Residential Investments in Germany – March 2024

Dear Readers,

The new year got off to a mixed start with a chance of sunshine to come. After a challenging twelve months for the real estate industry last year, market sentiment is still somewhat subdued, but the cloud cover is slowly clearing. Cancellations, developer bankruptcies, and declining commercial property purchase prices are still causing problems, but they will no longer shape the real estate landscape in the year ahead.

Germany’s cities have enjoyed a year-end spurt, capital market interest rates have recently decreased, and the inflation rate has fallen sharply, all of which gives us plenty of reason to be happy and look ahead with a keen sense of optimism: What changes lie ahead on the European residential real estate market in 2024? Increases in key interest rate appear to be a thing of the past end and the availability of financing for property buyers is likely to continue to improve as the year unfolds.

It is important to take advantage of this window of opportunity: moderate interest rates and lower prices allow us to address the important questions in the residential real estate segment. When is the right time to buy and when to sell? What condition is the real estate industry in at the start of the year at MIPIM? How can we manage energy consumption efficiently? And why is over-insulation so inefficient? Last but not last, how do we best modernise real estate portfolios and ESG management processes in this age of digitalisation?

We wish you an informative read and a sunny spring!

JMS and HFR

Useless over-insulation

Right now, I have the feeling that Germany is increasingly becoming a “belt and suspenders” society. We want to double-safety-proof everything. For example, our country’s politicians want us to maximise energy-efficiency and minimise carbon emissions in the building sector, so they ask us to fit comprehensive exterior and interior insulation in all of our buildings. At the same time, they want us to install state-of-the-art heat pumps that run on green electricity. Why? To minimize emissions through insulation, even those emissions never even arise. Is that logical?

Moreover, grey emissions mean that excessive insulation is neither economical nor environmentally-friendly. The energy and carbon footprints of popular Styrofoam insulation materials are likely to be devastating.

In addition, triple glazing and thick insulation actually make the climate worse. At least the climate inside our buildings. It is only thanks to complex ventilation systems that real estate – whether residential buildings or office complexes – can be protected from mould.

Not that anyone gets the wrong idea: Depending on which figures you believe, the real estate sector is responsible for up to 40 per cent of greenhouse gas emissions. And our industry is rising to the challenge and making a valuable contribution to climate change mitigation. But let’s not go overboard. We need to concentrate on identifying and implementing sensible solutions. Because, undoubtedly, there is a great deal to do. However, intensively discussing the pros and cons of individual measures should not only be permitted, it should be welcomed and even encouraged.

I want us to approach this discussion with the greatest possible efficiency and effectiveness, and with all due consideration of the requirements of energy policy. Legislators clearly want to prioritise electricity in years to come, whether in the field of mobility, where electric cars have already been lined up as the backbone of individual transport, or in the real estate industry, where electric heat pumps have been earmarked as the technology of choice – if lawmakers have their way. At the same time, the federal government has set Germany the goal of generating a good four-fifths of electricity from renewable energies within the next six years. If the government hits its targets, the entire economy should be climate-neutral by 2045.

However, if the electricity for heating and cooling properties comes from renewable and emission-free sources, insulation cannot have any positive impact on our energy and carbon footprints. The opposite is likely to be the case. The biggest factor in the energy and carbon footprint of a building is its construction, and that includes insulation, which is usually unnecessary.

With a view to tenants’ energy costs, energy-efficiency upgrades certainly make sense if heating is still provided by fossil-fuel sources. My concern is simple: Let’s keep a sense of proportion in all this. Let’s do what’s best in each specific case. So, when it comes to the issue of insulation and a property’s carbon footprint, let’s leave our suspenders in the closet. A belt is all we need.

Digital competence – why technological innovation alone is not enough

The real estate industry is facing growing challenges: rising ESG requirements, evolving market conditions, and an increasing flood of data. Driven by the need to remain competitive in a highly dynamic market environment, digital transformation is no longer an option, it is an imperative. And this is changing the way real estate is managed and optimised. The loss of familiar routines also leaves employees grappling with new challenges, because digital competence requires openness to change.

