Residential Investments in Germany – June 2024

Dear Readers,

As the seasons brighten, encouraging market data is steadily improving the mood in the residential real estate sector. And the more positive sentiment is not only reflected in the progress made with Berlin’s Faster Construction Act, it is also evident on the market for apartment buildings in Berlin. What’s more, numerous market surveys have underlined the enhanced sentiment among industry professionals.

Towards the end of May, the capital markets responded calmly to the slightly better-than-expected price data from the USA and Europe. However, the pressure on prices and financing continues to impact residential construction, highlighting the urgent need for additional support measures. One potential solution could be the implementation of a higher special depreciation allowance.

Meanwhile, we also explore the future of construction, focusing on the benefits of sustainable and profitable operations through the utilisation of geothermal energy and photovoltaics, as well as looking at the political measures that are already promoting sustainable infrastructure today. This is where a flexible and secure transaction environment to enable swift data exchange and expedited transaction processing is so crucial.

With the latest edition of our newsletter, we make sure you stay informed and engaged!

JMS and HFR

Geothermal energy
It pays to harness the Earth’s heat

Developers who aim to increase the value of their properties rather than see them lose value in years to come already understand the importance of investing in sustainability. The aim of forward-looking property development should be to create properties that use as little energy as possible – and the more self-sufficient the energy supply, the better. One promising but often overlooked energy source is geothermal energy, which offers significant potential for sustainable energy generation. Geothermal energy is derived from the heat stored beneath the Earth’s surface. Within the first 100 metres below ground, the temperature remains a constant ten degrees Celsius. As you drill deeper, the temperature increases. According to the Renewable Energy Information Portal of the Federal Ministry for Economic Affairs and Climate Protection, the temperature rises by three degrees Celsius every 100 metres.

Depending on the location, there are three distinct methods for harnessing geothermal energy as a sustainable energy source: near-surface geothermal energy, which involves tapping into heat sources at depths of up to 400 metres; geothermal systems that utilise hot water underground and reach depths of around 4,500 metres; and systems that extract heat from deep rock formations to generate power, also known in specialist circles as petrothermal geothermal energy, tapping deep-lying heat reservoirs up to 5,000 metres below the surface. Of course, not all of these methods are universally applicable. For instance, when it comes to supplying houses with geothermal energy, the near-surface variant is typically going to be the preferred option.

The use of geothermal energy enhances the value of a property
For investors and property developers, it is well worth looking into geothermal energy as a viable energy source. Not only does it align with environmental principles and promote the sustainable development of our building stock, it also offers significant financial benefits.
Simply put, using geothermal energy enhances the value of a property. A building powered by geothermal energy not only meets the European Union’s sustainability standards, it also makes building users independent of the public grid. The only electricity the building needs is the power to run its geothermal heat pump, and this can usually be purchased at a subsidised price or generated directly via solar panels. This leads to a significant reduction in tenants’ ancillary costs. As a result, property owners can command higher rents over the long term, allowing them to recoup their investment in a relatively short period of time.

Test drilling needs to be approved by the authorities
While the benefits of geothermal energy are numerous, there is one hurdle to overcome: the need for test drillings to determine the suitability of a given building site. A Thermal Response Test (or TRT for short) needs to be conducted to determine the thermophysical subsurface parameters and establish whether on-site conditions are suitable for the use of geothermal energy. This procedure can be quite costly, with investors often required to pay substantial five-figure sums. Moreover, geothermal installations are also subject to approval from the relevant authorities. After all, drilling can have an impact on local tectonics, groundwater, and neighbouring buildings. Understandably, the authorities approach all such projects with caution, ensuring they comply with a strict set of regulations.

Geothermal power plants can have an impact on local vegetation
It is important to bear in mind that geothermal energy, when extracted from close to the surface, can potentially harm vegetation directly aboveground. The process of extracting heat from the earth can cause the soil to dry out, affecting the surrounding plant life.

However, this should not stand in the way of thoroughly assessing local conditions and gathering relevant data. Where test drillings have already been conducted or geothermal is already in use in a specific area, valuable insights may potentially already be available regarding the opportunities on site.

One potential drawback that may deter investors is the higher initial cost associated with geothermal heat pump systems compared to conventional heating systems. On average, a geothermal heat pump can cost between 12,000 and 15,000 euros and it typically takes approximately seven to ten years to yield a return on this upfront investment.

