German real estate – the fallout from Brexit

Last year’s surprising outcome of the UK’s EU referendum and the looming exit negotiations are affecting both the economy and the real estate sector, not only in the UK but in the rest of Europe as well.

This short analysis focuses on the fallout from this historic decision on the German commercial real estate market as a safe haven and how this has affected investment decisions. It comprises an overview of the status quo and a short-term analysis of the impact of Brexit and concludes with an overview of four of Germany’s most exciting cities for investors.

Status quo

Before the referendum date was announced in February 2016, the German commercial real estate market was solid, yet far behind the UK’s, with an overall investment volume of EUR 64 billion in Germany compared to EUR 91 billion in the UK between Q4 2014 and Q3 2015.¹

Following the announcement of the referendum, the investment volume dropped in both countries for the same period between 2015 and 2016. However, while the UK market dropped by 37.9 per cent to a wavering EUR 66 billion, Germany’s market only fell by 18.5 per cent to EUR 54 billion.² This implies that even before the Brexit referendum held on 23 June 2016, the German real estate market had nearly caught up with the UK market. The drop in investments in Germany can be explained, at least in part, by the fact that prime locations are so sought after that there is hardly any availability on the market. Due to the current political and legal uncertainties resulting from Brexit, investing outside the UK will become increasingly attractive as long as reservations continue. In this climate, Germany is considered a safe haven by many international investors, who generally seem, in the current global political and economic uncertainty, to favour a slow but stable increase in yield.

What makes Germany a safe haven is the fact that it has solid fundamentals with a 1.9 per cent GDP growth, an unemployment rate of 5.9 per cent and a robust debt to GDP ratio of 68.3 per cent.³ In addition, interest rates for financing investments are at an all-time low. This benefits Retail Space Properties, as they correlate with the purchasing power of the population. Furthermore, the political environment in Germany is stable. There are no indications of a drastic shift in politics in the foreseeable future, with the current governing party winning the three most recent state elections and the contending party candidate being a former President of the European Parliament. The recent outcomes of the Dutch and French election swill result in a further increase in stability, as Germany is arguably the country which profits most from a strong EU.

As such, the German real estate market slightly overtook the UK market in the first quarter of 2017, with an overall volume of EUR 12.65 billion⁴ compared to EUR 12.54 billion.⁵ This is supported not least by the fact that Germany is strongly diverse in its property markets, with its top seven cities (Berlin, Hamburg, Munich, Cologne, Frankfurt, Düsseldorf and Stuttgart) constituting 55 per cent of the total transaction volume in 2016.⁶

Therefore, it is easier for investors to diversify their investments within Germany towards multiple cities, further reducing their risk. In particular, the office-space market seems to be of interest to investors, with a transaction volume of EUR 4.9 billion compared to the UK’s EUR 4.6 billion.⁷

In addition, investors who have to follow an EU quota as a self-imposed investment requirement will have to shift some of their investments from the UK to the EU to remain compliant with that quota. This is supported by the fact that Open ended Real Estate Funds/Special Funds and Asset/Fund Managers are responsible for 57 per cent of total purchases with a percentage increase in international buyers of 48 per cent to a total of 43 per cent of all transactions in the first quarter of 2017 in Germany.⁸

In principle, business activities in Germany are free from regulations, as German law generally makes no distinction between Germans and foreign nationals regarding investments. Unlike in other markets, financial barriers such as restrictions on capital accounts or legal barriers such as differences in taxation or access to ownership of foreign assets do not exist in Germany. Supported by a strong and reliable legal system, restrictions are only allowed for reasons of foreign policy, foreign exchange, or national security. However, in practice, such restrictions are seldom imposed. There is no broad authority to review foreign real estate investments, and privatisation programmes for foreigners are non-existent. On the contrary, if the paperwork is drafted in the right way, foreign investments into German real estate can benefit from considerable tax incentives. For instance, instead of investing in a German limited liability company (“Gesellschaft mit beschränkter Haftung - GmbH”) owning a property, investors can purchase it through a foreign investment vehicle. Since the foreign investment vehicle does not form a permanent establishment in Germany it is not subject to German trade taxes, which range from 7 per cent to approx. 17 per cent. The GmbH, however, is subject to trade taxes and can only achieve an exemption under harsh conditions.

Short-term effects

It is still too early to see what the full impact of Brexit will be on the commercial real estate market, both in the UK and in Germany. This will depend largely on the details of the Brexit agreement, which is currently being negotiated between the UK and the EU.

In case of a “hard Brexit” the UK would give up its participation in the EU single market along with its submission to EU legislation and to the jurisdiction of the European Court of Justice. This would require the UK to carry out trade with Europe and other nations under the World Trade Organization rules. By contrast, a “soft Brexit” is interpreted as any number of possible arrangements that might be negotiated with the EU and that represent anything less than a full withdrawal. How such a deal is going to look will be determined by the ongoing negotiations which will last until March 2019, when the UK is scheduled to leave the EU. While Theresa May has ruled out the possibility that the UK will remain in the single market, the outcome of the 8 June general election, (which resulted in a hung parliament and May losing her majority,) may have put a sharp brake on her plans, as the loss of the Tory majority in parliament is a strong indication that a mandate for a hard Brexit is off the table. Officially, May is set to maintain the present course; however she is under enormous pressure from outside her own party and within to soften her stance. Currently she seems to retain her popularity but experts are uncertain whether, and for how much longer, she is able to hold her supporters together. In any case, this has resulted in further uncertainty for the UK market. Twelve months after the EU referendum, British politics is in chaos again, and the consequences for the Brexit negotiations are currently unforeseeable.

