| Residential property markets have boomed across Europe over the past decade, but in Germany prices have barely moved. David Brierley looks at why so many investors remain frustrated  It is the great enigma of European property. The German residential market, Europe’s largest, continues to be the vastly tempting and hugely frustrating exception for investors. Unlike France, Italy, the UK, the US and Australia, German property has not seen soaring prices in the last decade. Average prices have actually fallen by 15% since 1995, while rents remain unchanged.
The results seem mouth-watering. With €240,000 a buyer can pick up a 9 m2 shoebox in Kensington, London, or a superbly built 110 m2 maisonette in Lichterfelde, Berlin – a similar property in Ferrara, Italy, might cost up to twice as much. Back in London, the maisonette would cost between €1.5m and €3m in Kensington or Chelsea. Attitudes to this situation differ. To London-based investors, it screams “buy”. To German investors, it says “sell”. The latter see oversupply, strong tenant-friendly regulation, difficult administration, high transaction costs, demanding tenants, high vacancy rates – and low returns. For the former, it’s all about low, low prices, stable cash flows and the possibility of piling debt on undervalued assets. The upshot has been that German local authorities and leading German industrial companies have become sellers of their residential portfolios at rising prices while overseas private equity houses fight out bidding wars. If the authorities sold all their 2.3 million flats, they would raise €100bn and reduce their interest payments by €4bn annually according to IW, the Cologne economic think-tank. While this makes economic sense, political opposition to the idea is vast. Bankers and private equity houses like Goldman Sachs, Fortress, Cerberus, Terra Firma and Blackstone have tried telling a sceptical German public that they are honest investors rather than the worst of rogues, while investing billions in acquiring some 650,000 apartments. Yet seven years after the first breakthrough deal – Terra Firma’s purchase of railway workers’ flats – investors’ experience looks mixed.  Many investors continue to love German housing. Christian Schulz-Wulkow of Ernst & Young Real Estate says: “2007 will continue to see strong investment demand for German residential property.” Overseas investors, according to Thomson Financial, will account for some 20% of the €70bn market. They invested €13bn in 2006.
Some are beginning to dispose of their portfolios or lighten their exposure, however. Cerberus is offloading a portfolio of 22,000 flats, Blackstone has jettisoned its portfolio of 31,000 apartments, and Oaktree has sold Gehag and its 23,000 Berlin apartments to Frankfurt-listed Deutsche Wohnen. “Some investors took an exaggeratedly positive view of the prospects on the German market,” says Andreas Lehner, chairman of Deutsche Wohnen, which now boasts a portfolio of 50,000 flats. The German stock market has taken a dim view of the Deutsche Wohnen deal, marking down the shares strongly, just as it has failed to warm to both Gagfah, the Fortress-controlled group, and Patrizia, a market entrant in 2006. Both have fallen significantly below issue price. Analyst Steffen Haack of Nord LB attributes the declining share prices to over-optimistic valuation of the underlying housing assets. “We are returning to normality,” he says. Unlike the private equity investors, the stock market seems to perceive little growth potential in residential property. This is understandable. According to McKinsey, German communes achieve returns of just 2.6% on their housing stock, compared with interest rates of 4%. Rents are pegged to local indices, and selling apartments can be challenging in areas with high vacancy rates. By raising efficiency and reducing vacancies in their portfolios, investors can extract significant value from leveraged assets; this is a one-time effect rather than long-term growth, however. Each group has a different story to tell. Blackstone has exited completely, selling its 21,000-unit portfolio to an investor group. Oaktree bought Berlin-based Gehag for €1bn, then realised a 50% profit this summer by taking a 25% stake in Deutsche Wohnen. Fortress, too, remains committed to German residential through its majority stake in Gagfah.  Analysts believe the sales reflect both interest rate worries and the fundamental difficulties of the German market. Deutsche Wohnen claims it can raise Gehag’s returns from 4.1% to over
4.5% as rents rise, backed by improving consumer purchasing power. Thomas Beyerle of Allianz’s property arm, DEGI, comments: “Fortress said on floating Gagfah that rents would rise but has thus far been unable to make that happen.”
German property law fiercely protects tenants’ rights, as Ulrich Ropertz of tenants’ association Deutscher Mieterbund emphasises. “Even Deutsche Wohnen has to respect local rent pricing laws,” he says. Not every investor has managed to buy low, manage well and sell high. Franz Kammerer of the Berner Group believes some investors have made fundamental errors, ignoring the need for investment, even viewing housing stock from a helicopter, and paying too much. He states: “Several private equity companies are now simply being forced to sell.” Rising interest rates and tighter money will encourage some investors to exit; others look happy to remain for the longer term, however, having bought relatively early and having created strong local management seeking growth through small acquisitions. This is the case at Deutsche Annington, the largest portfolio group, managed by Terra Firma, as well as Gagfah and Deutsche Wohnen. These companies may be proved right, and the German exception may yet become less marked. Wolfgang Kubatzki, head of Feri Rating & Research, says: “There is a high probability that prices will rise. We continue to see massive potential – the same is true of rents.” Kubatzki foresees average returns in leading cities, where price inflation will be concentrated, reaching 9% annually during the next decade. There will be real winners such as Hamburg, Munich and Düsseldorf, where the population will increase and become wealthier. And there will be losers, particularly outside the main conurbations, where depopulation eliminates demand for property.  The Germans rent rather than buy property. Over two thirds are tenants and, while many think about buying, most do not. Property law vastly favours the tenant, while ultra-conservative German banks demand large deposits before providing mortgages.
Munich is one of the slickest, smartest and fastest-growing cities in Germany, and this is reflected in property prices for both tenants and buyers. It ranks as one of the top five cities for property in Germany, the others being Berlin, Hamburg, Frankfurt and Düsseldorf. Demand will continue to outstrip supply in Munich, according to Feri Research, and this has lead to a decade of rising returns for investors. Thus Munich is expensive by German standards but remains defiantly cheap by international measures. A family house in a good Munich area starts at €465,000, compared to €310,000 in Cologne or €260,000 in Hamburg. In the Munich-Bogenhausen district beside the Isar River, prices rise from €1m. In Schwabing, the once-Bohemian area around the university, a newly renovated two-bedroom 70 m2 flat in a stylish 19th-century tenement might cost €600 per month to rent. Prices are so low – by the standards of other leading European cities – because rents are pegged to local prices. It is impossible for landlords to drive up rents even to reflect high demand. The difficulty for tenants is finding the best flats if paying a premium is not possible. Even if you wish to buy in a high-end area, property may simply not be available. |