Attractive returns on long-term investments
Accordingly, equipping a property with a geothermal heat pump system is a particularly profitable proposition for investors who want to keep properties in their portfolios over a longer period of time. Conversely, anyone looking for a quick turnaround on their investment may struggle to recoup their outlay within a short timeframe.

Furthermore, geothermal heat pump technology may not be suitable for all types of properties. Retrofitting existing buildings can be a complex and labour-intensive process, requiring specific features such as underfloor heating. As a result, new construction projects are better suited for the installation of geothermal heat pump systems.

The economics of geothermal energy primarily depend on the type and scale of the project at hand. For instance, near-surface geothermal energy may be the most viable option for single-family homes with ample land, whereas deep drilling may be more suitable for larger buildings and larger-scale projects.

But where conditions do allow the use of geothermal power, it is a far more effective solution than an air-to-water heat pump. The enhanced efficiency of geothermal systems mean they are always going to be the more cost-effective and sustainable option in the long run.

Geothermal heat pumps provide heat in winter and cooling in summer
Geothermal energy is not only attractive from a financial point of view, it also enhances the overall quality of life for residents. During the winter months, living areas are efficiently warmed by underfloor heating. But that’s not all as, unlike traditional heating systems in Germany that do not offer a cooling feature, geothermal heat pump systems can be “reversed” in summer to provide a cooling effect, guaranteeing comfortable ambient temperatures whatever the season.

Geothermal energy presents a compelling opportunity for investors in the real estate sector to develop sustainable and forward-thinking projects. While the initial costs can be higher, the long-term advantages in terms of energy efficiency, environmental sustainability, and tenant satisfaction are undeniable. Incorporating geothermal energy into real estate developments could play a vital role in helping achieve ESG objectives and decarbonising the building stock.

The aim across all sectors should be to promote geothermal projects as effectively as we possibly can. And that goes far beyond simply handing out new subsidies. Above all, the government needs to streamline approval processes for deep geothermal energy, which are currently regulated by the Federal Mining Act (BBergG). And if developers could be granted controlled access to the findings of previous test drillings, they would certainly find it easier to evaluate the potentials of this technology in the first place.

Institutional investors set their sights on photovoltaics

The installation of photovoltaic systems on buildings is becoming increasingly popular among professional investors. A survey of institutional investors (insurance companies, banks, pension funds, and so on) conducted by Universal Investment in the spring of this year revealed that 68 per cent of respondents are already using photovoltaics, in particular to reduce the carbon footprint of their real estate portfolios. The same proportion, 68 per cent, said they had taken steps to optimise heating systems across their portfolios, while a staggering 95 per cent confirmed they had implemented initiatives to reduce electricity and energy consumption. The survey allowed respondents to select multiple applicable statements from a variety of options.

According to the survey, 45 per cent of respondents want to use the majority of the electricity generated by photovoltaic systems on their buildings and feed the rest into the grid, whereas 35 per cent said they would prefer to lease their systems to an external operator. And, of course, it is essential that investments in photovoltaics make economic sense. The survey revealed that 59 per cent of respondents are primarily focused on optimising the value of their properties, while only 14 per cent of respondents are looking to boost their free cash flow yields.

The growing political momentum to increase the use of decentralised, emissions-free energy sources currently coincides with the growing desire among institutional investors to expand the provision of owner-operated photovoltaic infrastructure. For example, an amendment to the German Renewable Energy Sources Act (EEG) in 2023 eliminated a technical restriction on photovoltaic systems installed after January 1, 2023, allowing them to feed in excess of 70 per cent of their nominal output into the public grid.

Among the forest of certificates, traditional energy certificates remain popular
One issue that is currently on the minds of professional investors is the complexity surrounding sustainability certificates. A relative majority of investors continue to rely on traditional energy certificates (35 per cent), with the GRESB methodology coming in second place (24 per cent). Other certifications, such as DGNB, LEED, or BREEAM, as well as proprietary scoring models, also play a significant role in the industry. The fragmented nature of the certification landscape highlights the lack of a universally accepted standard.

