In our caricature of Germans, we think of a nation of prudent egalitarians, fiscal conservatives with an Anglo-Saxon work ethic cast among a European peer group of profligate ne’er-do-wells. Indeed, there is a measure of truth in this: for example, except for a few years post-unification, the German economy has run an uninterrupted surplus since 1952.
When you talk about the opportunity in German property, you have to begin with the German macroeconomic miracle. It bears little reminder that this is an economy that twice in the last century was ravaged by war and went through an excruciating reunification in the 1990s which saw unprecedented wealth transfers, wages skyrocket and a surge in unemployment as German firms moved production en masse to the east.
Fast forward 20-some years, Germany is positioned at the top table of the global economy and is set to inherit the mantle of EU uber-power. In a certain sense, the Great Recession of 2008 was good for Germany. It consolidated its power base (and pushed France to the sidelines) and the post-crisis easy monetary policy has been a huge windfall to the German economy. Negative real interest rates and an artificially low euro exchange rate are as wrong for Germany as they are for Greece. But with a common monetary policy, we can do little more than offer a Gallic shrug.
This global monetary stimulus has led to a relative boom in German GDP, led by exports. As manufacturing is a larger percentage of GDP in Germany than in almost any other developed economy, not surprisingly half of Germany’s growth over the past decade has come from exports. In a recent report, McKinsey forecast German exports will rise by 80% through 2025, pushing them from 50% to 68% of GDP. Meanwhile, Germany’s external surplus already stands at €188bn or 7% of GDP, the world’s biggest in absolute terms and one of the biggest relative to the size of the economy.
The resulting employment picture is incredibly strong. Unemployment at 5.4% is the lowest in two decades and among the lowest in Europe. German youth unemployment is below 8% – half that of the US, we might add. Over the past 10 years unit labour costs in Germany have risen by only 5%, compared with 21% in Italy. Combine the favourable labour market with negative real short interest rates, low levels of household debt and rising wages, there is positive pressure on consumer spending. To date, growth in German domestic demand has been relatively moderate but it could certainly accelerate.
Keep a look out for further stimulus from a slew of consumer-oriented policies (for example, the recent reduction in forced medical and pension contributions).
So we like the German macroeconomic story. As a fundamental, value investor, the macro picture painted above supports a healthy market for tenants and occupiers and continuing demand for space, the ultimate drivers of financial returns from property.
Beyond the stable macro story, there are also some quite specific reasons why we are drawn to Germany as a place to invest in real estate.
It may surprise you that Germany actually has quite a disorganised property market. We like this as inefficient markets and low price discovery provide the opportunity to find good value. One of the reasons surely has to be due to the polycentric nature of Germany as a whole. Berlin, for example, is the largest city in Germany with a population of more than 3.5 million but still has only 4.3% of Germany’s population. Compare this to London, which makes up 13% of the UK’s residents.
**The road to Berlin**
This polycentrism is equally true at the city level within Berlin, which makes it a particularly interesting place to invest. It was once split down the middle by an (almost) impenetrable wall and had two prime centres until 1989 when the periphery became a new heart of the city. The impact of this is still playing out today with the rise of a number of important sub-markets, set to continue for some time to come. The result is a much more dynamic market.
Strong ‘B’ and ‘C’ cities of 50,000 to 200,000 inhabitants thus become an important hunting ground. This is further reinforced by the long history of the Mittelstand companies, mid-sized hidden champions often located in such smaller urban centres. Key drivers of German growth, they also support a property investment strategy that includes these cities for the office, retail and residential sectors. We do like offices in these markets in addition to the traditional big six cities. For us the key always is to focus on A-locations, which provides a measure of downside protection and enhances exit liquidity.
We also like retail. Much has been written about the downfall of the traditional high street and centre city retailers as consumers tighten their belts and shifting spending patterns favour online retailers. We agree with this. However, we see good opportunities in out-of-town centres with staples like food, pharmacy and clothing – the so-called Fachmarktzentrum. As institutional capital flows have focused on core, prime properties, this asset type has been overlooked. We find good out-of-town retail deals at 10%+ yields on long leases, which we think represents mispriced income. The key here is being able to underwrite the residual value, otherwise you may end up with expensive farmland.
We should also say a word or two about residential. A nation of savers, Germans have stockpiled cash. However, median household net assets at €51,000 are less than that of the typical Italian, Spanish and yes, Greek household. One of the main reasons for this is that Germany has one of the lowest home ownership rates in the West: around 43% of households own their own home (versus roughly 65% in the UK and USA). There are lots of reasons for this – macroeconomic, social, the overall structure of the residential property market and the nature of German housing stock. While too detailed to go into here, the unique character of the German residential market has been the siren call to many an investor over the last decade. Witness the spectacular implosion of many household name funds in the 2008 financial crisis. For us, we like the multifamily residential opportunity where we can buy single buildings on a highly selective basis and where there are asset management opportunities to drive net operating income, particularly through rental increases and operating cost efficiencies.
We are not, however, buying into the story that German residential rents are low on a global scale and will automatically normalise.
**Home ownership**
We also see opportunities for condominium sales as Germans gradually increase their percentage of home ownership. This trend has gained momentum as households look to invest excess savings and are fearful of inflation. Combined with a historically good level of mortgage availability and ultra-low borrowing rates, we are seeing increasing interest in home ownership. These developments are starting to show up in the data: after a decade of stagnation, German residential property prices rose by 5% (in nominal terms) in both 2011 and 2012. Cities like Berlin and Munich have seen much bigger jumps. Yet there is a long way to go. Relative to income, German property prices are still 20% undervalued.
Finally, at the most granular level, the fragmented nature of the Germany property market and resulting inefficiency provides the opportunity for property investors to build a competitive advantage in sourcing good investments. We see good opportunities as often from one- or two-person brokerage firms and “friends and cousins” of vendors as we do from the big name brand agencies. In what is frequently characterised as a closed and secretive market, it is important to wiggle your way into the flow and build a reputation as a trusted actor.
On balance, we think Germany is one of the most compelling investment markets for property globally, with a number of very solid strategies that make sense. Economically prosperous and politically modest, we think the macro picture in Germany looks good – and the micro story is even more compelling.
We should not lose sight of the risks. Germany is the Eurozone’s largest creditor and a meltdown of the EU and contagion of the German banking system would be catastrophic, and property values would be but one casualty. So, too, part of the reason for the favourable employment picture that is propping up property values is an ominous demographic shift, a depopulation trend that by some estimates will see 6.5 million leave the workforce over the next 10 years. With a very close election pending in the autumn, populist policies are also on the rise, like the recently enacted reduction of the permitted rent increase from 20% to 15% over four years in Berlin. Outright rental caps for new buildings are being discussed.
The macro and microeconomic situation in Germany remains positive and underlines its purpose as a safe haven in a volatile time. Key to success in the German property market is prudent and extensive due diligence and excellent relationships in order to turn the market imperfections into the investor’s favour.