Digitalise data and processes together
For years, the real estate industry was so successful that many companies saw no urgent need to optimise their data processing and business processes via new digital capabilities. The value of real estate continued to rise, even without exploiting its full potential in asset and property management. But times have changed. Digital management is now becoming increasingly important as companies strive to increase the quality of their data and improve their workflows. However, simple software solutions that can be applied to individual workflows are not enough. Companies need comprehensive digital solutions that solve the problem of data silos if they are to effectively use data in every facet of their businesses.

However, even a meticulously maintained data set can only be used to improve real estate assets and their performance if everyone involved in the value chain adheres to defined, clearly structured processes. It is essential that digitalisation also includes work processes. Digital workflow management takes the diverse range of tasks in different departments and defines specific conditions, rules, and decision points. This enables routine tasks to be automated, which, in turn, can speed up accounting processes, to name just one area of application.

In particular, process landscapes that have many interfaces – for example between asset and property managers, or between property and facility managers – stand to benefit greatly from digital networking. In addition, digital process environments are adaptable systems that allow users to modify processes whenever other methods prove to be more efficient in practice. This allows workflows to undergo continuous optimisation.

Digital competences
Real estate management companies not only benefit from digitalisation because it gives them more efficient processes, but also in recruiting employees. A modern, technology-oriented job profile can help reduce the shortage of skilled workers in the industry. Younger people have grown up with digital tools and are drawn to jobs that use and promote digital skills. The integration of modern technologies into property management directly appeals to this digitally savvy group.

For employees who are used to traditional work methods, digitalisation often means adopting a new way of thinking. Openness to change is crucial. Employees must be prepared to fully exploit the potential of digitalisation and to actively participate in the continuous development of processes. To do this, each individual must be empowered to rethink familiar processes in order to identify ways to optimise them.

It is therefore crucial to create a culture that welcomes and supports change. Employers should foster an environment in which questioning routines and experimenting with new solutions are viewed positively. You also need to recognise that employees who are not so tech-savvy can find transformation processes stressful. A lack of management support or inadequate training and resources to cope with new demands can increase uncertainty. It is therefore important not only to consider the technical aspects of the transformation, but also to consider the psychological impact of change on employees.

Willingness to change
The digitalisation of the real estate industry marks a turning point that increases the efficiency of data and process management and also modernises job profiles, making the sector more attractive for the next generation of employees. In all this, it is important not to underestimate the challenges for the workforce, because employees will need to adopt a mindset that embraces change. Employers should support the introduction of digital tools through training and a supportive culture. Ultimately, digitalisation is a holistic approach that combines technical innovations with the ability and willingness to change.

Smart buying strategies in times of crisis

Complaints from stakeholders within the real estate industry are getting louder and louder: interest rates and construction costs are too high; large numbers of property valuations need to be reduced; transaction volumes collapsed dramatically in Germany in 2023. According to data from JLL, the total volume of transactions fell by 52 per cent to EUR 31.7 billion. And overall prospects for this year are not exactly rosy either, even if the European Central Bank (ECB) does decide to lower its key interest rate. In this environment, many market players are saying that there are hardly any attractive opportunities to buy at the moment, at least not at current interest rates and market conditions. They are wrong.

Because, at the same time, the volume and ratio of real estate loans at risk of default on bank balance sheets have also risen sharply. According to the latest calculations from Germany’s Federal Financial Supervisory Authority (BaFin) and the Bundesbank, the volume of non-performing commercial real estate loans (NPLs) on the books of institutions supervised by the ECB was more than ten billion euros at the end of September 2023. In the middle of the year it was around eight billion euros. Moreover, the NPL ratio at major banks rose to more than three percent.

BaFin even sees dangers for individual banks, as it writes in its current report “Risks in Focus 2024”: “The difficult situation on the commercial real estate market is likely to impact the earnings of the affected banks for a longer period of time and require higher risk provisioning. Highly specialised business models or poor selection of properties by the banks could even cause difficulties for individual institutions”.

Given these statements, credit institutions will certainly look to divest themselves of NPLs. Especially since the BaFin requires real estate loans to be backed by a sectoral equity buffer of two percent.

