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When news changes almost daily, transactions are missing and market events cannot simply be extrapolated, real estate valuers also face unusual challenges. In an article for "Immobilien & Finanzierung", we looked at the residential, office, retail, logistics and hotel segments from a valuer's perspective.
In the trade media you can read news such as "Commercial real estate in the corona crisis - corrections are also occurring in prime locations" and "Values of top offices continue to rise". How does this fit together? Property valuation should always be fact-based and reflect what is actually happening in the market. First of all, it is a fact that the pandemic has triggered a shock and massive uncertainty. But it is also a fact that the pandemic has not caused a widespread real estate crisis and that there is no sign of a general price decline. However, it is wrong to say that Corona has not affected the real estate market at all. Differentiation is more crucial than ever.
Fewer transactions equal less market information
In the first lockdown in March, market activity more or less came to a standstill. As a result, the overall transaction volume declined massively. Some market segments experienced a catch-up effect in the course of the year. A lack of transactions of individual asset classes initially means a small amount of market information for the real estate valuer to evaluate when preparing the appraisal. This is aggravated by the fact that market activity is very inconsistent. This makes the valuation more demanding, as significantly more market research has to be done than before the outbreak of the pandemic. The "half-life" of market reports has become much shorter.
The reason for the often contradictory headlines on the development of the real estate market is therefore that very different market developments are taking place in the various types of property use and no uniform direction can be discerned. The subjective perception of the players in the real estate industry also coincides with this, as the evaluation of the Deutsche Hypo Real Estate Climate revealed. The need for even more extensive analysis of the market environment of a specific type of use makes the valuation of a property more complex than before. Even within the property types there are serious differences, as the following brief overview shows.
The residential property market shows the least changes of all property types. Due to the contact restrictions during the first lockdown in spring, fewer transactions took place temporarily. Subsequently, the market development picked up more or less where it had already been before the outbreak of the pandemic and continued its development. Transactions not carried out in the spring were largely made up for. Rents and purchase prices continue to rise, even if in some places the dynamics of price development are somewhat slower. This may be due to the fact that economic effects of the Corona pandemic could be partially averted or at least postponed by government support. The interest rate environment is still very low and the desire for safe investment opportunities remains high.
Even in the case of the high-volume segment of residential real estate, there is often hardly any daily information available on transactions. When making an assessment, therefore, the general development of values is an important orientation aid. According to bulwiengesa's RIWIS database, the following changes occurred in German class A cities from Q1/2020 to Q3/2020 and thus under the influence of the Corona pandemic: The average multiples of apartment buildings increased across the board. The increases ranged from +1.3% in Munich to +4.7% in Cologne. Purchase prices for newly built condominiums increased on average between +0.8% in Berlin and +9.3% in Hamburg and for existing condominiums between +1.3% in Munich and +7.7% in Frankfurt/Main. Rents also rose on average for the most part in these cities. Average rents for re-let flats increased between +0.9% in Berlin and +2.5% in Hamburg, while stagnation was observed in Cologne and Munich. Rents for flats in first-time occupation rose on average across the board. Munich continued to increase slightly by +0.5% at an already very high price level, while the highest increase was recorded in Berlin at +3.5%.
To the astonishment of some market participants, the office property market is also very stable, even though leasing decisions are being postponed due to the existing uncertainties and the discussion is lively as to whether in the long term people will increasingly work in home offices and thus require less office space. However, increasing flexibility does not necessarily lead to an actual reduction in office space. After all, even those who work in the office only three days instead of five must be able to occupy a workplace. Moreover, there was a shortage of supply especially in the big cities before the pandemic. The economic development shows that so far at least government initiated measures have been able to mitigate the economic impact of the Corona pandemic.
Due to the crisis-related demand shock, rental turnover collapsed in the spring of this year - from the 3rd quarter onwards a clear recovery is noticeable here. Nevertheless, at the end of the year we should see a decline in turnover of 20 % to 40 % compared to the previous year. Due to the very good state of the market before the start of the Corona pandemic, the negative effects in the most important German office locations have so far remained within limits; however, in some cases, especially in the less established locations, stronger corrective movements can be observed.