This particularly applies to the one-third of respondents who have not yet assessed the ESG performance of their real estate portfolios. Conducting this assessment is, however, the first decisive step towards successfully transforming the building stock. While there has been no shortage of discussions on this topic in recent years, there is clearly still a need for action on the part of some. Implementing a standardised methodology would streamline processes and enhance clarity and transparency. This should be the ultimate goal for both policymakers and businesses.

The new gold: Data play an increasingly important role in the transaction process

The length of time it takes to close a transaction on the real estate market has reached a new record level. This has made buying and selling even more difficult, further exacerbating the challenges on what is already a stagnant real estate market. The slowdown certainly has not been helped by escalating regulatory requirements. However, the persistently challenging economic conditions, including high construction costs, unattractive interest rates, and an uncertain market environment, are also putting the brakes on countless transactions.

To conduct a thorough analysis of transaction activity, we sifted through all of the data from transactions in Drooms data rooms last year. We also asked a select group of real estate experts for their insights. With the “Drooms Real Estate Transaction Barometer 2024”, we can pinpoint issues within the real estate market and provide a framework for understanding overall market trends. But the data are not only valuable in terms of retrospective analysis, they also play a crucial role in identifying and addressing potential issues during the transaction process itself.

Closing a deal has never taken longer – only Switzerland bucks the trend
At an average of 342 days per transaction, transaction times in Drooms data rooms reached yet another historic high last year. This is remarkable in several respects, as it represents the continuation of a longstanding tend rather than just a one-off snapshot. In last year’s report, we reported a new all-time high – and even this has now been surpassed. In fact, a majority of investors surveyed said that the time needed to close a deal had risen by up to 20 per cent.

In established real estate markets such as the UK and Germany, we recorded a notable uptick in transaction timelines, with the UK experiencing the most substantial increase. In the UK, transaction times rose from 319 to 391 days, an increase of 72 days. In Germany, in contrast, the transaction duration increased by just 21 days. Despite these clear European trends, there were also a number of positive surprises, such as Switzerland, where the average transaction timeline of 46 days was significantly lower than in the previous year.

Residential real estate continues to lead the field
The second key insight from the Drooms Real Estate Transaction Barometer 2024 is that residential and logistics real estate are still rated as attractive. While this is not exactly surprising, it is nevertheless well worth mentioning. Clearly, investors appreciate the reliability of rental income from these asset classes. More than 50 per cent of respondents see these two asset classes as the most attractive investment targets, with logistics/industrial at just under 35 per cent in first place and residential properties at around 20 per cent in second place. Our report also provides a glimmer of hope for the long-suffering real estate market: 40 per cent of respondents indicate they are open to new acquisitions.

However, the outlook for office properties is less favourable, with only nine per cent of respondents showing interest in investing in this sector. The long-term nature of this development is confirmed by the investors we surveyed, over 70 per cent of whom expect office space to be significantly less in demand in the future.

Increased regulation dampens the real estate market
The likelihood of closing a transaction after the completion of due diligence has apparently begun to decline: More than half of Drooms’ respondents reported a falling success rate for property transactions in the past year. It is particularly worrying that around a third of those surveyed noted a decline of more than 20 per cent.

The declining certainty of projects is having a detrimental effect on the real estate market as a whole. Developers and investors are finding it increasingly difficult to accurately predict the duration of a project. This uncertainty is further impeding the real estate market, which is already so heavily dependent on new construction and development.

Expediting transactions means you are more likely to successfully close deals
Slower transaction processes, regulatory uncertainties, and the challenges of a growing volume of data, particularly in relation to ESG criteria, are becoming ever greater hurdles in the transaction process on the property markets. Data are worth their weight in gold because having a better overview of the transaction process means you can make decisions more quickly.

Modern data rooms are a valuable tool that can expedite the completion of real estate transactions. And while they may not resolve financing issues, they do have the capability to highlight problems and identify unfavourable deals more quickly. Added to this is the growing use of AI-based data rooms, which are also gaining in importance in view of the shortage of skilled workers and shrinking margins in the transaction business.

Click here to download your copy of the Drooms Real Estate Transaction Barometer 2024

Residential Investment Barometer points to optimism

Despite some pretty healthy figures, sentiment on the residential investment market did not really improve last year. Nevertheless, many in the industry are now expressing a more optimistic outlook. The trend towards a potential upturn in the market seems to be gaining momentum and the fundamentals have become more robust.

