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Lesson from Germany: the value of hybrid property

  • 19Apr 16
  • Stephan Schanz Senior Analyst, Continental European Property Research

Home builders are seeing booming business in Germany, but they are still not building anywhere near enough properties – despite the appearance of brand new developments in city suburbs such as Frankfurt’s Riedberg.

A total of 245,300 homes were completed in 2014, according to Destatis, but net immigration was more than double that. The arrival since then of large numbers of refugees makes the need to build new accommodation all the more pressing. Well-regarded forecasts such as those issued by the Federal Institute for Research on Building suggest that Germany needs up to 400,000 new homes each year.

However, immigration is far from the only factor supporting values in residential property. Output in Germany grew by 1.7% in 2015 – the fastest pace in four years. Consumer confidence remains high, buoyed by low energy prices, which have boosted wages in real terms.

Another factor driving residential property is low interest rates, making mortgage debt affordable. A low-rate environment can  also encourage institutional investors to continue putting money into the sector: with yields on investment-grade bonds so low, many are looking to property to provide them with decent income.

Given the supportive background for residential property, it’s not surprising that prices have already risen, but we believe there are still many opportunities for investment.

One promising sector is high-quality assets with good energy standards. They offer potential for institutional owners to grow rents. Another is the commuter belts of cities, since there is less competition among investors for property here.

Investors often focus on pure residential, but they should also consider mixed-use property which combines residential with retail – for example, a block that includes a supermarket or a medical center as well as homes.

Mixed-use investments can often provide higher overall returns than residential on its own – but without adding much risk. The sectors can, in fact, complement each other, like two metals forming an alloy that is more effective than each metal on its own. The residential part offers low vacancy rates and tenant turnover, while the retail part can offer attractive long-term leases.

Mixed-use investments can often provide higher overall returns than residential on its own – but without adding much risk.

To put this in numbers, we estimate that a typical gross yield for newly built residential property is about 4.5%. A typical yield for convenience retail – smaller and mid-sized stores serving the local neighborhood – is around 6%. Combining the two might provide a yield, for a mixed-use asset, of a little over 5%.

Another advantage is practicality. An institutional investor might find a single supermarket too small to bother with, after considering the costs in manager time required to invest in and then look after the asset. Mixing a supermarket with residential property, however, could increase the value of the investment considerably, bringing it into line with the kind of size that institutional investors need.

We believe investors are, in some ways, like those intrepid naturalists who foray into unexplored cloud forests, classifying every bird, beetle and butterfly they find by family and species. They love to identify the existence of new asset classes, and then to split them into various sub-classes. But this focus on classification can be excessive – at least in the world of investment. Dividing property into a number of discrete types, such as office, retail, industrial and residential, can result in missed opportunities. In investment, as in nature, it is sometimes the strange hybrids that are strongest – as any old-time gold prospector who relied on mules to get his heavy treasure the long way back into town could have testified.

Important Information

Investments in property may carry additional risk of loss due to the nature and volatility of the underlying investments. Real estate investments are relatively illiquid and the ability to vary investments in response to changes in economic and other conditions is limited. Property values can be affected by a number of factors including, inter alia, economic climate, property market conditions, interest rates, and regulation.

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