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For almost a decade and a half, the German real-estate industry has grown fat on success. But now the industry finds itself confronting a whirl of fast-changing circumstances that could permanently transform the market. High inflation accompanied by rising interest rates; supply bottlenecks due to shortages of building materials; soaring construction and energy costs; increasingly rigorous sustainability regulations applied to buildings – and on top of all that, the threat of recession. This scenario has made banks more cautious, not least because the Federal Financial Supervisory Authority (BaFin) has also tightened up regulatory requirements. Significantly higher interest rates will have a negative impact on demand for mortgages and other property-related loans. Prospective purchasers will delay or suspend their property investments. Real-estate development projects are being put on hold, deferred, or even cancelled. But while the current situation as a whole poses major challenges to the real-estate industry, it is also an opportunity for those with the necessary new skills to reposition themselves as individuals who are fit for the future in a very fast-moving environment.
Residential construction is the segment most seriously affected – especially residential newbuilds. For many investors and developers in many parts of the country, the rise in interest rates (by between three and four percentage points), plus increased building costs, have made new construction projects unprofitable. This is further exacerbated by the fact that in large towns and cities in particular, rents have risen dramatically over the last few years, so there is no significant prospect of rent increases that could guarantee the profitability of real-estate investments. Increased energy costs, which show no immediate signs of dropping, also hugely restrict the scope of rent increases – indeed, they may be causing rents to decline. In view of the current situation, as well as the often lengthy and challenging process of obtaining planning permission, it is highly unlikely that the political target of 400,000 new housing units per year will be achieved in the near future.
The German market for commercial property is, on the other hand, comparatively robust. Vacancy rates are low, and the number of upcoming newbuilds is moderate. High-quality office space remains in short supply. Furthermore, the service sector – the main driver of demand for office space – is still expanding.
The situation in the retail property segment is very different. Here, prices have continued to fall since the coronavirus pandemic – even in prime locations – and in view of the current uncertainties, this trend is likely to continue. The outlook is more positive in the food and groceries retail segment, not least because of retailers’ key role in supplying local residents with products that meet their daily needs. Even so, it is probable that the market in many regions has already reached a high level of saturation.
The current trend is towards reduced-risk real-estate finance projects, accompanied by higher equity-capital requirements for banks and other lenders. Investors with insufficient equity are more likely to be forced out of the market, because it has also become considerably more expensive to obtain equity-type funding such as mezzanine capital. Thus many real-estate projects will not come to fruition in the future simply because the associated debt finance is unsupported by a debt-servicing capability adapted to the new market realities. In the past, exceptionally low interest rates negated this market-constraining effect.
Development projects in particular are being subjected to much more critical scrutiny. This is especially true of project costing, due to higher construction costs that are also very difficult to estimate (e.g. for materials like steel, timber), as well as much greater uncertainty surrounding future sales prices. Developers engaging in future real-estate projects will have to focus even more attention on high-quality product and location, as well as realistically achievable sales prices.
In the medium term, the real-estate market will become strongly differentiated. Demand for modern and above all, sustainable properties consisting of high-quality product in good locations will rise. Green bonds, already attracting considerable interest from institutional investors in multiple markets – not least the real-estate sector – will become even more attractive. Not only will this affect newbuilds; it will also increase pressure on property owners to modernise or refurbish their existing properties in line with sustainability criteria. Banks and other lenders will find themselves swept up by this trend, obliged to offer relatively favourable funding whenever the real estate to be financed meets the recognised sustainability criteria.
Germany’s economy is expected to plunge into recession by 2023 at the latest. Inflation and interest rates will remain high. It follows that the trends we have already identified today will continue unabated. In the short term, the deeper the recession turns out to be, and the longer inflation and interest rates remain at the present high levels, the more profoundly the market will be disrupted. As soon as there is a perceptible easing of the many uncertainties described above (not to mention their geopolitical counterparts), so that it becomes easier for market players to calculate the profitability of their real-estate investments and draw up implementation schedules, the process of dramatic change currently characterising the real-estate sector will gradually come to a – provisional – end.
If we observe the last decade and a half from a long-term perspective, they appear to represent an extraordinarily positive but also exceptional situation which, after many dramatic changes, will culminate in more normal market conditions. No longer driven by excessively low interest rates and overblown expectations of soaring prices, the markets will instead focus on projects offering long-term prospects that make sound business sense.
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