Optimism has returned to the residential investment market – at least as far as existing properties are concerned. This is a significant development, especially considering the prevailing negative sentiment that has otherwise been widely reported. Given the doom and gloom headlines, we could be forgiven for thinking that the entire real estate market is on the verge of a total collapse. Every day we read about a “Real estate market collapse”, “Tough times ahead”, or a “Deep freeze on the real estate market”. In reality, the challenges are far more localised, affecting submarkets such as new construction or the office and commercial real estate sectors. But the truth doesn’t make for such exciting headlines. The fact that there are markets in which the economic slump has bottomed out and things are looking up is also rarely mentioned, both in terms of sentiment and figures.

In the residential investment market, for instance, sentiment and figures are both positive. This is confirmed by the latest data from the Schick Immobilien “Zinshausmarktbericht Berlin” (Berlin Residential Investment Barometer”) for the first quarter of 2024. These figures suggest that the fundamentals of the residential investment market in the German capital are sound. Incidentally, it is worth noting that Berlin’s market is representative of the overall German residential real estate market, as it accounts for approximately 20 per cent of the nationwide market for apartment buildings. In the first quarter of 2024, there were 116 transactions involving apartment buildings in Berlin, compared to 108 in the same quarter of the previous year, marking an increase of around 7 per cent. While this increase is notable, it is not a game-changer in and of itself.

There were clear indications of a significant turnaround in the previous quarter, as evidenced by a notable increase in the number of transactions. In the fourth quarter of 2023, transactions rose by approximately 30 per cent compared to the previous quarter, reaching a total of 184 (compared to 142 in Q3/2023). This followed a relatively modest 106 transactions in the first quarter of 2023. The market for multi-family homes in particular registered an exceptionally strong increase in transaction volumes. In the fourth quarter of 2023, sales in Berlin reached EUR 1.1977 billion, marking the highest figure in two years and representing a 48 per cent increase compared to the same period in 2022. In comparison to the third quarter of 2023, the increase is even more impressive, equating to roughly 120 per cent. The volume of transactions also grew significantly in the first quarter of 2024. With an increase of 114 per cent to EUR 832.6 million, the transaction volume more than doubled compared to the same quarter of the previous year.

Sentiment has brightened
So, do the data point to a significant change between the two quarters? Not really. Both periods showed signs of a recovery. However, the key difference lies in market sentiment, which we gauge in our Residential Investment Barometer ­– a survey of 2,000 private and commercial investors. A direct comparison of the results of the two most recent barometers reveals that the mood among the surveyed investors was far more pessimistic last year. Thankfully, in line with the improvement in revenues and transaction volumes, sentiment has now brightened considerably. The majority of respondents now view investment opportunities as “average” (around 41 per cent), with a quarter rating them as “good” (25 per cent). This marks a significant improvement over the last survey in November 2023, when most respondents expressed a negative outlook on investment opportunities.

Hope for the year as a whole
The latest Residential Investment Barometer reveals consistent trends across various parameters. Take price trends, for example: A relative majority of investors and property owners, approximately 35 per cent, anticipate stable prices, while around 23 per cent are forecasting rising prices. This marks a notable shift from the previous survey, where less than a third expected stable or rising prices. Or take willingness to buy: In the November 2023 survey, only 37 per cent of investors said they were planning to expand their portfolios. In the latest survey, in contrast, the figure has increased to 58 per cent – indicating another significant positive correction.

These examples illustrate a significant shift in the mood on the residential real estate market and give us great hope that the current stability will continue through the middle of the year and the second half of the current year.

There are already some significant forks in the road ahead: How will regional election campaigns affect residential construction and rent regulation? What decisions will the ECB make regarding the key interest rate? And what impact will foreign policy developments and crises have? It is therefore imperative that all stakeholders – including politicians, investors, owners, and users – work together to chart the right course ahead. By doing so, we can anticipate a positive ripple effect throughout other submarkets across the real estate sector, leading to a brighter outlook overall. With a concerted effort, we may soon be seeing headlines proclaiming “Positive signals from the real estate markets” and “Things are finally looking up again!”

