by John Morgan
The present political and economic scene makes it virtually impossible to give a reasoned forecast of the future of the German property market. The sudden collapse of the East German regime last November came as a complete surprise to politicians and businessmen alike, as have the recent rapid moves towards reunification.
But what will be the effect of reunification on the economy and, in particular, the property market in West Germany?
Industry and commerce in West Germany have been quick to recognise the tremendous business opportunities both in East Germany itself and, through East German contacts, in other parts of Eastern Europe. This should mean further orders at a time when West German industry is already working at almost record capacity — the result of which is likely to be higher inflation.
The huge investment programme needed for East Germany will be financed largely by the private sector, but one should not underestimate the contribution necessary from the government, particularly in the area of social infrastructure — pensions, unemployment benefit, social security and the health service.
The West German government recently announced a DM115 bn unity fund to raise money “off budget” for East German reconstruction over the next four and a half years. With such outlays by the government there can be no reasonable expectation of interest rates being reduced in the near future. On the contrary, if the Bundesbank acts against inflation, as is to be expected, this will tend to increase interest rates.
German industry continues to have full order books, and demand for commercial and industrial properties therefore remains high — albeit accompanied by high interest rates and much higher inflation than the Germans are used to. One leading German economist, Bruno Tietz, expects inflation to rise from its present level of around 3% to 7% or 8% in the next 18 months to two years. This will continue to make life difficult for both closed-end and open-ended funds and, if interest rates remain high, the life assurance offices are more likely, in my opinion, to stick to bonds for their investment, rather than real estate. Foreign investors will then effectively be shaping the market, which will tend to make it more volatile than in the past. If, for example, the DM were to weaken against other currencies or the present tax loopholes, enabling foreign investors to pay virtually no tax in Germany, were to be changed (something which is under discussion at the moment), foreign interest could wane considerably.
Offices
Owing to the tax advantages of owning properties, a market in rented offices has emerged only during the past 20 years in those major cities of interest to foreigners — Hamburg, Dusseldorf, Frankfurt, Stuttgart, Munich and now Berlin. For the past three years demand for modern offices has been at a record level throughout Germany, doubling the average take-up for the previous 10 years. The two most active markets at present are Frankfurt and Munich, where demand is currently 250,000 m2 to 300,000 m2 pa. They are followed by Hamburg, Dusseldorf and Struttgart where annual demand is about 140,000 m2 to 160,000 m2. In West Berlin, where the average take-up for the past 10 years has been only about 41,000 m2, the new political situation has meant extremely heavy demand for offices — a reunified Berlin could well see demand for office space as high as that in Frankfurt and Munich in coming years.
Rents for first-class city-centre offices are currently highest in Frankfurt (DM75 per m2), followed by Munich (DM60), Dusseldorf and Hamburg (DM35-DM40) and Stuttgart (DM35). In West Berlin rents have shot up over the past six months from DM30 to today’s maximum of about DM45-DM50. Demand is also strong for modern offices in decentralised locations, where rents are very similar throughout the major cities, normally running at about DM20 to DM25, with the exception of Frankfurt and Munich where rents can go up to DM28-DM32.
On the supply side there is a considerable amount of space in the pipeline in decentralised locations in all the major cities, but most of this will not come on to the market for two years or more. In the meantime, vacancy rates are at an all-time low and, particularly in the city centres, modern space is extremely scarce and will remain so. But a word of warning: even if demand remains at present record levels, there is a danger of an oversupply in the next two to three years in decentralised locations in the major cities. This is already evidence in some poorer locations.
Retail
German planning law requires a special consent for the construction of more than 1,200 m2 of retail space outside city centres. As this is rarely given it is virtually impossible to build out-of-town shopping centres or retail parks. Therefore demand has remained extremely strong for those new retail schemes permitted, and retail rents have increased considerably in the past few years. Retail sales were up noticeably in the first half of 1990 by comparison with 1989, and with the present economic outlook it seems certain that demand and rental growth will remain buoyant. This means that there is extremely strong competition for both existing retail investments and new schemes which are permitted.
