Desperate times call for forward thinking

Just when it seemed things couldn’t get worse for the German property market, a wave of scandals has hit the country’s real estate business. The market had already been suffering heavily from a glut of buildings with no one to move into them for several years. Then late last year, news broke of property developers bribing fund managers to buy their buildings at inflated prices.

Despite the doom and gloom, now might be the perfect time to enter the German property market: real estate is at rock bottom prices, domestic developers and fund managers are selling off swathes of stock and the long awaited economic recovery is expected to pick up speed in 2007.

Confidence in the German property industry has undoubtedly suffered a blow this year. The German financial regulator BaFin is investigating around 80 people accused of taking bribes from property developers. The backhanders are understood to total ?20m and they surround 30 property deals worth about ?4bn. Those under investigation are believed to include high-ranking staff at Germany’s second largest fund management group DekaBank and Deutsche Bank’s London-based subsidiary Deutsch Real Estate.

The fallout has already begun at DekaBank, where Axel Weber, chairman of the management board, and three senior real estate executives have resigned over the issue.

Cleaning-up time

Gunnar Herm, head of the German property joint venture Warburg-Henderson, says that such developments are actually good news for the property market: “Of course, it could always happen again and Germany needs to improve its corporate governance generally. There is a lot of talk about transparency but nothing has been agreed yet, and that makes me suspicious.”

But he says “companies [involved in the scandals] are changing their whole boards and people have left the property industry as a consequence of these dealings. So we must assume that everything is clean now.”

The scandals appear to be a symptom of the German property market’s desperate state. According to the latest research from Deutsche Real Estate, German property is struggling with weak demand, labour market rigidities and the strength of the euro. A glance at the country’s highly indicative office market demonstrates this.

Office availability

Frankfurt, the country’s financial capital, “remains one of the worst affected office markets in Europe due to on-going restructuring in the financial sector and a huge amount of supply”, says the report.

In Berlin, “due to ongoing completions [of new buildings] the availability rate continues to rise and rents remain under pressure.” Again, in Munich, “despite a reduction in completions, office vacancies continue to rise and rents remain under pressure.”

On the face of it the market doesn’t look promising. But a closer look shows that the situation offers a number of interesting investment opportunities. Why else would ABN Amro Asset Management be poised to start investing in German real estate for the first time in several years? Senior staff at the firm confirm that they expect rental recovery to kick in in early 2007, and while domestic property players are selling their stock at cheap prices, there is a strong case for buying it up.

ABN Amro is not alone. Mr Herm says, “there are a good few opportunities being created by distressed sellers, particularly German funds which have delivered weak performance after over exposing themselves to the domestic market with weightings of up to 80 per cent in Germany.”

For example, the Northern German banks HSH Nordbank and Nord LB are each understood to be selling 20,000 apartments this year.

According to Thilo Wagner, senior portfolio manager responsible for Germany at Henderson Global Investors, the buyers of such portfolios are foreign players from Western and Eastern Europe, Israel and the US. “They are getting bargain prices,” he says.

The best prospects in the office sector are in Germany’s second cities: Düsseldorf, Hamburg and Munich, says Mr Wagner. In retail property, he prefers shopping centres in Western Germany. The East, he says, is still suffering heavily from over supply due to building activity in the 1990s.

A new route to German property investment could add further to market potential. Real estate investment trusts are on the government’s agenda. Industry experts believe that even with the expected change of government next year, Reits will be introduced by early 2007. And London-based venture capitalist Guy Hands has made his move on the German property market, acquiring a portfolio of 150,00 flats for E7bn.

Herm: scandal is good for the market