Flexibility and conservatism shaping investment strategies to a major degree in the wake of the coronavirus

Markus Reinert FRICS

V, W, U or even an L? Whereas at the beginning of the year there was still a debate as to whether the historic upturn could be maintained, only a few weeks later the focus was on the possible curve for one of the deepest global economic crises of all time. Although there had already been repeated discussion of possible external shocks, such an abrupt and far-reaching crisis scenario was something scarcely imaginable for the majority of people.

The real estate sector has also been heavily hit by the corona crisis, with ramifications which still cannot be foreseen even several months after the beginning of the ensuing lockdown. Gradually, however, there is a realisation that the sector will probably be characterised by the virus and its consequences for much longer than many people had originally hoped. At the same time, the pressure to invest has not by any means declined as a result of the crisis. Investors continue to be driven by low interest rates and high levels of liquidity, meaning they cannot simply sit out the current situation and hold on to their capital. Rather the flight to defensive asset classes that is typical of a recession will ensure that market players increasingly set store by real estate.

Lack of clarity regarding demand in the wake of the coronavirus

Investors are currently facing a clear dilemma therefore: on the one hand, demand for real estate as a product remains very high, on the other hand nobody can say with any certainty what will be the long-term impact of the pandemic on the manner in which we use areas in the future – and on how future-secure the respective assets actually are.

The best example for this is to be found in the office segment, traditionally the largest asset class on the real estate market. Before the crisis the excess demand on the part of investors and tenants was enormous, and in some markets such as Berlin and Munich, for instance, the available office space was virtually fully leased. We can now see, however, that the home office – a concept which often used to be ridiculed – can function. In the broadest sense many companies do not have to fear any decline in efficiency when employees work from the confines of their own living space or in their favourite café. This finding is likely to ensure that aggregate demand for office space decreases rather than rises. Against this background the Cologne-based German Economic Institute recently forecast price declines of as much as 47 per cent in the segment for prime office properties – whereby this negative scenario appears extremely speculative and somewhat exaggerated in the current situation.

A new form of conservatism

In view of these uncertainties I am convinced that a more conservative investment approach across all asset classes is the order of the day. By this I mean that the fundamental real estate and market performance indicators will once more gain in importance. The economic efficiency of an investment is the most meaningful criterion for its future viability – and not for example how “green” or “connective” a property is. Such secondary issues will take a back seat at least for the time being.

But on no account does greater orientation to the economic fundamentals of the sector mean less complexity. On the contrary: the workload associated with asset and property management will increase considerably, and complementary services will also gain in relevance. Ultimately the current lack of clarity means that real estate strategies and area concepts have to be amended quickly and efficiently in line with developing needs. A mixture of conservatism, flexibility and an ongoing desire to improve will be necessary so as to also safeguard the marketability of the respective areas in the long term.

Ensure all the eggs are not in one basket

A typical scenario is the shift of focus from the single-tenant property to multi-tenant real estate, for example. While properties with a dominant anchor tenant have often performed impeccably over many years and have often actually developed better than originally foreseen in the business plan, this does not necessarily have to be the case in the future. Just what the insolvency of an anchor tenant can mean for a property is shown by the Wirecard bankruptcy, in the wake of which there is the risk of 60,000 square metres becoming vacant in a Munich business park. Naturally this particular development is not a direct consequence of the pandemic, but the fundamental threat of such a scenario as a consequence of a Corona-related insolvency would be the same.

The degree of complexity has not only increased considerably in the wake of the coronavirus for the above example of office real estate, but also for retail properties, hotels and care homes, for instance. Accordingly, the possible factors that decide on the success of an investment are more numerous than ever before. Alongside specialist expertise, extensive knowledge of the market and a local presence have gained greater weight, therefore. The same is true of the interplay within the value creation chain, between fund, investment, asset, property and letting management therefore: especially in the current crisis, which has such a tremendous impact on the use of the areas themselves, the changes in requirements are seen first of all by those market players who are in constant contact with tenants.

Will Germany as an investment location become the global front-runner?

The coming months and years will undoubtedly be extremely challenging for the German real estate markets. Nevertheless, there are some particular opportunities, and especially so in an international comparison. On the one hand, the COVID-19 pandemic has passed off relatively mildly in Germany to date, something which is due to the interplay of political and societal factors, among other things. The measured reaction of the political decision-makers at federal and state level in conjunction with the robust German health care system has ensured that it was in part possible to contain the COVID-19 outbreak. In this respect, the legal security that is appreciated by many international investors was never in any serious danger at any point in time.

In addition, the extensive economic aid packages have assisted Germany’s real economy. This was above all possible thanks to the healthy state of Germany’s federal finances. Prior to the crisis, for instance, the national debt was around 60 per cent of the annual gross domestic product, whereas the same ratio in the USA was significantly higher than 100 per cent. Even the enormous level of new debt on the back of the economic stimulus packages does not appear to pose any threat to the stable overall economic situation.

While there can be question that the fundamental economic data here in Germany have deteriorated since the onset of the crisis, in the current international comparison, however, Germany is in an excellent position, which is why its role as a safe haven for investors has again been consolidated. In this respect the decentralised economic structures represent a key advantage. In contrast to centralised real estate markets such as France and Great Britain, Germany has seven or eight top real estate markets, depending on the definition, as well as numerous established secondary locations, meaning that a purely German real estate portfolio can be widely diversified. Nevertheless, this spread alone does not suffice as a security feature and under no circumstances is it a guarantee for long-term value appreciation – which is why a more precise consideration of each individual asset and each individual market is more important than ever before.

About: Markus Reinert FRICS is the Chairman and CEO of IC Immobilien Holding AG