Residential Investments in Germany – June 2023

Dear Readers,

Is Germany’s existing residential building stock on the verge of a renaissance? There are at least a few indications and strong arguments that this is indeed the case. Apart from a few flagship projects, new residential construction is effectively dead across the board. The reasons are all too familiar: soaring construction costs, a sharp hike in financing costs, building regulations that can hardly be met on a break-even basis, and interminably long approval procedures. The goal of 400,000 new apartments per year originally set by the traffic light coalition of SPD, FDP and Greens is becoming increasingly remote.

Prices for existing apartment buildings, on the other hand, are lower than they have been for many a year. In major cities, prices have fallen by double digits in some cases since interest rates started to climb. A square metre of rented housing in Berlin now costs less than half of what it would cost to build a new building.

At the same time, rents in Germany’s biggest cities are far from falling – on the contrary, demand remains high and will not be satisfied anywhere in the foreseeable future due to a lack of new construction. This means that existing apartments also represent a long-term hedge against inflation. And they often have the potential not only to achieve capital gains, but also to achieve an enhanced environmental footprint via judicious refurbishment measures with modest capital expenditure.

Jürgen Michael Schick & Holger Friedrichs

How AI refines the search for the best residential locations

Digitalisation and Artificial Intelligence are starting to have a significant impact in more and more areas of daily life. These twin technologies are conquering new industries in rapid succession and providing high-quality insights that would have been unthinkable in the very recent past – due to a lack of data. In the real estate industry, for example, the potentials of generating added value through data analysis and Artificial Intelligence have become an indispensable pillar of investment management in almost no time at all.

Today, a comprehensive valuation not only analyses a property’s equipment and features, it also includes data on the surrounding area to a far greater extent and in much greater detail than was the case just a few years ago. Both the scope and quality of location-related data and the possibilities for evaluating them have improved enormously. Today, it is possible to determine much more precisely what makes a location attractive for specific tenant groups and, above all, how the respective location will develop in the future. As a result, investment managers gain important insights into where investments are particularly promising and how properties can best be developed. This makes the search for the best location much more precise.

Identifying attractive locations
A wealth of location-specific data on cities, districts and neighbourhoods, and even individual sites is now available. Data suppliers and online map services can already tell us everything we need to know about public transport, bus stops, e-charging stations, petrol stations, schools, green spaces, shops, restaurants, doctors’ surgeries, medical care centres, pharmacies, playgrounds and all of the other amenities that make a location attractive.

For instance, PATRIZIA’s database includes more than 250,000 data points for London and Berlin, 80,000 for Munich and 115,000 for Hamburg. In total, the database currently records more than 25 million data points – and more are being added all the time. This location-oriented data is then combined and enriched with key data on the real estate market and socio-economic factors. The analysis requires structured data collection and IT systems with sufficient computing power. Once the data have been collected and are available, the challenge is to continuously update and intelligently evaluate the accumulated database.

Spotting market developments more quickly
This all requires a proprietary analysis methodology with meaningful variables, such as the one PATRIZIA has developed for its investment management. Artificial Intelligence methods are superior to classic regression analysis in this respect, as they are better able to map developments in the real estate market.

Starting points for the analysis of residential real estate are, for example, the concept of the “15-minute city” from the French-Colombian urban planner Carlos Moreno, who suggested that a location is attractive if most daily necessities and services, such as education, work, mobility, shopping and leisure, can be easily reached within a quarter of an hour on foot or by bike. This accessibility – and thus the attractiveness of a residential location – can be determined on the basis of location-specific data. The key factor at this point is correctly weighting the importance of the individual criteria. That’s where input from local investment managers comes into play.

Artificial Intelligence plus investment experience
As a result, the search for the best location becomes much more precise. Depending on the criteria you select, it is possible to ascertain which tenant groups will be particularly attracted to the respective residential location and, consequently, how many rooms and what features they are most interested in. And since these data are now available over longer periods of time, it is possible to pinpoint specific trends in each city.

