Commercial property investment market defies all odds: record transaction volume possible in current year

Commercial property investment market defies all odds: record transaction volume possible in current year

October 05, 2018

FRANKFURT, 4th October 2018 – It’s fair to say that we are living in uncertain times both from a political and economic perspective. The governing coalition in Berlin lurches from one ordeal to another, while a similar level of domestic upheaval is taking place across the Channel as the deadline to reach a final decision over Brexit looms. Even the European Union is anything but united on more issues than just the refugee crisis. Meanwhile, Donald Trump plays his own part in destabilising the geopolitical order, as do Messrs Putin and Erdogan. The list of “disruptors” seems endless. In any event, the political landscape is unlikely to stabilise anywhere in the world before the end of this summer. And yet Germany’s economic upturn endures. The central banks will be of particular interest in future when it comes to assessing the capital market outlook in the coming months. Inflation trends and the exit from the ultra-loose monetary policy will be at the centre of attention. Investors wonder when Mario Draghi will raise interest rates, and by how much. It is to be assumed, however, that the European Central Bank will adapt flexibly to developments in the foreseeable future and react accordingly. “So we expect to see a gradual and cautious process, and peak interest rates should be lower in the coming cycle than in the past,” said Timo Tschammler, CEO of JLL Germany.

Strong transaction volume in the third quarter – €60 billion expected in the full year
The somewhat uncertain circumstances have so far left no traces on the German investment market. On the contrary, the transaction volume for commercial real estate increased 8% year-on-year to €42 billion in the first nine months of 2018. Never before has a third quarter performed this well, and the transaction volume of €16.4 billion also positions it as the fourth-strongest quarter in the ranking of the past five years. Among other deals, the Kaufhof/Karstadt transaction contributed towards this exceptional result with a value of €1.8 billion. Of course, such transactions do not take place every quarter. 
“Given that the market is usually very active in the last three months, and the expectation that some of the many transactions still in the negotiation phase will be realised in the final weeks of the year, a transaction volume of up to €60 billion seems possible,” said Timo Tschammler. He added: “As is so often the case, the probability that such a forecast will be realised depends particularly on the implementation of large-volume transactions. But aside from that, the momentum beyond mega-transactions also points towards an exceptional investment year in 2018.” 

Dominance of the Big 7 intensifies – investors focus on office properties
The third quarter not only witnessed a consolidation of the half-yearly trend, but also an acceleration of this development. More than ever, investors are focusing on the Big 7. While an aggregated volume of more than €26 billion (60% of the transaction volume of the first three quarters) was invested in all seven strongholds, corresponding to an increase of 27%, around €16 billion was invested outside these markets. This was around 13% below the previous year's volume.
“In our view, this reflects the dynamic development that is particularly evident in the office lettings markets in the Big 7. Investors are increasingly relying on rental growth in the face of declining yield compression in order to meet their return targets and generate value. This is one of the reasons why value-added properties with short remaining leases or properties with vacancies are currently in demand, as higher rents are most likely to be realised here through new contract agreements,” said Timo Tschammler.
When a large amount of capital is to be invested at once, there are very few alternatives to the Big 7. Of the 67 individual transactions in the three-digit million range that took place in the first three quarters, the Big 7 accounted for 62. In terms of the biggest individual transactions in the nine-month period, the largest deal outside the Big 7 is only ranked 37th with about €150 million.
Office property remains the most popular asset class, accounting for around 45%. Approximately €19 billion was invested in this type of real estate from January to September. “In the search for investment options, sub-markets outside city centres and CBDs in the Big 7 seem to be the preferred choice of investors ahead of smaller and therefore riskier markets,” said Matthias BarthauerResearch, JLL Germany
Here, it is possible to realise significantly higher rental increases on a selective basis than in the prime locations. Retail property is in second place, accounting for over 20% of the total thanks to the billion-euro department store transaction. Otherwise, the focus of investors in the retail segment is predominantly on specialist retail products with anchor tenants from the food industry that have so far been relatively unaffected by online competition. This is also one of the reasons why very large transactions in the retail segment have become relatively rare. Most transactions range between €20 million and €60 million and, unlike in the office sector, are geographically more widely dispersed.
Frankfurt and Hamburg with strongest momentum in the third quarter
“Frankfurt is back”, we claimed at the end of the first half of the year, and this applies all the more to the third quarter (€3.16 billion). After the first nine months of the year, the banking metropolis is the undisputed leader among Germany's investment strongholds with a volume of about €6.9 billion. Compared to the previous year, the figure has more than doubled owing to a series of large-volume transactions: out of Germany's ten largest individual deals this year, seven took place in Frankfurt. Berlin is next with €4.9 billion and Munich is in third place with €4.5 billion. While Munich registered a slight increase of 8% compared to the previous year, the German capital suffered a decline of about 17% despite the €1.7 billion that was invested in the period from July to September. Hamburg also exceeded the €4 billion mark with an increase of 70% — boosted by the strongest third-quarter performance (€1.72 billion) after Frankfurt.
At the end of the third quarter, there was no change in the ratio of German to foreign buyers, with foreign capital sources accounting for around 45% (just under €19 billion). “An increase in the share of foreign investors would have been expected considering that the department store merger was registered as an Austrian investment. However, this was balanced out by numerous purchases by domestic institutional investors especially in the €100 million-plus range, in particular during the third quarter,” said Barthauer.

Continuing momentum causes further decline in yields
During the third quarter the office property segment, which accounts for the highest transaction volume, continued to see only moderate declines in yields for top products in the best locations. The prime yield averaged across all seven strongholds narrowed slightly to 3.20% compared to the previous quarter. In a 12-month comparison, the yield declined by 19 basis points. “In view of the continuing strong momentum, we have again slightly revised downward our forecast for the end of the year. Across all seven strongholds, we expect to see a prime yield of 3.15% by the end of the year,” said Matthias Barthauer.
The fact remains that top products are scarce and demand is still very high. The trend described above regarding the shift in investor preferences to products or locations in the Big 7 that do not meet the definitions of “prime” is also reflected in the yield development. The yield for properties in prime locations, but with a poorer building quality and shorter remaining leases, is only 3.95%, which is just 75 basis points below the prime yield. 
Top properties in sub-markets outside the prime locations also experienced further yield compression to 3.54% on aggregate. This represents the lowest level in more than five years and is only 34 basis points below the prime yield — the smallest gap ever seen.
However, the strongest momentum in yields is still evident in the logistics property segment. Currently, the average prime yield for the top 7 logistics regions stands at 4.10%, which is a further 15 basis points lower than at the end of the second quarter. The thriving online retail trade and its positive outlook for the future are attracting foreign investors to this asset class, which is no longer a niche product. By the end of the year, we expect a further decline to 4.00%.