Since 2013, the International Real Estate Business School from the University of Regensburg has charted the German real estate lending market through its annual lender survey, the German Debt Project.
During that time, Tobias Just, professor of real estate at the business school, has closely monitored the factors that shape property lending activity in the country. In July, prior to embarking on interviews for the 2020 edition, Just shared his thoughts on how covid-19 might affect the market.
Prime real estate has been priced high in Germany in recent years. Will the impact on values of covid-19 leave lenders with highly geared portfolios?
The pandemic will affect values asymmetrically and, therefore, investors’ and lenders’ portfolios will be similarly affected. For example, I do not expect a major impact on residential portfolios, but it is likely that hotel and retail values will fall, particularly in secondary locations. It is, therefore, less a question of overall gearing but more about individual asset classes.
Will covid-19 make ultra-low lending margins a thing of the past?
Yes and no. Competition in the German lending market remains fierce. Of course, lenders will be much more selective than in the past few years but the result will be a widening in the spread between margins for low-risk, trophy assets and opportunistic and peripheral deals. Liquidity has returned after some weeks of virtual immobility, so margins for residential and well-let, top-location offices will drop quickly towards 2019 levels, or slightly above those meagre margins. We will see significantly higher margins for more risky transactions, which should increase pricing pressure in these segments.
Do you expect the crisis to reduce competitive pressure in the German lending market?
There was a comparatively short-lived window where competition eased, as every lender had their hands in their pockets. For risk-takers, this will have created opportunities. However, this window is closing as the economy has reopened. Competition will definitely return.
Are insurance companies showing signs of growing lending market share?
Insurance companies have favoured financing the safest assets and I expect them to remain in that segment of the market. It will be difficult for them to grow market share in the core financing market, though, as some banks will increase their focus on low-risk transactions.
Are German banks likely to curtail foreign lending and concentrate on domestic clients?
Typically, crises result in a stronger home bias. However, every crisis is different, and lenders tend to look at risk on a relative basis. For example, one of the key risk factors cited by every bank in our 2019 survey was Brexit. This risk is pretty much dwarfed by the pandemic. So, I would expect there to be more business in the UK by German lenders, as the Brexit risk factor is downplayed by lenders that are now making decisions with the overall risk of covid-19 in mind.
Conditions that might affect foreign lending decisions are volatile. For example, lenders will be looking at the outcome of the US election and the somewhat surprising policies put in place by leading politicians there. They will also be thinking about the scale and scope of the European financial stimulus package. The next few months will determine the relative benefit to each European economy and might impact banks’ lending decisions.
That all said, the big story for the time being will be a flight to quality. For as long as lenders see Germany as a safe haven, there will be a strong home bias.
How liquid do you expect the German real estate financing market to remain?
The market will remain active. I do not think the level of liquidity is the main issue. Rather, the issue is whether lenders will allocate capital in the best way. The most important consideration is the relative performance of sectors, and some tough questions remain unanswered. How will the office market be affected by working from home and higher unemployment due to the recession? Should there be more differentiation within the logistics sector? When will hotel or retail property become attractive again? What are the potential new uses for those properties?
Lenders will also need to consider whether intra-European migration will create a new growth story for Germany if places like Spain, Italy, the UK, or France are more severely affected by the economic turbulence ahead.
The answers to all these questions will widen the spread between core assets and more risky ones. This growing asymmetry across the real estate market is, in my view, more relevant than any change in the overall level of debt liquidity.