Thanks to automated analytics, investment managers receive assessments of each residential location in a matter of minutes. These can be compared with rental data to identify an overvaluation or undervaluation, measured by the attractiveness of the location.

The potentials of data analysis go far beyond the environmental assessment of residential real estate and can also be applied to other asset classes, such as offices and care homes. Data analysis can provide investment managers with a useful tool for identifying attractive investment opportunities, thereby enabling them to meet the increasing demands on the investment management of real estate.

Why residential real estate includes inflation protection

With its latest interest rate hike of 25 basis points at the beginning of May, the European Central Bank raised interest rates in the euro area to their highest level since the Global Financial Crisis. And there are no indications that the cycle of hikes will end anytime soon.

In principle, this is not good news for residential real estate investments: the higher the interest rates, the more difficult it is to enter the residential real estate segment. Above all, however, the uncertainty surrounding further interest rate developments means that potential buyers and sellers are unable to achieve their price expectations in the current market environment.

As a result, both private and professional transaction markets remain subdued. According to the real estate service provider CBRE, the transaction volume in the professional segment amounted to a weak EUR 1.9 billion in the first quarter of 2023, which corresponds to a year-on-year decline of 63 per cent.

At first glance, these figures – in conjunction with the recent rise in initial yields – might suggest that family offices, pension funds, fund managers and other institutional investors are backing away from real estate as an investment asset. This is, however, not the case. Instead, capital is becoming much more selective: business cases and investment opportunities are being scrutinised more carefully than ever before, and not every residential property will find a buyer. Nevertheless, a product that offers stability, value retention and a promising future will always meet with demand. Even in the case of revitalisation properties that are cheap to buy but expensive in terms of subsequent upgrading measures.

Effective inflation protection
In fact, there is one factor in particular that contributes to the long-term value stability of residential real estate investments: effective inflation protection. In the case of residential real estate with inflation-indexed rental adjustments, this is even guaranteed in the lease, in black and white, so to say. But what about conventional leases without such clauses?

For portfolio owners, one of the reasons for this high degree of value stability is the across-the-board decline in new construction projects in Germany – while demand continues to outstrip supply and determine prices. More importantly, however, rental prices never decouple from inflation in the long run: while all too often there is talk of the knock-on effects of inflation and its impact on employee wage demands, both service charges and net rents adjust gradually. Thus, properties with indexed leases offer the twin benefits of allowing adjustments for both existing tenants and new leases. This is especially true for those markets that are not subject to excessive regulation.

Therefore, one thing is clear to me: the current market environment offers favourable opportunities on a scale we have not seen since the Global Financial Crisis. Younger semi-professional investors in particular should take this situation into account and, for the reasons mentioned above, include real estate in their portfolios instead of allocating their money exclusively to other asset classes.

The urban measure of all things: the “in-between” city

When you think of London, what comes to mind? Big Ben, The London Eye, Buckingham Palace? Test passed! We can now try the same with Paris – that’s right, the Eiffel Tower, the River Seine, Arc de Triomphe. How about Berlin? I think we can all see the pattern here: Whenever we hear the name of a major city, we associate it with the city centre, including all its landmarks. Politicians, by the way, feel the same. When they talk about the “future city”, they talk about the centre. When they discuss the density and height of buildings, car-free zones or green facades, they mean in city centres. But firstly, the core city is not the city where most people live, and secondly, it is not the city of the future. In the future, that will be the “in-between city” – where the outer districts of the core city and the inner suburban ring intersect. At least that is what Thomas Sevcik claims. How does he arrive at his thesis? You will be surprised.

