The state of German CRE lending: five crucial issues

Our recent special report on the health of the German real estate lending market laid bare the challenges facing the country’s banks.

Driven by their funding model, real estate bankers are under continual pressure to replenish property loans to maintain the pools of assets that back their issuance of Pfandbrief notes; their principle source of capital. The largest of Germany’s property finance units write north of €10 billion of loans each year, but in a heavily banked sector protecting market share can be tough.

This was highlighted in the findings of the latest German Debt Project report; an annual study published by the International Real Estate Business School at Bavaria’s University of Regensburg. Like the UK’s De Montfort University report, it is a crucial source of data on one of Europe’s key real estate finance markets.

The latest edition provides plenty of talking points. Here are five to consider:

1. Germany is flooded with equity. There’s no shortage of investor interest in German property – Savills predicts a record €60 billion of transactions this year. Activity is being fuelled to a large degree by pressure on investors to put large reserves of equity to work. The sheer volume of equity capital in the market is driving up core property prices to sky-high levels, while there is a drop in borrowed capital.

2. Leverage eased back slightly. A result of the flood of equity is a slight drop in average loan-to-values. In the 2015 report, bankers had expected LTV ratios to rise from an average 68 percent to around 70 percent in 2016; what happened was a drop to below 66 percent. It signals that there is not a credit-fuelled bubble in German real estate, even though values are rising. It’s worth bearing in mind that, while LTVs are down across core deals, there is still demand for higher leverage from those with more challenging properties and development projects.

3. Growth in new business halved. A 10 percent growth rate in new real estate financing business during 2016 suggests that bankers remain determined to deploy capital. Lending institutions had predicted growth in the region of 6 percent, so it was significantly higher than expected. Consider, however, that the rate of growth halved compared with 2015. Lending institutions are aiming for 5 percent growth in 2017, which would be another halving of the growth rate for new business. Despite this, banks are determined to maintain large property lending portfolios to protect their earnings.

4. Margins are still under pressure: Speak to a German real estate banker, and they will tell you that lending margins can surely only go up. Across the report’s huge sample, however, margins are expected to decline by a further 5 to 10 basis points, potentially bringing the average figure to below the 100 bps mark. There is plenty of anecdotal evidence of deals done far below that – 80 bps, or even 60 bps in some cases for core business – and pricing pressure shows little sign of abating.

5. Foreign growth was modest. Loan portfolios seem to be getting more diverse, with a higher proportion of finance going to logistics and hotels, as well as development. However, geographically, the major banks remain focused on the major cities in order to source large lot sizes. Although many lenders are determined to grow business in foreign countries, the UK’s EU referendum had an impact on their plans. As the report noted, the “foreign valve” did not ease competitive pressure – while there was double-digit growth in Germany, there was only 1 percent growth in foreign business.

As long as earnings from real estate outperform other banking activities, Germany’s lenders will continue to provide property debt. Volumes look set to remain high and margins to remain low – and the German Debt Project report suggests lenders can expect little respite in their ultra-competitive domestic market.