And this is where potential investors come into play. Because one person’s suffering can become an opportunity for someone else. For example, for investors who are interested in real estate transactions despite the crisis. In our view, the loans at risk of default are a suitable purchase target, as this would allow investors to obtain the underlying assets more economically.

Lower entry prices reduce the risk of further devaluations for investors. In fact, we might even see the opposite of devaluations. In an ideal case, asset values could even increase.

In addition to banks, insolvency administrators and mezzanine investors are also likely to be potential suppliers of bargain real estate. The latter in particular are under significant pressure in the current market. Some may even find themselves owning a distressed property or two. If they do not want to risk the total loss of their investment, mezzanine financiers would be left with just two options: sell their loans or take on a partner. Both are likely only possible with significant discounts on the purchase price, which means opportunities for other canny investors.

Is springtime approaching on the Côte d’Azur?

The international real estate trade fair MIPIM is due to open its doors in a matter of hours. What can German participants expect? And what does the future of the market hold in store? Let me see if I can provide a touch of perspective.

As is the case every year on the eve of MIPIM, there is a lot of talk about Mediterranean flair, the fantastic light, and the incomparable Cannes coastline. There will be talk of champagne, parties, and the awakening of spring. But the crisis and decline in new construction are also part of the reality this spring and will be major topics, at least among German participants.

Whatever the topic of discussion, the German real estate industry has long played a major role in the trade fair in the fashionable city of Cannes. In 2022, around 14 per cent of international guests were German, and they accounted for around 10 per cent of the stands.

One thing is clear: MIPIM is an important event for lots of real estate managers – as well as for investors, developers, financial institutions, and intermediaries. Noticeably, marketing representatives from both smaller and larger German cities – and their sub-exhibitors in particular – seem to feel particularly at home in Cannes. Berlin, Munich, Leipzig, Stuttgart, and Cologne: so many German cities and metropolitan regions are at MIPIM. But how much party spirit are these participants bringing with them on their trip to the south of France this year? And how much gloom and crisis will they have in their suitcases?

Strong end-of- year spurt in Berlin
Sometimes it’s worth looking at the fundamentals to understand the sentiment. On the one hand, there is no end in sight as new construction continues to bottom out. The list of insolvent developers gets longer every day. Some players who recently made a big impact will be gone entirely this year. On the other, there are a number of market segments that started 2024 with signs of optimism. The Berlin residential investment market, for one, has shaken off any talk of ongoing crisis, falling prices, and declining transactions. The Berlin market for residential and commercial buildings experienced a strong end-of- year spurt. The number of transactions increased to 184 in the fourth quarter of 2023, around 30 per cent up on the previous quarter (Q3/2023: 142). In the first quarter of 2023 there were only 106 transactions.

The market for multi-family homes also experienced unusually strong growth, particularly in terms of sale volumes. In Berlin, these reached their highest level for two years at EUR 1.1977 billion in the fourth quarter, which corresponds to an increase of around 48 per cent compared to the fourth quarter of 2022. Compared to the third quarter of 2023, sales climbed by around 120 per cent. These figures come from the most recent edition of “Zinshausmarktbericht Berlin” (“Berlin Investment Housing Market Report”), which is published every quarter and is based on data from the Expert Committee on Berlin Property Values and SCHICK IMMOBILIEN’s own calculations and was published in January 2023.

Time for optimism
So – as long as you focus on existing properties, including those in the Berlin residential investment market – there would seem to be no reason to go to MIPIM with a heaviness in your gut.

The European Central Bank’s (ECB) recent decisions could also provide latent optimism this year, as it can be assumed that the key interest rate will fall slightly before the end of the year, even if the two-percent inflation target is not reached. That would send a positive sign to the real estate market.

It is clear that the key interest rate will also have an impact on the all-important cost of borrowing. The peak seems to have been passed here, which could send a positive psychological message to the entire market. From a buyer’s perspective, the beginning of 2024 in particular has already turned out to be an exciting time with numerous attractive properties coming to market. Moderate interest rates and falling prices, combined with a large selection of properties, ensure increased affordability.