As a visionary, he loves to think outside the box: Thomas Sevcik
Whether Autostadt in Wolfsburg, LabCampus at Munich Airport or GreenwichPeninsula in London – they all bear the signature of Thomas Sevcik, who has made Switzerland his home. The co-founder of the strategy think tank arthesia has offices in Hong Kong, Zurich and Los Angeles and advises companies, organisations, cities and regions on repositioning. So, he clearly knows what he is talking about. He also loves facts: for example, two million people live in the Paris of tourists, while ten million live in the banlieues, the suburbs on the other side of the Boulevard Périphérique ring road. But we don’t have to look that far. We find a similar situation in Munich, Hamburg, Cologne and Berlin. So Sevcik’s call to focus on the “in-between cities” can’t be all that wrong.

Leveraging the potential of the “in-between city” – Zurich is showing the way
“In-between cities” – i.e. the urban areas that begin beyond Tariff Zone 1 and end before the classic dormitory towns – have a lot of potential because they are per se home to important infrastructure such as airports or ports as well as large office and logistics zones. So far, planners in Germany’s metropolises have not appreciated or exploited this, says Sevcik, who likes to bring Zurich into play as a successful counter-example. Zurich made an early start by developing a former wasteland between tram depots, marshalling yards, airport feeder roads and city boundaries with intelligent urban ensembles that score points with an exemplary social mix and a well-thought-out mobility and education infrastructure.

Politicians also need to embrace the “in-between city”
There are certainly interested investors and imaginative property developers in Germany. What Sevcik misses, however, are:

• More flexible building and zoning regulations that redefine the interplay of urban manufacturing, housing and culture and that allow for diverse combinations of functions.
• Clearer quality guidelines beyond specifications on distances and building heights – for example, with guidelines on cultural density, added health value and visual attractiveness.
• Planners who have the necessary experience with multifunctional complexes, mobility hubs and very large urban districts.

The pilot project, Innovation Corridor Berlin-Lausitz, with its multi-faceted mix of functions is like a ray of hope for the visionary Sevcik. He must also have liked the fact that the distribution and logistics manager Feng Xu applied for the office of Lord Mayor with the idea of a Greater Frankfurt Bund. His idea: Frankfurt forges a pact with the surrounding municipalities for a joint development plan – just as Greater London and Greater Paris have already done. Feng Xu did not become mayor, but that does not change the fact that, as Thomas Sevcik writes, “new ideas, new debates and new policies” are needed.

You can find the guest article “The core city is not the future” here

New construction is dead, long live existing buildings!

It is difficult to ignore the gloomy figures for new housing construction in Germany these days. Sharp rises in lending rates coupled with soaring construction costs have led to more and more developers, builders, as well as wealthy private and commercial investors, turning their backs on new construction – for now and the foreseeable future.

In general, the market for residential real estate has been very restrained in recent months. In fact, it came to a virtual standstill.

But something is happening. Only slowly, but it has now become clear that the market for existing properties is emerging as the nexus of activity for private and commercial buyers.

Above all, two main types of investors are attracted to existing properties. The first are those who pursue a consistent value-add strategy, which includes, for example, improving the fit-out of the properties, using space more efficiently with better floor plans, or even converting an unneeded shop space into a residential unit. In recent years, of course, energy-efficient refurbishments have been added to the list due to stricter environmental protection requirements – an increase in value that, despite the current uncertainties, certainly makes sense with a view to the years ahead.

In contrast, the other type plays the classic long game. Solid existing properties serve as a very long-term investment, especially for wealthy private investors and family offices, to generate solid returns over an extended period of time.

Both investor groups have one thing in common: they believe in the market for existing property as a market full of opportunities, and if one follows some of their arguments, they could both be right.

This is because an existing property combines several advantages. First of all, purchase prices in this segment have fallen in all of Germany’s Top 7 cities, in Munich and Stuttgart by almost 10 per cent, to name just two.

At the same time, existing properties cost about half of what new construction currently costs – and it is cheaper than it has been for years. Prices for apartment complexes have fallen by 25 to 30 per cent in large cities. For example, the price per square metre for a rented property in Berlin in 2021 was between €3,000 and €3,500; it is now between €2,000 and €2,500. At the same time, rental prices are pointing strictly in one direction. Especially in many large cities, rental prices are experiencing double-digit growth rates.

