The German real estate market | Q2′22

A market positioned between wait-and-see and revaluation

With a transaction volume of around EUR 36 billion in the first half of 2022, the German real estate investment market achieved a result on a par with 2021. But at first glance the result is deceptive, as the second quarter was one of the weakest quarters in quite some time with a total volume of around EUR 12 billion. The war in Ukraine and the resulting inherent uncertainty have left their mark on the German real estate market. A considerably changed geopolitical situation, highly volatile interest rates, persistently high inflation and rising fears of recession raise questions about the appropriate valuation of real estate.

"The year 2022 ranks as the worst start in 50 years for both stocks and bonds "

Larry Fink, founder and CEO, Blackrock

Sometimes a small glance over the end of one's nose is enough to gain a feeling for the market environment. The release of various statements on the global situation by major international financial institutions in recent weeks gives little cause for optimism in the near future. Blackrock declares "the Great Moderation, a period of steady growth and stable inflation" to be over; Barclays even sees a "new era of instability"; and the Financial Times sums up the mood in the headline "The era of great despair has arrived among investors".

Against this backdrop, the slogan of perseverance frequently heard in the German real estate market at present, "there will once again be investments from autumn onwards", referring to the great availability of capital in the market, would suggest a desperate attempt to end the ongoing fragility with a forecast. This phase of uncertainty will probably not end so easily and quickly, and this is all too clear from the downward trend that has prevailed for months, with high volatility on the capital markets. Highly efficient capital markets show changes in investors' expectations more quickly than the real estate market, where transactions take much more time and the traded goods are less homogeneous.

In summary, we are in the middle of a probably painful process of recalibration in the German real estate market. In addition to investors' yield expectations, the general willingness of investors and financiers to take risks is also changing.

Subsequently, the "Germany = Safe Haven” mantra, so repeatedly and rightly invoked in crises in the past, no longer applies. There is currently a clear reluctance on the part of international asset managers to invest in continental Europe, which appears to be justified in many respects:

• The war on the borders of the European Union
• The impending weakening of the economy due to the unavailability of goods, especially raw materials
• The decline of the Euro and the resulting dramatic loss of purchasing power (almost 20% in the last year) for all goods invoiced in US dollars. Germany in particular is suffering at the hands of the ECB decision-makers who are far too hesitant to raise interest rates having regard to southern European countries and compared to other monetary areas. The argument that a low Euro exchange rate boosts exports and therefore drives up employment is moot in a phase of full employment and non-availability of goods.

In the real estate market, the increase in the cost of financing is cited as the main argument for a change in the price level. The first thing that catches the eye is the high volatility of key interest rates. For example, since the beginning of the year, the 10-year Euro swap has shot up by around 250 basis points to its highest level. It is currently trading around 100 basis points lower, an extremely unusual dynamic in historical terms. Due to the timing of real estate transactions, it is not yet clear how yields will develop in the different real estate segments. In the case of office properties, for example, it is extremely likely that yield levels of below 3.0% (gross) will be a thing of the past for the time being. Quite simply, investors are currently, once again, being offered attractive investment opportunities outside the real estate market. These specifically include bonds which traditionally make up a high weighting in the portfolios of institutional investors.

We do not see a quick return to last year's valuation levels due to the significantly higher key interest rates, even after their decline in recent weeks. In addition to the current level of key interest rates, the availability of debt capital and the risk and liquidity margins applied by financiers justify this gloomy outlook for the second half of 2022. Since the beginning of the year, we have observed an increased risk aversion on the part of banks, i.e. an increased reluctance to provide financing for non-Core assets. Despite this restraint, the interest rate levels set by banks are still attractive compared to real estate bond yields, which have risen to an extent that cannot be explained by the key interest rates. We currently see a danger for the market that banks will also extend their risk and liquidity margins, thereby making financing costs even more expensive.

Value-Add properties and speculative projects are currently almost impossible to finance through banks and this is prolonging the trend of recent years towards alternative financiers. In view of the above-described uncertainties in the market and the reluctance of banks, deliverable debt funds are experiencing considerable demand, which is enabling them to push through significantly increased interest rates. But even here there are limits where supply and demand will not converge. Therefore, it remains to be seen whether debt funds can take advantage of the banks' reluctance.

We anticipate a decline in development activity across all real estate segments in the medium term, as the fluctuating commodity prices in combination with the incalculable supply bottlenecks, the valuation uncertainty and the financing problems represent too great of an obstacle.

In view of this overall situation, we expect the third quarter to be characterised by restraint after the significantly weaker second quarter, and a transaction volume of around EUR 65 billion for the year as a whole.

Oliver Obert, Dr. Joachim v. Rheinbaben, Management, Oceans&Company, Copyright 2022