German commercial investment market in line with previous year despite political and economic volatility
Press release including overview table [PDF]
FRANKFURT, 4th July 2018 – Jeans, peanut butter and whiskey. These three products manufactured in the USA are representative of a global trade dispute between China and the USA as well as between the EU and the USA. A dangerous escalation of the situation has begun with new announcements of trade tariffs at every turn. In the almost unanimous opinion of most experts, there will only be losers in this seemingly archaic power struggle with a succession of retaliatory tariffs. A well-functioning system of global trade remains the basis as well as the driving force for economic prosperity. A disruption in trade relations directly affects the green shoots of recovery in the EU and is already having a markedly negative impact on the economic forecasts for export-oriented countries such as Germany.
Thus the first research institutes have also lowered their economic growth forecasts for both 2018 and 2019 — and by a considerable amount. All institutes have noted that the export economy is already weakening. Companies are no longer expanding their capacities, and also clearly no longer expect the economic environment to improve. A further escalation and a spill-over into the financial markets (such as the sale of American government bonds by the Chinese state bank) cannot be ruled out for the rest of the year. At the same time, the trade dispute with the USA is only one of numerous upsets that seriously jeopardise further economic recovery. Italy’s possible exit from the EU and the EU dispute over a common asylum and refugee policy certainly have the potential to trigger political tremors. In particular, the refugee debate is putting the governing coalition in Berlin under significant pressure. Meanwhile the European Central Bank is caught between the still favourable economic data and rising inflation on one hand, and political disruption on the other. The bank has only just communicated relatively clearly that the period of historically low interest rates is coming to an end and that it also wants to terminate its massive bond purchase programme. However, in order to be prepared for a possible relapse of the economy, it may be forced to increase interest rates more quickly. Otherwise it would lack the monetary policy means to be able to take new countermeasures.
“All these ‘grey or black swans’ have so far played practically no role on the German investment market. Nevertheless, there is growing scepticism and concern that the persistent upswing since 2010 could be nearing its end. This is at least the message from surveys on the future business expectations of property experts. In any case, the topics we formulated at the end of the first quarter under the heading of a ‘challenging investment year’ have certainly proved correct,” said Timo Tschammler, CEO of JLL Germany.
Transaction volume at previous year’s level
The transaction volume on the German commercial real estate market of about €25.6 billion was almost identical to the volume recorded in the previous year’s period (minus 1%), and thus confirmed the trend from the previous quarter. The number of transactions was also at a similar level, maintaining the underlying market dynamics. "Even though Germany’s reputation as a haven of political stability has suffered in recent days, we expect to see no significant impact on demand for German commercial real estate at least during the remainder of 2018. As a result, we are sticking to our full-year forecast of about €55 billion. However, a further deterioration of the crisis within the government could have a negative impact on investors’ appetite for risk and prompt them to adopt a wait-and-see attitude next year,” said Timo Tschammler.
"A quick word about the hype surrounding co-working and flexible office space operators: while we are seeing an ever increasing desire to expand on the lettings markets, from an investor perspective it is clear that they are still critical of the new concepts. The sustainability of the business model has yet to be proven, especially during periods when vacancies could increase again. At least for now, we are unable to confirm that investors are specifically seeking properties whose main tenants are WeWork, DesignOffices et al,” said Helge Scheunemann, Head of Research at JLL Germany.
High demand for property in the Big 7 – Importance of secondary cities is waning
It was also the case in the period from April to June that no transactions above the billion mark were registered. The biggest deal in the quarter, as well as in the first six months, was the sale of 71 clinics by a US REIT to France-based Primonial for more than €800 million. This is the first time that a top transaction has taken place outside the established asset classes.
The ten largest deals in the first half of the year with volumes of €300 million apiece amounted to almost €4.4 billion in total, accounting for 17% of the transaction result. “The importance of very large transactions has therefore declined, which in our view is due more to a lack of such offers, particularly portfolio transactions, than to a reduction in demand,” said Tschammler.
