A relatively strong property market sees less foreign investment and a wariness of office buildings
The German commercial property market (office, retail, logistics & hotel) recorded approximately €10 billion of transaction volume in Q1 2021. Whilst this is historically quite a strong result and in line with the 10-year average, it is very weak compared to Q1 2020 with a decline of over 45%.
"Investors are not confident that the office market will recover quickly."
The total transactional volume share of office space in commercial real estate, at 33% or approximately €3.5 billion, was considerably below the long-term average of approximately 40%. It is the weakest result of the past five years and less than 56% of the investment volume of Q1 2020. It is for this reason that we do not share the optimism that the office sector will be resilient against the effects of the pandemic; in our opinion, at least in the short-term, it will not be.
Why are offices viewed so critically? We see three reasons. The first and most obvious is the absence of foreign investors: you do not buy real estate if you cannot travel. The share of foreign investment dropped significantly, down to 30% from a historically high level of over 40%. Secondly, at the moment, investors are carefully considering and pricing-in new risks associated with non-Core office investments such as restricted finance, longer letting periods and a less positive outlook on rental growth. This contrasts with the approach being adopted by potential sellers who are not yet willing to revise their price expectations; and this leads to a classic stalemate situation and less transaction activity. The third reason concerns the recovery of the market and is much more complex. It will not be possible to establish how the office sector will perform until the worst of the pandemic is over. There is a general consensus that office space will continue to be in demand as people will wish to return to their office workplaces.
However, the situation is more complicated than this. It is a question of what the actual impact on the working environment of major companies will be. HSBC’s CEO Noel Quinn recently announced a 40% reduction in its space requirement over the next few years to achieve financial savings and promote greater flexibility in working practices. Here lies the crux of the problem. This issue pertains not only to the long-term effects on working culture, but also to the short to medium-term economic consequences of the pandemic. Moreover, real estate investors are paying greater attention to the location of properties. Who will the winners and losers be? Since the beginning of the pandemic, the common perception in Germany has been that CBD locations will be the winners and submarkets will be the losers. However, research does not support this simplistic view. The letting markets have clearly suffered greatly in the first 12 months of the pandemic; however, it will probably be the end of the year before a trend becomes apparent. Indeed, the current market data does not give investors either courage or the assurance they seek.
But there is also good news. The economy will grow again in 2021 with current estimates ranging between 3.0% and 3.7%, and the confidence of sellers appears to be returning with a rise in the number of prospective property sales being reported. This will reveal the actual situation in the market because it will include sought-after Core products as well as non-Core properties. The key element will be non-Core property sales.
In the property market in 2021, the successful completion of non-Core transactions and the convergence of expectations in terms of supply and demand will make the difference.
The outlook for yields is undisputed. All researchers expect yields to compress further and this is supported by the strong demand for lower risk investments. There is also a conservative view that there will be greater disparity in the market when considering non-Core products, because prices for Core properties are expected to rise and prices for non-Core products are expected to fall.
Stay strong and healthy. We look forward to seeing you properly again soon.