May 30, 2011

The inconvenient truth

The Association of German Pfandbrief Banks (Verband deutscher Pfandbriefbanken, or vdp) have started a new (welcomed) initiative publishing a German office building rent index. The first result of this index are available on the vdp website (you will find the press release , and the index itself - theses links are for the English version but the same documents are available on vdp site in German as well).

First, I need to say, that I trust vdp stating that they have access to outstanding first hand data. Assuming the information is gathered across the loan portfolio of their members, it is probably the most extensive database I can think of (outpacing by far any other data provider, including the most accurate so far, IPD which whom we publish our own annual rent index). This initiative can only be welcomed as it is a further step to increase the transparency of the German Market

Now what does this new index tells us? I like the positive stance the vdp is taking when stating that German rents were stable during the period. The “inconvenient truth” is that they were down almost 2.6% between 2003 and 2010. This decline is in line with what IPD data shows over the same period of time (-3.5%). The data might not be perfect yet the trend leaves little room to interpretation.

It is interesting to note that over the same period, German GDP grew by almost 14%. As a graph is worth a thousand words, here is how GDP growth vs rent increase (data from both vdp and IPD, inflation disregarded). If you thought that GDP growth translates automatically into rental growth, this should help you think again.

Sources: vdp, IPD, destatis

Is this a bad news? Not for alstria. We have built our business model on this fundamental assumption. When asked about our future market rental growth expectation, we have been consistently responding that we assume rent levels are going to remain flat (read our post on this topic back in 2009,

So if GDP growth does not translate into rental growth, why is it a good news for office real estate? Well simply because in a growing environment, leasing markets are much more fluid than in any other environment. Companies have strong confidence in their future. They are willing to commit to new office space, generating increasing turnover in the market place. Note that this increase in turnover do not necessarily changes the balance of offer and demand, and thus do not have an impact on rental growth. However, for a company which is prepared to capture such demand, the environment can be extremely favorable. In a competing environment having the right asset at the right price, is going to prove a key for success. Anticipating tenant needs, offering professional services, understanding the changes in the markets, taking a longer term perspective, are all advantage that real estate listed companies will have over a number of short term investors, or non-professional real estate players.

We do not expect market rental growth to drive our business going forward. It has been our strong belief that shareholder value for real estate companies is coming from hands on asset management, not of market growth expectation. The vdp index, is just another sign out there, that this approach has its merits and that we are well advised to stick to it. We do believe that the current economic environment is providing enourmus opportunities for a company like alstria despite limited market rent growth. What if  the view we express in this post proves wrong ? In that case, we will benefit fully from the strong rental growth. On top of what we are planning to generate with our existing plans…

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