Strong demand for housing
And one last argument: We continue to see Germany’s growing population driving demand for housing. This creates attractive opportunities for institutional and private investors, especially in major cities, which are the main beneficiaries of immigration into Germany and have seen the sharpest increases in demand for housing.

The bottom line is that there is a good chance things will look up this year. And the industry? For some, this year’s MIPIM will provide the first feelings of spring. And as far as I’m concerned, I’ll definitely be packing a healthy amount of optimism in my luggage.

What do you think? I look forward to seeing you at MIPIM – you can find us at stand P4.C3 – or afterwards in Berlin.

News

Berlin’s Senate aims to introduce Faster Building Act in mid-2024

Christian Gaebler (SPD), Berlin’s Senator for Urban Development, Construction, and Housing, recently told the German Press Agency that the Berlin Senate’s new Faster Building Act is now expected by mid-2024. Previously, Governing Mayor Kai Wegner (CDU) had declared on 4 August 2023 that the law was due to come into force “this year”. Over the past few months, hundreds of comments, suggestions and proposals from associations and municipalities have been evaluated and sent to the respective administrations for feedback. Gaebler believes it is realistic that the new law could be in place by the summer, but added: “I can’t guarantee that we will have dotted every ‘i’ and crossed every ‘t’ on all of the implementing regulations by then”. The Faster Building Act was promised in the coalition agreement between Berlin’s governing parties, the CDU and SPD, who have been in office since 2023. The new legislation is intended to significantly accelerate planning and approval procedures in order to develop more housing in Berlin. In December, the Senate revised Berlin’s building code to make it easier to add extra storeys, convert attic floors, and build with wood. The problem with legislative proposals is that administrations take time to provide their feedback, which in the worst case could be up to six months, Gaebler explained. “In my view, the most important aspect of all this is having reliable deadlines”, Gaebler said. The Faster Building Act’s provisions include stipulations for shorter deadlines and faster procedures.

Rents continue to rise rapidly in Germany’s major cities

An analysis by real estate service provider JLL shows that rent increases in German cities are still accelerating. In total, JLL analysed around 35,000 rental offers and 41,000 sale listings. In the second half of 2023, asking rents in Germany’s eight largest cities – Berlin, Hamburg, Munich, Cologne, Frankfurt, Düsseldorf, Stuttgart, and Leipzig – rose by an average of 8.2 per cent compared to the same period of the previous year. The 2022 study reported an increase of 6.3 per cent. Over the past five years, JLL finds, annual rent increases have averaged around five percent. According to JLL, many prospective buyers have been priced out of buying a property, which is driving demand for rental units and pushing asking rents ever higher. Berlin and Leipzig recorded particularly strong annual increases, each registering double-digit rises in the period under examination. While asking rents in Leipzig rose by an average of 10.6 per cent, the figure for Berlin was 21.4 per cent. In the existing apartment segment in Berlin, the average increase was higher still, at 31 per cent. On average, rents in the capital are closing the gap with Munich, the most expensive rental market in Germany. Averaging EUR 19.42 per square metre, Berlin is the most expensive city after Munich, where rents average EUR 22.50 per square meter.

Signa’s construction projects in Berlin are insolvent

Having announced a halt to construction on several Berlin projects in November, the troubled Austrian real estate group Signa filed for bankruptcy for a number of these projects at the beginning of the year, reports the Süddeutsche Zeitung. The reason for the latest developments is “a cascade of insolvencies from top to bottom”, explains Gerhard Weinhofer, spokesman for the credit rating agency Creditreform. Late last year, the two subsidiaries Signa Prime and Signa Development Selection AG applied for insolvency proceedings and restructuring under self-administration after an out-of-court restructuring failed. Signa Prime owns several commercial properties in prime locations, including KaDeWe in Berlin and Elbtower in Hamburg. According to Creditreform, Signa Development’s portfolio comprises 39 construction projects. The insolvency application for the Berlin construction sites includes the “P1” development on Passauer Straße and the “Femina Palast” project on Nürnberger Straße, according to the Tagesspiegel. The Galeria Karstadt Kaufhof department store chain, which also belongs to Signa, has also filed for bankruptcy; after the third bankruptcy in four years, the chain is currently in discussions with potential investors.