The fundamentally still good market situation in the A-markets is reflected in the key indicators of the individual office markets. For example, prime yields have remained largely constant since the first quarter of 2020. Prime rents for office space in these locations also remained largely the same across the board from Q1/2020 to Q3/2020, fluctuating by around 50 euro cents in one location or another.
From the valuer's point of view, it is of great importance to be able to interpret this data correctly: Even if the nominal rents have obviously remained constant so far, one cannot draw conclusions about the effective rents from this. Here, when analysing the leases, one has to take into account the so-called "incentives", which describe one or even several rent-free periods and lead to a reduction in the total rental income on the owner's side.
Not all retail properties are the same. When valuing retail properties, a distinction must be made between properties that serve local daily needs, i.e. grocery retail, and those in which clothing, shoes, jewellery and electronic goods are offered to a large extent, such as shopping centres. The latter were already affected by a structural change before the outbreak of the Corona pandemic, which is now being further accelerated by Corona. It can be assumed that the turnover that stationary retail lost to online retail during the pandemic cannot be attributed to stationary retail in the future, or at least not completely. Consequently, significant price declines can be assumed for such property types.
The local supply and specialist stores, on the other hand, were able to benefit from the Corona pandemic and in some cases even posted higher sales than in the previous year. Due to the high liquidity in the market, properties with a favourable risk profile are particularly sought after. If the location, turnover, rental level and lease term match the investors' expectations and if the property is a core property, the yields have fallen again. The gross yields of specialist stores peak at around 4.5% and are stable. Here, too, the available information must be carefully weighed and interpreted. Without a doubt, the market situation for shopping centres looks less rosy. In this segment, the peak gross yield is currently approx. 5.5% and a further increase is to be expected.
The logistics segment can certainly be described as the profiteer of the Corona crisis par excellence. Logistics has gained in importance and is considered systemically relevant, even without Corona. The shift in turnover from bricks-and-mortar retail to online retail, which can be observed in the retail sector, ensures increasing demand for logistics properties and further rising prices. In addition, logistics properties have been able to establish themselves as a recognised asset class in recent years. Net yields of well below 4 % can now be observed here. The transaction volume rose by approx. 25 % in a year-on-year comparison up to the third quarter.
Hotels are a prime example that it is worth taking a second and even a third look. Like no other type of real estate, hotels are directly affected by the lockdown and the general rules of conduct as a result of the pandemic (see also blog article "Good night? Hotel projects in Germany"). The dramatic drop in occupancy and significant drop in turnover is reflected in lower RevPars (revenue per available room) and consequently also leads to rising yields. Analysts assume that an occupancy rate like before the outbreak of the pandemic can only be reached in 2023 or even 2024. It is to be feared that numerous hotel businesses will not be able to cope with the slump in turnover and will have to file for insolvency. The willingness of banks to finance hotels has decreased significantly. The transaction volume from Q1 to Q3 fell by approx. 37 % compared to the previous year; however, distress sales have not yet been observed. Investors willing to buy want hotels to come onto the market at favourable prices.
If one analyses the economic key figures of a hotel operation in more detail, it may be possible to determine that even with a low occupancy rate, as is to be expected in the Corona year 2020, an economic result can be achieved for the operator. Decisive, not only for the determination of the capitalised earnings value, is the amount of the rent to be paid. With a correspondingly low rent, the hotel operation can still be adequate even if the occupancy rate is significantly lower than usual. However, this only applies to the comparatively few hotels where low fixed rents have been agreed.
Conclusion: More intensive disputes than ever before
General statements on changes in the value of specific properties are not possible. The individual property types are affected too differently to be able to depict a corona effect, as the above-mentioned value ranges show by way of example. If the necessary differentiation of the available market information is carried out, strongly differing value developments can result. It is more important than ever to take a close look at the property, its location, the concept, the economic viability, the rental and lease conditions, etc. and to carry out extensive market analyses. When drawing conclusions about periods before the outbreak of the pandemic, one of the questions that must be answered as part of a critical examination of the property is to what extent rents can be collected in the future with the same certainty as in the past.
Note: The text (slightly shortened for the blog) was first published in „Immobilien & Finanzierung“, issue 12/2020 (in German language).
Contact person: Marcus Badmann, Managing Director of the real estate valuation company bulwiengesa appraisal GmbH, badmann [at] bulwiengesa.de