second glance, however, significant differences are apparent. What was missing in 2018 were larger shopping centre transactions, with investors tending to be extremely hesitant in this segment. On the other hand, retail warehouses and retail parks have emerged as new ‘investor darlings’. They now account for more than 40% of the transaction volume within the retail asset class, and properties with strong food retailers as anchor or main tenants are in high demand,” said Scheunemann.
At the end of the fourth quarter, there was a small shift in the ratio of German to foreign buyers. In terms of the total transaction volume, around 42% was attributable to foreign capital sources (approximately €33 billion) in 2018. Foreign investors further increased their investment activity in the last quarter of the year. “The traditional capital-producing countries of the United States and the United Kingdom are still ranked top, but have lost their dominance of earlier years. In return, investors from other European countries as well as from Asia have expanded their activities compared to recent years,” said Helge Scheunemann.
The bottom has not yet been reached with office and logistics yields, but returns for shopping centres are rising
The trend towards a moderate decline in yields for top products in prime locations of asset classes with the highest transaction volumes continued during the fourth quarter. The average prime office yield for the seven strongholds stood at 3.11%, which was slightly down compared to the previous quarter and 16 basis points lower in a 12-month comparison. “In 2019, we expect yields to settle at this level,” said Tschammler. Tschammler added: “Since top products are again likely to be in short supply and demand will remain at a high level in 2019, the investment preferences of investors will again shift to products or locations in the Big 7 that do not meet the definitions of “prime”. This will also be reflected in the returns, for instance resulting in continuing yield compression for properties in prime locations but with poorer building quality and shorter contract terms, and a possible reduction of the gap to the prime yield to around 80 basis points.”
The same applies to top properties in sub-markets outside the prime locations. Yield compression has also continued here, and yields have reached their lowest level in over five years with an aggregate value of 3.44%. The gapto the prime yield is just 33 basis points, which is the lowest level ever reached.
However, the strongest momentum in terms of yield development is still evident in the logistics real estate segment. The thriving online retail sector and its positive future prospects attract foreign investors to this asset class. At the end of 2018, the prime yield stood at 4.1%, which is 60 basis points lower than at the end of 2017. However, we expect to see a further decline to well below 4.00% over the course of 2019.
In combination with rental growth, office properties again registered a double-digit increase in capital appreciation during 2018. Aggregated across the seven property strongholds, the capital value growth was 12%, which compares to an average growth rate of 15.5% for the previous three years. The rate of growth is expected to weaken to around 4% in 2019 owing to the more stable yields.
With regard to retail high street in city centres, the strong increase in value seen in past years is already over. Indeed, growth of only 3% was registered for 2018. For the most part, stagnating rents and effectively no appreciation in value are expected to be evident in 2019. Demand will focus more than ever on specialist store products with discounters or food retailers as anchor tenants. Since demand here will be significantly higher than the available supply, prime yields in this segment could still fall slightly in 2019 —they stood at 4.50% at the end of 2018. Shopping centres represent the first segment in which the prime yield has risen again for the first time since the end of 2010. At the end of 2018, the yield was 4.10%, which is 20 basis points above the lowest value of the last four quarters.