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Germany’s sky-high property prices mean it’s all about the rent

Yields have reached a floor in the country, meaning investors and lenders should focus on assets with potential for rental growth.

As half-year data on Germany’s commercial real estate market emerges, it seems prime property in the country is about as expensive as it is likely to get this cycle.

Yields on core German real estate have stabilised, most consultants’ reports indicate. The average prime yield across the seven major cities is 3.24 percent, says JLL – virtually unchanged on the previous quarter and down just 23 basis points during the past 12 months.

Germany’s reputation as a safe-haven for capital has clearly not been too tarnished by the period of political flux in the nation this year. Fear of a global trade war, greater political uncertainty in other parts of Europe and the pressure to park capital in a low- to zero-interest-rate environment are among the factors keeping Germany’s shiniest buildings on investors’ shopping lists.

Real estate transaction volumes for the first six months of 2018 – CBRE, JLL and Colliers International all agree – were just more than €25 billion, slightly down year-on-year. Office deals dominated and there was a continued focus on the major seven cities. A total of 10 properties valued at between €250 million and €500 million changed hands in the first six months of the year.

Such activity in the core German market has served to keep lending margins well below 100 basis points, as the country’s pfandbrief banks battle for financing mandates. While it should be noted German banks have remained disciplined on leverage this cycle, the pressure to maintain market share at such a late stage of the cycle has the potential to encourage large volumes of lending against assets which could decrease in value by the end of the loan term.

While many German banks have increased their business outside domestic borders in a bid to capture higher margins, lenders should keep a close eye on those investors buying property within Germany which does not fit the traditional notion of ‘prime’.

Faced with dwindling availability of core assets, investors are increasingly looking at slightly poorer-quality property in the best locations. Indeed, that is where yield compression in Germany can be found. JLL shows the gap between yields on prime offices and less prime offices in core locations has narrowed to just 76 basis points, as buyers choose properties with sound fundamentals which need some asset management to unlock their full value.

Investors are buying into Germany’s continued economic growth story. Rental growth, rather than capital value appreciation, is at the forefront of an increasing number of investors’ minds. Investment in alternative sectors is up – the largest deal in Q2 was French REIT Primonial’s purchase of 71 healthcare facilities – and hotel purchases in Q2 broke records, by Colliers’ estimation. There is also more investment in land for commercial development. Land transaction volumes soared by 106 percent to €1.3 billion in the first half of the year, according to CBRE; a clear sign of faith in continued strong performance in the German economy.

While lenders need to assess the risk of any deal which tests their lending parameters, trends evident in Germany’s real estate investment market demonstrate there remains potential to finance those firms aiming to create additional value, and capture rental growth, in the country’s ultra-competitive property sector.

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