During the second quarter, investors clearly focused on the seven property strongholds, which accounted for about 63% of the total German transaction volume. Of the 20 largest transactions in the period from April to June, only one did not take place in one of the strongholds. The transaction volume in the Big 7 increased significantly by 29% in the first six months compared to the previous year. Transactions fell accordingly in secondary or tertiary cities. The strategy of only investing in top and secondary cities clearly dominates the current market environment,” said Scheunemann.
“Frankfurt is back”: Berlin and Munich have regularly shared the top spot in recent quarters, but the banking and finance metropolis resumed the leading position by the end of the first half with a transaction volume of at least €3.8 billion and growth of 62% compared to the first half of 2017. This was mainly due to eight transactions with a volume of more than €100 million apiece (including Frankfurt properties in portfolios). Munich (€3.62 billion) and Berlin (€3.18 billion) also exceeded the €3 billion mark. Cologne was the only top 7 city to experience a decline, with a 43% reduction in the transaction volume.
At about €11.4 billion, office properties accounted for around 45% of the transaction volume and remained by far the most dominant usage type. Retail property accounted for a share of almost 18%, while the transaction volume for logistics property stabilised in the double-digit percentage range (11%). Clinics, nursing homes and retirement homes are becoming increasingly established among the various usage types, accounting for approx. €1.6 billion and therefore only just behind hotels and mixed-use properties.
Nothing changed in the ratio of foreign to domestic buyers during the second quarter. No salient trends have emerged here in terms of either buying or selling activities among the investor groups. “What is undermined at the geopolitical level by punitive tariffs fortunately still functions on the investment market. All possible capital flows can be observed here,” said Timo Tschammler.
Prime yields are unchanged, but yield compression increases elsewhere
Market players are always anxiously awaiting the latest news on yields. Are they still falling? Are things getting even more expensive? Are property yields reacting to changes in interest rates? It’s a mixed picture, and every asset class has its own cycle. Different trends are also evident in this respect. In the office asset class, which is responsible for the highest transaction volume, the trend towards what is now a very moderate decline for top products in the best locations continued into the second quarter. The bottom seems to have actually been reached here. The average prime yield for all seven strongholds is 3.24%, which is virtually unchanged from the previous quarter. The 12-month comparison shows a decline of 23 basis points. “We are seeing a shift in investment preferences on the part of investors towards products or locations that do not meet the current definitions for prime investments. For example, the yield on properties in top locations, but with a poorer building quality and shorter remaining terms, has fallen by 12 basis points to 4.00%. The gap between these and prime yields has thus narrowed to 76 basis points, which is the smallest yield gap since the second quarter of 2010,” said Scheunemann.
And Timo Tschammler explained: “The background to this is an optimistic assessment by investors with regard to the lettings market. Apparently they still see rental price growth potential in sub-prime properties and have the confidence in themselves or an asset manager to realise corresponding increases in value through a repositioning or a new letting. This optimistic attitude is even more evident with regard to sub-markets outside the city centres. Here, yields fell on a quarterly basis by 13 basis points to 3.59% on average, and are now 30 points lower than a year ago. We have not seen such a small risk premium compared to the prime rate since the start of our research in 2009.”
However, logistics properties continue to fuel the strongest yield momentum. The average prime yield for the Top 7 logistics regions currently stands at 4.25% and is therefore 15 basis below the rate at the end of the first quarter. There has been no drop in demand from investors for well-positioned logistics halls or portfolios. The yield compression of almost 70 basis points within the last 12 months illustrates this trend, which is further compounded by the persistently low availability of products.
Even commercial buildings in the top retail locations of major city centres remain a rare investment product. However, yields for such properties have been stagnating at a low level for several quarters and currently lie at 2.91%. The net initial yield for individual speciality stores, retail parks and shopping centres have also remained at previous quarterly levels, at 5.20%, 4.50% and 3.90% respectively.
“The days of strong yield compression are obviously over for the time being. Although high-priced investments are still being made, capital security is playing a much greater role. Thus the focus of performance is increasingly on rental price development. There is still optimism here that the positive economic environment will continue and that suitable rental adjustments can be undertaken with sound asset management,” said Timo Tschammler.