Investors betting on Germany’s regained self-confidence

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Real estate investors rediscovered Germany about three years ago. The economy still sagged, but many believed it was bottoming out. The first wave of foreign investors entered the country in 2003 and bought large chunks of non-performing loans that had been depressing the performance of German banks for years. Then they bought large housing portfolios from the state. Last year, retail property was high on the wish list of foreign investors.

In 2005, more than €41 billion of German real estate changed hands, according to German fund manager Degi. Retail property accounted for 13 per cent of the volume. During the first half of this year, property transactions totalled €21.3 billion, with retail accounting for 48 per cent of the volume. Degi expects the total investment volume to reach €42.6 billion this year.
Demand has been largely driven by high property yields compared to the rest of Europe, although this is changing, low interest rates and the abundance of real estate for sale. The Germans were too depressed about their own country’s economic prospects to be interested in real estate. The country has five million unemployed, and the government has been cutting back benefits. Too worried about the future, German consumers have shied away from spending. The national savings rate was about eleven per cent, one of the highest in Europe.

Steady, if unspectacular returns
The main attraction of German retail property is that it provides steady, if unspectacular, returns.
Long leases signed by creditworthy retailers have been in high demand. Discount stores
such as Aldi, Lidl and Plus are considered good tenants, because the discounters control about
35 per cent of the retail market. This is the highest percentage in Europe, according to Mercer Management Consultants. Low interest rates and eager, foreign banks willing to finance ninety per cent or more have made it even more attractive to invest in German retail property.

The majority of foreigners buying retail assets in Germany are British and Irish private equity  buyers (see box text on page 61). Disappointed by the tight property markets and low returns at home, they have turned to the continent. Edinburgh House is a typical UK investor, playing  on the yield gap. Explains David Roberts, managing director: “We have looked at France and Belgium but Germany is very large; there are more deals. The leases are of reasonable length, ten to fifteen years, and the tenant structure is similar to the UK. You’re buying a strong company on a long lease, which means it’s easy to get finance. Banks offer better margins because they feel safe.”

More recently, some of these property investors, including Dawnay Day, have listed their foreign

More and more shopping space is coming to the market in Germany. At the beginning of this year, Germany had 372 large shopping centres with a total floor space of 11.7 million m2. The EHI Retail Institute expects this to rise by three per cent this year and 6.3 per cent next year. EHI research director Bruno Groner sees a clear trend of shopping centres moving into the city centres as German politicians seek to keep the purchase power in the city centres. Until 2010, 61 new shopping centres are planned with only five in Eastern Germany. With 140 m2 of shopping centre space per 1,000 inhabitants, Germany occupies a medium position in the EU league table, but Groner points out that a relatively large portion of shopping space is outdated or empty and needs replacing. Department stores have long lost their attraction and inner-city shopping galleries should replace the lost purchasing power, but Groner warns that they need to be developed in proportion. "If the city centres and galleries are too big, the retailers will be destroyed."

property ventures on the Alternative Investment Market (AIM) in London, the rules of which are more relaxed than the main market. Often, a channel island construction is used to avoid tax.
Edinburgh House has also tried to list on the AIM market but its private backers in Scotland did not like a debt level of more than 70 per cent.
The hot property market and the relative ease of listing new property ventures has prompted a number of bankers and property consultants to leave their high-paying jobs to set up their own investment companies. Earlier this year, a former DTZ consultant and a developer got together and listed a new venture called Develica Deutschland with the aim of investing €1 billion in Germany. Develica Deutschland, at least, has some experience of investing in properties. More recently, a new property venture, Deutsche Land Plc, was launched by a 27-year old and a property broker twice his age.

Still, Deutsche Land Plc listed and raised £70 million. The company also secured a five-year credit facility of up to €400 million from ABN AMRO. In June, Deutsche Land made its first investment; a town centre shopping mall in Castrop Rauxel, North Rhine Westphalia, for €19.9 million, reflecting a yield of 6.8 per cent.
Consumer spending spree may be short-lived.
The majority of these investors are betting on an economic rebound and it does indeed look as though things are improving. In June, market researcher GfK reported higher consumer confidence, but noted that the Germans were more sceptical about economic developments and their personal income prospects than in May. Germans are also spending a bit more, but that may have to do more with the prospect of higher VAT next year than with increasing consumer confidence. Many have started to buy consumer goods as the government plans to raise VAT to 19 per cent from 16 per cent this year to reduce the budget deficit.

Edinburgh House’s Roberts has no illusions about a quick turnaround. “It is not a situation where we expect rental growth or the economy to pick up in the short term, but there is a tendency to focus too much on weakness. Germany is not a poor country and I still think of Germany as one of the powerhouses in Europe.”
Germans have been watching the foreign shopping spree with growing disbelief. Stefan Widmann, head of valuation at property consultants Atis Real in Frankfurt, has seen a lot of non-performing loan portfolios with empty supermarkets in them. “I’ve often seen empty Aldis or Lidls with three year lease left,” he says. “They have moved on, because there is always space for an Aldi or a Lidl.”

As discounters such as Aldi, Lidl and Norma fought for market dominance in ever smaller towns and villages, only one of them could win. The problem is that there is no rest value for an Aldi or Lidl that is not in a prime location. Hence, German banks are not keen on financing the wave of international investors.
However, foreign banks, such as ABN AMRO, the Royal Bank of Scotland and the Bank of Scotland, have stepped in to finance them.
They typically lend up to 90 per cent or moreon a ‘non-recourse’ basis, which means that the investor can hand back the keys if the investment turns sour. The banks, in turn, try and sell on the loans as bonds to institutional investors, such as pension funds. This makes the German real estate game a safe bet for international investors. They are unlikely to be stuck with the assets if it does not work out the way they had expected.

Selected retail deals in Germany: • November 2003: Metro fails for the second time to sell a €3 billion retail portfolio as investors worry about the high price and possible soil pollution. • July 2005: UK private equity investor William Pears Group buys a €55 million portfolio fromGerman supermarket developer KIZ. • July 2005: UK private firm Capital & Regional forms joint venture with German developer and investor Hahn to jointly acquire and manage out-of-town retail properties in Germany, starting with a portfolio of eight out-of-town retail schemes worth 1 10 million. • August 2005: UK developer and investor Edinburgh House makes continental debut and buys €100million worth of assets in Germany, including a 42,500 m2 logistics facility from Tchibo and themixed-use Rathaus Gallerie in Wuppertal. • August 2005: Troubled German retailer KarstadtQuelle sells 91 stores to Curzon Global Partners/IXIS AEW Europe and Dawnay Day, as part of a programme to raise €1.1 billion by selling non-core businesses. • April 2006: KarstadtQuelle disposes of €600 million worth of properties in a €4.5 billion deal withGoldman Sachs, the biggest retail deal in German history. • April 2006: Metro sells 127 Kaufhof department stores to Apollo Real Estate Investors for €265million. • July 2006: Capital & Regional buys 22 out-of-town big box retail properties for €214 million.