Magazine article Real Estate Issues

How Risks Are Shifted within the German Real Estate Market

Magazine article Real Estate Issues

How Risks Are Shifted within the German Real Estate Market

Article excerpt


The current interest rate environment in the European Union (EU) creates the following situation, which can be described best as a "wall of equity meets a wall of debt": Real estate projects, which could not have been realized/financed several years ago, are financed today using favorably priced equity, hybrid and/or debt capital. Because of steadily decreasing bank loan margins, loan-to-value (LTV) or loan-to-cost (ETC) ratios exceed the post-finance crisis level of over 80, sometimes 90 percent of the investment volume (the exceptions are the institutional products regulated by German investment law) - while still receiving very favorable terms, particularly in the area of "senior stretch loans." Ever more crucial for success is the product, the piece of property, itself.


As a federally organized country, Germany does not have only one hotspot city, as the UK has with London, or France with Paris. Rather, the "safe core havens" ("A-cities") are considered to be the top seven largest cities in Germany: Berlin, Hamburg, Munich and Cologne (all metropolises larger than 1 million inhabitants), as well as Frankfurt, Stuttgart and Dusseldorf (major cities between 600,000 to 800,000 inhabitants, with Frankfurt being the home of the European Central Bank).

Given the current favorable loan terms, core products in mostly A- or B-locations in A-cities, as well as A-locations in the second tier B-cities (major cities, 14 in total, normally between 250,000 to 600,000 inhabitants) of Germany are heavily overbought. Further, the so called "yield compression" takes place (yield levels decrease). This basically describes the situation where real estate gets more expensive, while the amount of cash flow generated by the property remains almost unchanged. This leads to a disconnect of the normally stable relation of rental income to investment price. A dangerous situation is created - considering the high LTVs/LTCs and the decreasing amortization periods for current German commercial real estate investments. A refinancing wave some years from now, with interest rates being 200 to 300 basis points higher, could move the market into a risky imbalance, as this would represent a multiplication of the interest burden: Property values might decrease simultaneously - in the worst case, accompanied by decreasing property cash flows - in times of potential economic recession/crisis scenarios.

Many investors have taken this thinking into their risk management considerations and now choose alternative investment strategies in order not to act pro-cyclically. But by doing so, they accept other systematic risks. Where will the pressure start leaking offof the "AB/BA-investment valve?"

Four strategies - sometimes combined - are chosen in order to mitigate structural investment risks.


Institutional investors in core products (German capital allocation sources such as insurance companies, pension funds, occupational pension schemes, as well as foundations) are confronted with very high prices - multipliers respectively - in core locations or for core properties. In order to avoid this dilemma of acquiring supposedly safe real estate at too aggressive a price level, institutional core investors now attempt to acquire properties earlier in their life cycle. Thus, they intend to buy in the phase of property development, combining the purchase with a competitive "purchaser financing" for the project developer, in order to be able to acquire the desired property for their own institutional portfolio at acceptable multipliers.


These days, the "conventional" German AB/BA property types, such as office, retail or residential real estate, are facing a high demand and, at the same time, an aggressively priced financing. As a consequence, institutional investors also consider completely different real property types as investment targets. …

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