And due to the restraint of institutional investors, potential buyers are currently facing far less competition for real estate investments.

In summary, one could say that there is currently a window of opportunity to acquire existing properties at yesterday’s prices for tomorrow’s rents.

Added to this: investments in existing properties fit much better into the political-social mainstream than new construction, which is more problematic in this respect. In many cases, they contribute to many of the urban development goals we are all committed to. In this context, the strengthening of inner-city development should be emphasised, i.e. the designation of new residential and commercial spaces in existing areas and not through comprehensive new construction measures on greenfield sites “at the gates of the city”.

On top of all this, less land is sealed – an important climate adaptation measure in our already highly sealed cities. And existing properties are also more cost-efficient than new buildings in terms of infrastructure development. This does not have to be planned or built from scratch. It is simply already there, just like the people.

It is true that anyone who buys an existing building will probably need to have it renovated to improve its energy efficiency in the foreseeable future. Nevertheless, it remains the case that buying and renovating existing housing costs significantly less than a new building today.

My conclusion: the future belongs to investments in existing properties.

News

Berlin real estate market is all set for the challenges of climate change

The Savills Climate Resilient Cities Index has named Berlin the most climate resilient real estate market among 23 selected cities. The other top spots go to Toronto, Paris and Madrid. The study focuses on how 23 of the world’s largest, wealthiest and most populous cities are fortifying themselves against climate-related events and analyses a range of factors, including geography, the proportion of ESG-certified properties and public authorities’ climate risk planning. Temperature and precipitation changes over the past decade, elevation, groundwater volume and potential exposure to natural disasters were also considered. Although all cities still have work to do and Berlin is also affected by periods of drought, severe weather and heavy rain, the German capital picks up lots of points for its location, having the second-highest proportion of certified properties at 1.5 per cent, and its strong climate policy measures.

Real estate industry eagerly awaits consultation on Building Energy Act

Public uncertainty regarding the future specifications for heating systems and energy-saving measures for homeowners and property developers continues. On Friday, 19 May 2023, the German government debated the proposed Building Energy Act in cabinet. Whether the law is passed before the summer break, and if so, with what changes, no one can say for sure at the moment. The real estate industry in particular is following the deliberations with mixed feelings. According to the IVD real estate association, a successful energy transition in real estate depends on the new law being technologically neutral and lowering the hurdles for local heating networks and hydrogen solutions. After the adoption of the Emissions Trading Scheme ETS2 in the European Parliament on Thursday, 18 May 2023, the heating costs for buildings will in any case rise significantly from 2027. In view of the increased regulation of the real estate industry, IVD President Jürgen Michael Schick has called on politicians to focus on economic reality and appropriate funding measures: “We need the German government to balance the realities of construction and financing with its requirements for heating technology and energy-efficient refurbishments. Clear and reliable funding is also essential. Those who make demands must also ensure the right support is in place”.

Berlin property prices dip slightly, only three per cent planning to buy

In the first and second quarters of 2023, prices for condominiums, detached and semi-detached houses in Berlin fell compared to the annual average, as reported by the analysis and consulting firm Empirica. The price decrease was significantly slower than in Hanover and Hamburg, but still noticeable. In the previous quarter, a square metre in a free-hold apartment cost approximately €5,615. It now costs €275 less. House prices have also dipped, by an average of €126 per square metre to €4,054 per square metre. According to figures from the Dr Klein Trend Indicator, apartment prices in Berlin have fallen by 2.7 per cent and house prices by 2.24 per cent. Meanwhile, Berliners remain unimpressed as housing becomes slightly more affordable. According to a representative survey conducted by Berliner Sparkasse in February, only three per cent of Berliners are planning to buy real estate this year.