Creeping up on the Big Six

IFR Germany Report 2014
10 min read

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Germany is riding the crest of a property wave. According to research from real estate adviser Savills, the country saw investment in commercial property of around €9.9bn in the first quarter of the year – a hefty 40% increase in turnover year on year. A sign of how significant that is, is that in volume terms it snaps at the heels of the final quarter of 2013, traditionally the busiest period of the year, which saw €11.4bn of investment.

It is the same for residential property. Most indicators forecast that the upswing in the housing cycle will continue well into 2014. The ifo construction survey reflects the high demand in the sector. Last year, for example, there was a double-digit increase in the issuance of residential building permits – for the fifth year in a row.

“The ongoing favourable financial and economic parameters are increasingly joined by a rising risk-embracing attitude of investors so that the investment market in Germany is now definitely no longer limited to core,” said Andreas Wende, chief operating officer and head of investment at Savills Germany.

Traditionally, the Germany property market has been focused on the Big Six – Berlin, Dusseldorf, Frankfurt, Hamburg, Cologne and Munich. The rest of the country has not had much of a look-in. The rental figures would appear to confirm this. The average rent in five of the six cities was higher, in the case of Cologne by as much as 15%, according to Savills. Only Frankfurt saw a slight decline of 2.8%.

But what is interesting is the yield seen in these cities. The prime office yields in five of the Big Six cities have declined – Dusseldorf by as much as 30bp to 4.6%, while only Munich held steady at 4.3%. What has happened is the long-awaited push away from the Big Six.

“We are now seeing demand for either B locations in A cities or A locations in B cities,” said Markus Kreuter, head of Deutsche Bank’s mortgage-backed securities business. University towns such as Heidelberg and Freiburg have long been tipped and they are beginning to break through. Although in terms of costs it remains high and in terms of yield it is still near the top, for the first time in years, Berlin was not among the five top locations in terms of transaction volume in Q1 2014. Instead Kiel, Bremen and Moenchengladbach all recorded larger volumes.

But more than that, properties in former East Germany are coming to the fore. Despite the low starting point, many cities are starting to see significant investment. Provincial capitals such as Magdeburg, centres of manufacturing, especially those with an airport like Dresden and dynamic cities such as Leipzig have all seen a pick-up.

Indeed, two of the three biggest commercial transactions in Q1 were in the former east – the Unibail-Rodamco €540m purchase of CentrO in Oberhausen and the Morgan Stanley/Redos €400m purchase of four shopping centres in Eastern Germany and Berlin.

This is especially attractive to increasingly yield-hungry, yet still cautious investors. With a spread of anything between 300bp and 500bp over Bunds for German property, no wonder both insurance companies and pension funds are upping their allocation of real estate in their portfolios. The CentrO deal above, for example, has a yield of 4.4%.

The other result of the boom is that banks and private equity have taken advantage of building enthusiasm either to refinance their portfolios or to sell stakes. What has certainly driven the investment is M&A activity.

“Germany saw €78bn of M&A activity last year, of which 18% was in the real estate sector. That makes real estate the second-largest sector after telecoms,” said Alexander Doll, co-chief executive of Barclays Germany.

The first quarter of the year was driven by three weighty deals in the residential sector. In February, Immofinanz subsidiary BUWOG, acquired a residential property portfolio with around 18,000 units and 1.09m sqm of lettable space in Northern Germany for €892m. It was sold by Solaia RE, a joint venture between Prelios and an investment fund managed by Deutsche Asset & Wealth Management.

To minimise execution risk after the deal was completed, BUWOG was spun off and dual-listed on the Frankfurt and Vienna stock exchanges at the beginning of May. “Our decision in favour of a spin-off will allow us to reach our goal of listing BUWOG in a way that is less dependent on capital market sentiment,” said Immofinanz chief executive Eduard Zehetner.

