Research

Investment Market Overview

Q2 2022
July 27, 2022

German investment market loses momentum and must realign itself

Transaction volume of €36.1 billion at the end of the first half of the year slightly above the previous year

In view of the unsettled and uncertain market climate, transaction momentum in the German investment market declined significantly between April and June 2022. Most of the transactions concluded in recent weeks were initiated before the recent interest rate rise. The result for the second quarter was €12.3 billion which is around half the volume of the first quarter. Nevertheless, in the half-yearly review, at €36.1 billion, there has been a rise of 5 percent compared to the first half of 2021.

The investment market is currently balancing itself between the changing financing conditions, the prevailing price expectations of sellers and the increasing capital pressure in the market. So far, there is no empirical data for such a situation, i.e. no evidence for general doom and gloom.

It is much more important to differentiate. Not only are we seeing sales at the price level of the beginning of the year, but we are also already seeing transactions with a new pricing. However, due to the rise in interest rates, recalculations will have to be made for most transactions, especially Core transactions, and this will be influenced by whether sellers wish to stick to their previous price expectations or maintain them due to their exit strategies.

It is unlikely that sufficient comparative values for the current market situation will be available before the fourth quarter. However, in future, it is already clear that prices will be calculated not only against the backdrop of significantly stronger inflation at a higher interest rate level, but also significantly higher building costs.

New market situation meets interest rate turnaround by international central banks

What applies to the real estate industry also applies to the economy as a whole: the challenges associated with the Ukraine war, cost increases, climate change and Covid are substantial, and in some cases cannot be foreseen at all at present. This uncertainty is something that is despised in the stock markets and by banks, investors and businesses because it makes it difficult for politicians and economists to sketch a scenario of likely future trends.

€36.1 bn

volume of transactions in H1 2022

+5 %

compared to H1 2021

It is therefore not surprising that the DAX and its international counterparts have lost up to 25 percent in some cases in recent weeks. And these losses are coinciding with the rising interest rates of central banks. The likelihood of a global or German economic recession still appears moderate, but the dangers of it are there, with concerns in Germany about significantly reduced gas supplies in the coming autumn and winter being particularly high. At that point, the economy would join the crisis rhetoric. However, it is almost certain that inflation will remain high for some time because it is extremely difficult for central banks to counteract such supply-driven price rises. It is true that there has been a recent easing of prices, at least for certain commodities such as timber and copper. However, in global supply chains, China's zero-Covid policy is and remains the great unknown. The ECB is now daring to take its first interest rate step, raising the key rate by 25 basis points in July. Too late? Too little? Too much? Opinions differ widely here. In any case, interest rate hikes have already been priced into the markets.

At the ECB, there is also the fact that the monetary guardians have to keep an eye on the entire Eurozone and national debt. The risk premiums on government bonds from the southern Eurozone countries have already risen significantly. So it is a balancing act of fighting inflation with higher interest rates and preventing the Euro debt crisis from flaring up again. Alongside inflation, financing conditions have deteriorated significantly and very quickly in the last month from an investor and corporate perspective. The five-year swap was minus 0.3 percent a year ago and has since increased to its current level of around 2.3 percent - an increase of 260 basis points. At the same time, banks' margins have also increased which means that an increase of 300 percent within 12 months has been recorded. All this cannot pass the investment and real estate markets by without consequences.

Total annual volume heads for €70 billion

JLL currently assumes that the total annual volume in 2022 will be around €70 billion, some 37 percent below the previous year's figure. The sharp and historically strong rise in interest rates has led to a certain rigidity in the investment markets. On the one hand, those investors who operate with a high proportion of debt capital have halted their purchase plans within a very short time; on the other hand, even investors with a high level of equity capital are currently waiting to see how prices and the general market situation will develop. This waiting phase is likely to last until the autumn.

Nevertheless, the days of "cheap money" definitely seem to be over and it is time to move back to a more normal financing environment. This means that some institutional investors will now turn back to the bond markets and real estate will lose its TINA (There Is No Alternative) status. In nominal terms, the yield spread between 10-year government bonds and real estate yields (measured at the average prime office yield) narrowed by around 120 basis points to 1.1 percentage points within the second quarter. The long-term average yield spread since the first quarter of 2009 is 2.96 percent. In order to maintain the attractiveness of real estate as an asset class, including an adequate risk premium, property yields would have to trend upwards.

However, this is where inflation comes into play, pushing real bond yields further into negative territory and revealing a current historically high spread to real estate yields in this calculation logic. So it is not a foregone conclusion that real estate yields have to follow the path of capital market interest rates in parallel. The more inflation is above current bond yields, the more attractive real estate is as an investment.

