REC Germany Forum: Facing up to political risk

At our annual Frankfurt gathering, hopes were high that Europe’s economies were moving in the right direction – but there were other reasons for anxiety. Andy Thomson reports.

In his opening remarks to the REC Germany Forum 2016 at Frankfurt’s Villa Kennedy, Alexander Fischbaum, the founder of real estate advisory firm AF Advisory, proclaimed that the opening months of the year had heralded dramatic change.

Citing the fall in oil prices, political instability and the possibility of a British exit (Brexit) from the European Union, Fischbaum contended that political risk is something “you cannot be blasé about” – especially when you also consider the volatility in China, terror attacks in Paris and growing concerns about the situation in Poland, to name but a few additional factors.

However, while Fischbaum suggested that delegates should be taking political risk every bit as seriously as economic risk, his was not a downbeat assessment. Indeed, with delegates saying they expected another two to five years of increased investment activity, the overall mood in the room was cautiously optimistic.

Andreas Segal from BUWOG, Gertrud Traud from Helaba and Chairman Alexander Fischbaum from AF Advisory
Andreas Segal from BUWOG, Gertrud Traud from Helaba and Chairman Alexander Fischbaum from AF Advisory

‘Buy opportunity’

In a keynote address, Helaba chief economist Gertrud Traud pondered whether things have changed dramatically in reality, or whether that is merely the perception. With market sentiment strong just over a year ago, and the DAX index riding high at around 11,000, Traud pointed out that Helaba saw a sell opportunity as risk was not being priced into equities. Now, with the DAX at just over 9,000, “we think it’s a buy opportunity as the market is cheap”.

She expressed the view that, while China’s growth rate is slowing as it transitions from a pure industry focus to services and from external to increasingly internal consumption, the danger of a recession in the country is low. She also said that, while oil prices were an over-shoot on the upside in 2007/08, they may now be an over-shoot on the downside.

Moreover, she forecast that “extraordinarily low interest rates will not last” as the US steadily raises rates amid stronger growth as the oil price stabilises and consumption increases.

However, Traud agreed with Fischbaum that political risk is a cause for concern. “The big questions in Europe are how to solve the migrant crisis and whether the UK will stay in Europe – which is in turn linked to the migrant crisis,” she said.

She mooted the possibility that a Brexit may precipitate the demise of the Eurozone, saying that Europe could not afford to be without a country that “wants more competition and countries sticking to the rules, and which has ideas about solving the migrant crisis”. Or, to put it another way: “You need a country that gets on everyone’s nerves.”

Nuanced picture

When the first panel discussed future growth prospects, it became clear that there was optimism in the air. Michael Ramm, managing director and co-head of acquisitions in Europe at JP Morgan Asset Management Global Real Assets, claimed that “the occupier market is healthy and there is good rental growth”.

However, the picture is nuanced. Andreas Segal, CFO and deputy CEO of residential specialist BUWOG, said that the likes of quantitative easing and very low interest rates have made it “extremely difficult to define the cycle”. He added: “For us, the migrant crisis means additional demand. But some people are forgetting it’s a cycle and, in my view, LTVs have to come down.”

Ramm acknowledged that there is a choice to be made regarding which type of market opportunity you want to go for. “Some people try to find higher yield and they go into the secondary market and the tertiary market to find that higher yield. But there’s a liquidity premium. I feel more comfortable sticking with places that stay liquid even when there’s less capital around.”

Taking up the point, Gunther Deutsch, managing director and head of investment transactions Europe at Cornerstone Real Estate Advisers, said: “I do see reasons to look at secondary and tertiary opportunities but it depends on the product. If you have a dominant shopping facility and nothing else in the area has planning permission, then why not?”

Following Ramm’s observation that paying a premium for prime product is reasonable in a market where risk-averse investors are focused on liquidity, Bernd Bechheim, head of asset management and transactions continental Europe at Aberdeen Asset Management, replied:

“International investors will 100 percent share that view. But local investors say they want the income stream offered by secondary and tertiary assets so long as the assets are sound and the demographics are strong. Investors know they pay a price with low liquidity but they are happy if the income stream is stable and they have a good asset.”

When the panel was asked by moderator Ruben Herrmann of US-based investment firm Westbrook Partners whether foreign investors in Germany were trend setters or trend followers, Deutsch replied: “It’s a question of who takes what kind of risk. Foreigners were willing to take risk that locals wouldn’t.”

Added Ramm: “On the core side, the market is much more dominated by German investors. They are quicker as they understand the market better.”

Heading up the risk curve

In a panel dedicated to non-bank lenders, Elke Birk, a principal at investment firm DRC Capital, pointed out that “competition is very high in senior and mezzanine so it’s difficult to find the right product. You need to go up the risk curve to make the same return.”

Anthony Shayle, managing director and head of UK real estate debt at UBS, added: “The outstanding appetite is for prime, investment grade. When you shift to a more challenging investment proposition, the appetite tails off quite dramatically.” He expressed the view that non-bank lenders are “equipped to take the risks the banks should not be taking.”

But while Shayle said there had been a “strong push” towards alternative debt providers, he acknowledged that there was still a long way to go before they made the same impact as on the other side of the Atlantic. Over there, he said, “50 to 55 percent of commercial real estate is the banks and the rest is insurers, debt funds etc. In Europe it’s historically 90 percent banks and 10 percent insurance.”

Underlining the dangers of too heavy a reliance on the banks, he concluded: “When you have a banking model, you have a mushroom which can be knocked over.”

The search for hidden champions

In a panel exploring opportunities in the residential sector, Christian Windfuhr, CEO of turnaround specialist Grand City Properties, said that the residential hotspots in Germany were its seven largest cities. However, Grand City’s approach is to “buy assets that are under-managed and we find them everywhere, including in the former East Germany, with students moving in and lots of companies starting up.”

Residential panel (left to right) - Christian Thiele, Christian Windfuhr and Nikolai Deus von Homeyer
Residential panel (left to right) – Christian Thiele, Christian Windfuhr and Nikolai Deus von Homeyer

Nikolai Deus von Homeyer, managing partner at investment firm NAS Invest, added: “We are based in Berlin. It’s tremendous what’s happening there, and it’s only the beginning.”

Thomas Meyer, CEO of investment management firm WERTGRUND, said his firm targeted “hidden champion” locations. “We look for the ones with things like rising populations and good universities,” he noted, adding that the likes of Dresden, Erfurt and Rostock were of interest.

All panellists were awaiting the eventual impact of the refugee crisis on the residential market, “as when they’re qualified to work, they will go where the jobs are,” according to Windfuhr.

The big worry for all participants in the residential sector appeared to be regulation. Perhaps they were reflecting in part on the decision by Berlin to introduce rent caps last year.

“I fear we see far more regulation in the years ahead and more pressure on the rental market,” said Meyer.

“Clearly we are being over-regulated,” added Windfuhr. “Who will be out there building the new apartments to meet demand? The more you regulate, the less attractive it is to build new stock.”