The other two major deals were both courtesy of Terra Firma-owned Deutsche Annington, the largest private residential landlord in Germany, with almost 225,000 owned and managed units. At the end of February, it acquired Vitus Immobilien Sarl and homes owned by DeWAG in separate deals worth a combined €1.8bn and that will increase its residential portfolio by 24%.

But what is noteworthy is that acquisitions in the property market are being financed primarily with debt.

“The bank market is strong. Pfandbriefe never went away and there is a lot of liquidity there,” said Chris Stephens, director of real estate IBD EMEA for Barclays in London. But not just with debt, it is being funded with conventional bonds. Deutsche Annington has quite clearly said it was financing its recent acquisitions with €1.3bn of bonds.

By November, Deutsche Annington had completed all refinancing until April 2015 with a US$1bn two-tranche deal in the US (split into US$750m 3.2% four-year and US$250m 5% 10-year tranches) and a €500m eight-year issue at mid-swaps plus 183bp. To finance recent acquisitions, in March, Deutsche Annington raised €513m via the equity markets followed by a €700m euro hybrid issue of 60NC5 paper at 4.675%.

Other property companies have been going down the convertible bond route. In November last year, Deutsche Wohnen sold a €250m seven-year convertible bond issue with a 0.5% coupon, 35% premium, a call at four years subject to a 130% trigger and a put at five years. In mid-April this year, real estate rival LEG Immobilien sold a €300m 7.2 year issue, also with a 0.5% coupon and with both a put and call at 5.2 years.

What is notable is that they are not using commercial mortgage-backed securities. As an asset class, the CMBS has fallen completely out of favour. In the wake of Europe’s 2007 real estate crash, annual CMBS sales slipped from €39.9bn to less than €4bn, all thanks to Deutsche Bank’s semi-private DECO programme.

“CMBS have suffered from reputation,” said Deutsche’s Kreuter. The only issuer of note over the past 12 months is German property owner Gagfah, 48% owned by Fortress Investment Group, which has sold two CMBS issues: German Residential Funding 2013-1 and German Residential Funding 2013-2.

What allowed these to be priced was the refinancing Gagfah did of six pools of segregated assets in May last year into a €1.04bn five-year multi-family CMBS called Taurus 2013 (GMF 1). The securitisation of a single low-LTV loan originally from Bank of America Merrill Lynch proved that there was demand for the product. The €710m Class A notes were priced at Euribor plus 105bp. This then provided a useful point in the curve for Gagfah to emerge, a month later, with the first of two German securitised deals.

In June last year, it sold a decently oversubscribed €2bn deal: German Residential Funding 2013-1. With a 5.2-year WAL it was split into a large €1.24bn Triple A tranche, a €239.8m Double A tranche, a €137.1m Single A tranche and a €274m Triple B tranche. As well as this there was a Triple B minus €102.8m tranche and €105.2m of unrated bonds retained by Gagfah to comply with the 122a risk retention rule. The tranches were priced respectably at Euribor plus 115bp, 160bp and 210bp for the A to C tranches.

This was followed up by a €699.7m German Residential Funding 2013-2 in October, although it was sold as a club trade rather than a fully marketed transaction. Again successful, these two deals cut a full percentage point – 100bp – off the company’s cost of debt. Nonetheless, it hardly heralds a new pipeline of deals.

The transaction frenzy for property in the first quarter is unlikely to let up. The total transaction volume for Germany’s commercial property market peaked at €30.4bn last year. That was not only a year-on-year rise of 20%, it was also the highest volume seen since 2007.

But this year it is expected to be even higher. At the moment, Savills estimates a minimum of €35bn by year-end and few property watchers disagree. The first quarter, they all say, was not so much exceptional as actually the start of a trend.

“Over the coming months we expect to see various large-scale transactions and the non-core segment is only just gaining momentum,” said Savills’ Wende.

Graffiti is pictured at the fence surrounding the construction site of the new headquarters of the European Central Bank