For many, inflation is a spectre because people have forgotten how to deal with it. The market must learn again to build inflation into investment modelling. We have arrived at a whole new situation that will be a reality for many years. Accordingly, cash flows and indexation must be taken into account. Until recently, one could look at the multiplier alone, but that is no longer sufficient. Even now, the market offers good investments if properties are occupied by tenants who can bear indexation or pass on the additional costs. Some sectors are currently so strong that they will handle this challenge very well.

Continued brisk portfolio transaction activity - focus on core and quality

Taken together, the volume of individual deals across Germany was €20 billion in the first half of 2022, down 13 percent on the previous year. Portfolio sales, however, remain dynamic with a volume of €16 billion, which corresponds to an increase of 43 percent compared to 2021.

25 portfolios with a volume of more than €100 million each changed hands in the first three months of the year and another 17 transactions of this size were added in the months from April to June. In the first half of the year, significantly more portfolio deals (42 transactions) were registered than in the same period of 2021 (25 transactions). In Spring 2022, JLL also observed brisk demand for portfolios, although the volumes were significantly lower than in the previous quarters and the majority of these transactions were focused on the Living segment.

Number of portfolios

Volume each ≥€100 mn 

25

H1 2021

42

H1 2022

Among the individual transactions, the sale of shares in the Sony Center in Berlin to the Norwegian sovereign wealth fund Norges for almost €680 million stood out in the past quarter. There were also a further 12 transactions above €100 million, predominantly in the large established locations and with a focus on the office and mixed-use real estate segments.

Around half of the investments are in Germany’s seven real estate strongholds

With a volume of €18 billion Germany’s Big 7 cities account for around half of the transaction volume in the half-year analysis. At the same time, the volume increased by 4 percent year-on-year. Berlin continues to lead with a transaction volume of €6 billion, ahead of Frankfurt with €3.9 billion and Hamburg with €3.6 billion. The increase in the Hanseatic city is significant at 87 percent.

The fact that the investment market is in an orientation phase is particularly noticeable in the office segment. Properties worth just €3.5 billion were traded here in the second quarter. Although the bare figures are around two-thirds less than in the first quarter, we do not expect them to remain low over a sustained period. For such higher-risk products, the price level must drop more significantly The office will retain its status as an investment product. In the short term, we expect a higher concentration on the prime locations in the Big 7 cities but with value-add strategies, we see a somewhat longer phase of consolidation in order to generate entry opportunities.

ESG is still part of the overall assessment of an investment. For long-term fund performance, it is essential to continue to consider carbon emissions in the long term. ESG statements of intent were principally made in a wholly different market climate. Now, in a climate of rising interest rates and economic uncertainty, they have to prove themselves. However, resetting the sustainability goals is not an option. 

Mapping the current price level in the real estate markets is not easy at present because the slackening demand means that there is significantly less evidence in the form of concluded transactions. Instead, we see a mixture of individual high-priced deals that confirm the previous yield level and reveal the uncertainty among many market participants about the current price level, which has caused some sellers to take their assets off the market because the original asking price does not seem to be achievable at present. JLL has therefore increased prime yields in the office segment by a moderate 10 basis points to 2.72 percent and in the logistics segment by 15 basis points to 3.11 percent to reflect the impact of financing, particularly for higher-priced products. Nonetheless, and this is important to emphasise in the current market, a rise in yields does not mean that property values will automatically fall. As long as the rents are secured by appropriate contractual clauses, higher rental income can be generated in the future, which can increase the current yield and compensate for a higher level of the initial yield at which the property was acquired.

A look at the rental markets also reveals that prime rents have currently risen in five of the seven real estate strongholds and JLL expects further rent increases by the end of the year. The evaluation of index-linked leases compared to those with no or only partial indexation will be given a new weighting, as will the selection of tenants who, thanks to their business models, will also be able to finance inflation compensation in the future.

JLL currently anticipates no change in prime retail yields. The focus of investors remains on food-anchored supermarkets, discounters and retail warehouses.  The times of “faster, higher, further” are definitely over, but there is no reason to sound the death knell for the German investment market. Liquidity is still available, but business cases need to be prepared more carefully and specifically. Only then will banks continue to provide the appropriate financing.

Contact us

Our Capital Markets contacts:

Capital Markets DACH:
Jan Eckert, CEO Switzerland & Head of Capital Markets DACH

Industrial Investment:
Diana Schumann, Co-Head of Industrial Investment Germany
Dominic Thoma, Co-Head of Industrial Investment Germany

Office Investment:
Marcus Lütgering, Head of Office Investment Germany

Residential Investment:
Michael Bender, Head of Residential Germany

Retail Investment:
Sarah Hoffmann, Head of Retail Investment Germany

Research:
Helge Scheunemann, Head of Research Germany

 

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