News

First draft of Faster Construction Act has now been finalised

After several announcements over the last few months, including one from Christan Gaebler (SPD) to the German Press Agency that the Faster Construction Act would be in place by mid-2024 (recently reported in his very newsletter), the Berlin Senate finally presented an initial draft at the beginning of April. Business and environmental associations were then given two weeks to provide feedback on the draft. The law, currently due to come into force at the end of 2024, comprises 41 amendments to nine state laws and one ordinance and is primarily designed to speed up the completion of residential construction projects. In general, the proposed law aims to streamline planning and approval procedures, introduce review and processing deadlines, and establish a clearer division of responsibilities between state and district authorities. This will give the state greater influence and aims to promote digitalisation in the construction sector. Additionally, building owners will receive more accurate information about approval timelines and, according to Christian Gaebler, stop the misuse of inspection procedures and nature and species protection to delay construction projects. According to the Tagesspiegel, the Expert Advisory Council for Nature Conservation and Landscape Management, an independent body affiliated to the Senate Administration, criticised the draft law for doing little to expedite the construction of new buildings or enhance social infrastructure. The Council also said that the proposed legislation would “alter key standards related to the protection, preservation, and development of nature and the environment”. As this could result in a significant dilution of nature conservation efforts, the council has recommended that the draft be “roundly rejected”.

State of Berlin takes over 4,500 apartments from Vonovia

As the Governing Mayor Kai Wegner (CDU) announced on April 24, the municipal housing company Howoge is taking over 4,500 apartments from the Bochum-based real estate group Vonovia in the district of Lichtenberg. The deal also includes 6.9 hectares of building land in the Berlin-Buch and Berlin-Lichtenberg districts, which Howoge is taking control of together with Berlinovo, another state-owned housing company. According to Handelsblatt, the EUR 700 million transaction is expected to be finalised by the end of the year. Ulrich Schiller, Managing Director of Howoge, has evaluated the location, construction, and condition of the newly acquired properties as being on par with Howoge’s existing municipal portfolio. According to Schiller, the average rent of EUR 7.04/sqm also aligns “perfectly with municipal housing.” The EUR 700 million will be a combination of equity and loan capital. Three years ago, Berlin’s three municipal housing companies Berlinovo, Degewo, and Howoge took over almost 15,000 apartments and 450 commercial units from Vonovia and Deutsche Wohnen, prior to the two companies’ merger, at a price of EUR 2.46 billion. In 2019, around 2,100 units were also acquired by Degewo from Deutsche Wohnen for EUR 358 million and almost 5,600 apartments by Gewobag from Ado Properties for EUR 920 million. The aim of these purchases is to bring the Berlin rental market back under municipal control. According to official figures, more than a fifth of Berlin’s approximately 1.7 million rental apartments are currently in public ownership.

KaDeWe changes hands as the list of insolvent Signa companies lengthens

Following the insolvency proceedings and restructuring under self-administration of Signa Prime and Signa Development Selection AG, two subsidiaries of the Signa Group, the iconic Berlin department store Kaufhaus des Westens (KaDeWe) has now been sold. The buyer, Thai Central Group, has agreed to acquire the entire KaDeWe property. The transaction was valued at one billion euros according to Berlin’s Senator for Economic Affairs, Franziska Giffey (SPD). Neue Zürcher Zeitung (NZZ) has also reported that Signa Prime is actively seeking buyers for its remaining properties, including the renowned Swiss department store chain Globus. In a related development, Galeria Karstadt Kaufhof, the Signa-owned German department store chain, also filed for insolvency at the end of the year, and now the investment company for department stores, Signa Retail GmbH, has also filed for bankruptcy. Signa Retail held stakes in Galeria Karstadt Kaufhof, KaDeWe, Globus in Switzerland, and the British Selfridges Group, among others. Following the takeover by a new owner, Galeria Karstadt Kaufhof will be rebranded as Galeria from the end of July, as announced by the insolvency administrator Stefan Denkhaus in early May. Additionally, 16 of the chain’s 92 department stores will be closed, as revealed by Denkhaus in late April. As the insolvencies within the Signa Group continue to mount, the Austrian Public Prosecutors Office for Economic Affairs and Corruption has launched an investigation into company founder René Benko. The investigation relates to the extension of a loan totalling EUR 25 million, with Benko allegedly having misled the lending bank as to the Signa Group’s financial situation.