May 14, 2009

Flat Lines

The new value of the IPD/alstria DMX index which measures the reversion potential of German office rents shows for the second consecutive year that, on average, there is little reversion to be expected in the German rental market. (Full IPD study and result can be found here).

This does not come as a surprise to me and hopefully will not surprise any of the investors we are used to speak to, as this is one of the base case assumptions we have been working on since inception.

At a time where alstria was a blank piece of paper, I came across a presentation made by what at that time was still HypoVereinsbank. This presentation from 2005 showed a very interesting slide on the rent development in Germany (Look at slide 8). This slide was one of the most important pieces of information that we have accessed at that time, and triggered a milestone thinking about the set up of alstria. Is the widely spread assumption that GDP growth in Germany will push rent higher from where they are correct? We came to the conclusion that most probably this will not be the case. This conclusion had in turn a structuring effect on the acquisition strategy and led to the acquisition of what at that time was considered as a boring low upside portfolio. But this is a different story…

For those of you who are looking at life from a macro economic perspective, here is a simplified way of looking at the situation:

Between 2000 and 2008, the GDP growth of the industrial sector (+48%) and the one of the Service sector (+54%) were pretty much in line in Germany. In the same period in the UK the service sector growth (+72%) was 1,3 time faster than the industrial sector growth (+55%) while in France the numbers were even more impressive with the service sector growing at a pace of 3.2 times faster than the industrial sector. Is that relevant to office real estate? I believe it is, as it shows that the overall GDP growth in Germany is creating less office needs (which is mainly driven by the Service sector growth) than the same growth rate does in the UK or in France. As a consequence, I guess it is reasonable to assume that rent levels in the office market are less impacted by GDP growth in Germany than they are in other European countries. Therefore, it is unlikely that the rental growth patterns seen in Paris or London are to be repeated in Germany.

I would also like to highlight that what is true on the way up, stays true on the way down, and the same reason that prevented rents to move up drastically in the times of strong GDP growth, should prevent the rent to move drastically downward in times of GDP contraction which we are going through.

As you all know, it is impossible to take a credible global view on the German real estate market, as this is a very fragmented market. The analysis would need to be done on a city per city basis to be really efficient. Obviously the result would be fundamentally different whereas you are looking at Frankfurt, Hamburg or Rostock. It’s pretty much the same for the UK, where London and Edinburg would show different trends.

This short analysis which is just looking at the macro view is clearly not enough to support a real estate acquisition strategy or real estate business plan. Macro analysis alone can be a recipe for disaster. Nothing will replace ground work, specific asset and micro-analysis. In an environment where there is a growing tendency to look at what is happening across the channel in order to guess what will happen in continental Europe, I thought it would be useful to highlight that some shortcuts can be misleading. This is particularly true when you try to link macro analysis with micro decisions. And office real estate is all about micro decisions.


PS: for those of you who wonder where the growth come from if not from rental growth should read this previous post.

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