Business/hi-tech parks
Strong demand has developed for Gewerbeparks schemes, comprising offices, service and warehouse space designed in a flexible way to enable easy conversion from warehouse into service and service into office space. Demand has been strongest in Dusseldorf and Frankfurt, but the first successful projects are now being carried out in Munich and Hamburg.
Industrial
Factories are rarely purchased in Germany as investments and there is only limited demand for pure warehouse space. Personally, I think an investment in pure warehouse space could well be profitable as demand is generally good and the competition for such investments is much less than for offices, retail or business/hi-tech parks.
Investment yields
The table above shows typical investment yields available for prime modern investments since 1971. In Germany full repairing and insuring leases do not exist and the yields indicated take into account the landlord’s outgoings and also the acquisition costs paid by the purchasers.
The population of a reunited Germany is just under 80m, making it the largest country in Europe after the USSR. In economic terms it will undoubtedly be the powerhouse of Europe. The problems which are being encountered on the way to unity, however, should not be underestimated.
So far, there has been little time for the respective governments to give detailed consideration to all aspects of the reunification. Economic and currency union came into effect on July 2 1990 and, while it has to date had little immediate negative effect on the West German side, after 40 years of a centrally planned economy the East Germans are experiencing little short of chaos. Many state firms will either be forced into bankruptcy or will have to shed a considerable number of staff. Unemployment could shoot up from 100,000 (at the beginning of 1990) to as much as 2m. Interest rates will probably remain high and inflation increase, but user demand for commercial and industrial real estate in West Germany should remain strong.
There are no real-estate markets in East Germany as we know them — under the East German regime both capital and rental values were fixed quite arbitrarily and bore no relation to market prices, as they might have been.
There is an extreme shortage of all types of commercial and industrial buildings in East Germany and competition for the few available from West German firms setting up in the east has led to artificially high rents. Once sufficient space becomes available, rents will undoubtedly fall to West German levels. At present it is not possible for non-East Germans to purchase the equivalent of freehold interests in East Germany and, even if it were, this could be something of a risky venture — there remains the possibility of claims from previous owners, whose properties were acquired compulsorily by the State or who had their real estate confiscated when they left the country. This ownership problem must be solved rapidly if West German and other European firms are to be encouraged to invest in East Germany. The government has recognised this as a major problem and is currently finalising the legislation in this respect. Landlord and tenant and fiscal legislation will also have to be brought into line with West German law if the major institutions are to be encouraged to invest.
The tremendous new construction programme in East Germany will mean full employment for the next few years for the West German construction industry, and building prices are likely to rise sharply in the next two to three years. Higher building prices, higher interest rates and higher inflation usually adds up to higher real estate prices, and this will certainly be the case in West Germany unless serious oversupply develops or investment yields increase.
There are several potential development areas and opportunities for investors in the reunified Germany. So far as West Germany (as it was before October 3) is concerned, areas of huge opportunity in the future will undoubtedly be found in the cities along the border with East Germany, West Berlin and the Ruhr. These areas have been largely ignored by investors in the past, but now offer great potential for development — close to the burgeoning markets of Eastern Europe and yet possessed of a stable economic and legal system. Now that Berlin has become the capital once more, with approximately 3.3m inhabitants it is by far the largest city in Germany, and has a significant property market.
However demand for development and investment properties has far exceeded supply in the past three years; increased further when reunification seemed likely. As the director of a leading bank said to me recently, “the whole world seems to want to invest in Germany” — and this has led to some foreigners paying silly prices. Restrictions on new developments in the city centres, coupled with a restrictive policy in respect of new retail space, means that one of the few areas of investment available has been in decentralised and suburban offices. The danger of oversupply in this sector could have an adverse effect on yields.
In the city centres, however, the situation is quite different — office space is in short supply and seems bound to remain so. This should mean a continued steady rise in rental values for prime city-centre offices — Frankfurt and Munich have displayed this pattern during the past four years, and it seems certain that Hamburg, Dusseldorf, Stuttgart and Berlin will follow suit.
Growth prospects in the retail sector throughout the country should be good, as should hi-tech developments in top locations.
The German real estate market has performed very well over the past three years, but the dangers of oversupply in decentralised offices combined with high interest rates and rising building costs, plus the uncertain effects of reunification, demand a more cautious approach than that shown by many foreign investors.