Independent of the exact details of Brexit, there are consequences which are certain. EU institutions currently residing in the UK such as the European Medicines Agency and, more importantly, the European Banking Authority will move to an EU member state. Currently, two main contenders have emerged as the latter’s new host: Frankfurt and Paris. In the case of a move to Frankfurt, the idea to merge with the European Insurance and Occupational Pensions Authority to create an agency with the purpose of regulating both insurance and banking activities seems reasonable. This would further strengthen Frankfurt as the financial hub of the EU since it is already home to the European Central Bank.

Along with the UK leaving the single market comes the loss of EU passporting rights. The EU passport provides a legal mechanism that permits financial services companies based and regulated in one country of the EU, and authorised under one of the EU’s single market directives, to do business in other member states purely on the basis of their home state authorisation. This affects many companies in the financial sector which cannot afford uncertainty as they have to plan several years ahead.

It remains to be seen how big financial players will react to a potential loss of passporting rights. This could have a substantial influence on the German commercial real estate market. However, it is currently unclear whether financial institutions will relocate in bulk, whether they will merely open small subsidiaries in Germany, or whether they will move to other major European cities, such as Paris, Amsterdam and Dublin. 

Impact on cities not countries

While Brexit certainly influences the German commercial real estate market as a whole, its impact is heavily concentrated around the major urban hubs. Similarly, current market opportunities are now more about cities rather than whole countries.

Unlike the UK, where the majority of commercial headquarters are located in London, Germany has multiple headquarter locations, and its seven biggest cities host a wide variety of businesses lines. While Frankfurt is the financial centre of Germany, Düsseldorf is home to numerous companies in the fashion and beauty industry, and Berlin is the new “start-up haven” of Europe.

Although all seven big cities in Germany seem to profit from post- Brexit insecurity, four cities stand out in particular. Berlin, Hamburg, Frankfurt and Munich have been ranked first, second, third and fifth respectively in a recent study.⁹

While the average rental price in the major German cities has remained relatively stable, it is nowhere near the average rents paid in London or Paris. This means there is tremendous potential for rent to increase in the coming years.

Berlin

Ranked first, Berlin is on its way to becoming a truly global city – young, fashionable and full of opportunities. It hosts numerous start-ups, with more than 40,000 companies founded in 2016 alone. With a harder stance on immigration as a likely consequence of Brexit, and the resulting difficulty in sourcing a wide range of skilled staff in the UK, many US and Asian businesses may choose Berlin as their new base of operations in Europe. This could be especially true for Fintechs, which are already represented quite prominently in the city, as they would profit from financial services passporting in Germany.

With an office vacancy rate of 4.1 per cent,¹⁰ the market is already stretched and in need of new investments.

Hamburg

While Hamburg, unlike Berlin and Frankfurt, might not profit from Brexit directly, its high sustainability makes it ideal for established, non-financial companies from the US and Asia considering relocation to Germany. Regularly voted as one of the most liveable cities in the world, it has serious power to attract qualified employees who might be deterred by the post-Brexit immigration policies of the UK.

Hamburg offers a diverse economy with a strong manufacturing industry on the one hand and an innovative media, life science and information technology sector on the other. With a vacancy rate of 5.8 per cent, Hamburg has potential for additional investments in the commercial real estate market.¹¹

Frankfurt

Frankfurt could be one of the big post-Brexit winners. As host of over 230 national and international banking institutions, and home of the European Central Bank, it would be only natural for the European Banking Authority to follow suit. This could tip the scales in favour of Frankfurt as the next financial capital of the EU. In addition, the Federal Financial Supervisory Authority of Germany is located in Frankfurt. This would have the advantage of short distances for those institutions that are considering settling in Frankfurt for passporting purposes.

So far, UBS has announced that it will be moving 1,700 jobs to Frankfurt. Goldman Sachs has concrete plans to move another 1,000 jobs to its Frankfurt office. Other financial institutions such as Deutsche Bank (4,000 job moves reported), JP Morgan (4,000 job moves reported), Citigroup and Credit Suisse are considering relocating at least some of their staff to Frankfurt. In total, experts expect 10,000 additional jobs over the next five years will be available in Frankfurt as a direct result of Brexit.¹²

While most Fintech start-ups are likely to favour Berlin, it is to be expected that a number of auxiliary services such as law firms (of which large numbers are already present) or asset managers will relocate staff to Frankfurt. Depending on how many jobs in financial services will be moved in the end, the commercial real estate market could expand drastically.

While the office vacancy rate of 9.1 per cent is high compared to the other top cities, this percentage is the lowest in over a decade.¹³

Munich

Munich is Germany’s economic powerhouse. Almost 10 per cent of Germany’s largest companies are headquartered in Munich, with 30,000 jobs created each year and an unemployment rate of 2.6 per cent – the lowest in Germany. As Germany’s hotspot for information and telecommunication technologies, as well as insurance companies, Munich is likely to attract companies from both within and outside the EU.¹⁴

While its office market is the largest in Germany at over 22 million square metres, it boasts the lowest vacancy rate at 3.1 per cent.¹⁵

Conclusion

Although the total investment volume of the German commercial real estate market decreased after the Brexit vote, it seems to have benefited from the uncertainty as a safe haven for investments in the short term. Long-term effects, however, are still quite unpredictable. Whatever the Brexit negotiations may bring, the German commercial real estate market remains a great investment opportunity. As the driving force of the European economy, Germany offers unmatched security coupled with competitive yields. While the search for investments in prime locations can be difficult due to unavailability of suitable properties, many opportunities can still be found in second- and third-rate locations, where there is sufficient room for prime-yield investments.

Ashurst and the Built Environment 

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