Cruise Control
by Thomas Glup
The Best in 2019
With a prime total return of 9%, the office sector in Cologne and Stuttgart will provide the best performance
The office sector of both city's will create the strongest capital growth at nearly 6%
Logistics yields are expected to fall by 5 bps in all major markets. With the exception of Berlin and Munich, retail yields will remain stable. Office yields remain largely stable
Berlin's prime rent could grow above 5% for the fifth time in succession
The forecast assumption is for hesitant increases in interest rates until 2023 and low 10-year bond yields, supporting Germany's status as Europe’s favoured investment destination, especially for overseas buyers. The transactional market will be in ‘cruise control’ for a number of years yet.
German offices are likely to post the strongest returns over 2019, led by Cologne and Stuttgart (both 8.95%). Berlin again stands out with 5.4% pa prime return over the 2019-2023 forecast period.
Market returns will be in double-digits in 2019 except for Stuttgart. Unsurprisingly, Berlin tops all German cities at 19.1% and is also the most robust on average over the forecast period (10.1% pa). Berlin and Cologne’s market returns will stay in double-digits in 2020 before fading by 2023.
The main driver for both prime and market total return is capital growth, which is clearly driven more by rental growth than by yield development. Capital growth will stay positive on average across the period for all markets.
The lowest prime yield of 2.7% will be achieved in Berlin. In Germany, we are looking at a market characterised by rental-led capital growth and yields starting to rise. Yields will rise only slowly in 2020 and 2021 and we forecast an increase of 5 bps for offices per year.
Berlin leads prime rental growth at 5.6% in 2019 and averages at 4.1% pa over the rest of the forecast. Market rental growth in Berlin is exceptionally strong in 2019 at 12% and 5.8% pa on average over the forecast period, arising primarily from low vacancy levels. Berlin’s vacancy will fall to 1.4% in 2019 and only expand to 2.1% by 2023. All markets will still be at historic vacancy lows by 2023.
Germany as a whole is likely to see prime total returns stay positive as they reduce over the five year forecast period,. Average prime returns for markets over the period range between 3.4%-4.0% pa.
We forecast falling capital values on average in Germany driven by weak performance in the mid-term. Consequently, logistics yields have not quite bottomed out yet and will lose another 5 bps by the end of 2019, reaching 4.00% in all major markets. Only then will there be a gradual increase of up to 4.45% by 2023.
Of all the asset classes, the most consistent positive rental growth comes from the logistics sector. Starting at 1.7% for 2019, rental growth of 1.6% pa can be expected until 2022 ending with stable growth in 2023.
Retail is the loser in a total return context as it is below 3% over the whole forecast period. Frankfurt and Hamburg are at the bottom end with 2.0% and 2.1% pa respectively, while Berlin is the best performing market at 6.4% in 2019 and 2.6% pa over the period. 2019 is the last year for positive capital values in this sector as they turn negative across the remaining years of the forecast. The retail sector is experiencing a similarly moderate increase in yields as logistics.
Retail rental growth is rarely a strong point in Germany; this region is after all the inventor of discount retailing. It ought not to surprise that we anticipate almost no rental increases in any German market across the forecast period.
Risk to the Forecast
Brexit and the trade war between US, China and the EU are the main risk factors for Germany as an export nation.
These have the potential to damage economic growth and from there undermine Germany's occupational base.
While this represents a large downside risk, the upside comes from stronger domestic demand, where private and public consumption plus investment helped offset recession in 2018. It may be more supportive of growth in 2019 than expected.