Investors are struggling more than ever to find investments with optimal or even adequate risk/return profiles in the current post financial crisis era. Due to a low interest rate environment (caused by central banks’ quantitative easing), a particularly depressed performance of emerging markets equities, the recent crisis of gold and stagnant price of other commodities, is today a true challenge when aiming to achieve appropriate diversification with consistent positive returns over the medium and long term.
In this context, real estate is quickly recovering its central role in investor portfolios due to the main benefits of it being hedged against inflation, stable and positive yields, a low correlation to other asset classes and real asset status. In particular, among the most attractive investments in European real estate are Berlin’s commercial and residential property markets.
It was the end of 2006 when I happened to be in Berlin and I discovered its unconventional real estate market with exceptional returns and an attractive outlook, and the opportunities it offered. In almost 20 years of investment origination, I had never found an investment opportunity offering similar yields, strong upside potential and limited downside risk. I decided to create as I saw the great opportunity international investors could benefit from with a company that could deliver an excellent level of service, comparable to the one offered by well-established asset managers and banks, but with the benefit of flexibility and the customised solutions of a small and client oriented firm.
[A]mong the most attractive investments in European real estate are Berlin’s commercial and residential property markets
Since then, Berlin’s real estate market prices increased by 60 percent and Optimum was able to successfully invest more than €500m spread over two funds. We are now in the process of launching our third fund. The reasons leading to the current exceptional situation in the Berlin real estate market are both historical and structural.
Unification brings change
From 1990 to 2005, Berlin faced the problematic issue of reunification – in the context of a stagnating economy – with a 20 percent unemployment rate and GDP growth close to zero. Public deficits combined with an enormous stock of property inherited from the German Democratic Republic of East Berlin resulted in a constant inflow of properties into the market through the government and public housing corporation auctions.
By that time, oversupply matched by weak demand – as a result of the poor economy – put enormous pressure on property prices, bringing them down to a level without comparison in the whole of Europe and other developed countries. Furthermore, before 1990 Berlin was managed by a vast amount of state subsidies that included the residential rental market, creating a legacy of low rental costs. This encouraged people to rent as opposed to buy, and led to one of the lowest homeownership rates in the whole EU area.
But Berlin is the capital of Germany, the largest economy in Europe and the fifth in the world by GDP, and important reforms conducted by the German government led to the development of fast-growing sectors such as tourism, life sciences, mobility and services with information and communication technologies. Indeed, since 2005, the situation has been significantly improving, and Berlin’s economic data has been constantly positive.
The city’s economy has grown continuously above the German average in the period from 2005 to 2013 and in the last year, its unemployment rate fell to 11.2 percent with a GDP growth rate of 3.8 percent, more than 0.4 percent in Germany and 0.1 percent in the EU28 countries. Moreover, Berlin is benefiting more than other German cities from the economic recovery because of the low cost of living, an excellent educational system, as well as its strategic position in the country and its technological prowess – it is the leading German city in terms of network infrastructure.
Structurally, the extremely low prices of Berlin properties have created a one of a kind situation in its real estate market. The prices for existing properties are, in fact, still below the cost of new construction and, therefore, poor new residential building activity has taken place over the past 10 years. This situation, coupled with a continuously growing population (currently, around 3.4 million people live in the city and in 2013 only, the population increased by roughly 50,000 inhabitants) led to over-demand for real estate.
As a consequence, the vacancy rate sharply decreased, standing now below two percent for residential properties. With a significant difference between institutional (whole buildings) and retail (single units) property prices – and due to constantly rising rents – yields for institutional investors are pretty stable at an average of 6.5 percent, with peaks reaching eight percent.
Berlin’s purchasing power
Even after growing for almost a decade, Berlin’s prices are still substantially cheaper than other comparable German cities, including Munich and Frankfurt, and other major metropolises in Europe, including London, Rome, Paris, Madrid, and even Athens. Moreover, new key developments are changing the city’s property market. Experts expect the homeownership rate to increase (currently around 15.6 percent against a German average of 45.7 percent), also thanks to a misbalance in the purchasing power of Berlin residents who, compared with other German residents, have a salary-to-property price ratio significantly higher (see Fig. 1) and can benefit from the positive incentive of low rate mortgages coupled with increasing property value.
This is leading to the establishment and strengthening of a high-potential retail market, providing an exceptional exit strategy to institutional investors like Optimum who can buy entire buildings and then split them to be sold on a single unit basis at the much higher retail prices.
The profitable situation of the Berlin real estate market is already clear to both national and international investors. According to the latest data released by the city’s market registered the highest liquidity within Germany, showing a continuously growing trend, and the number of traded properties was four times higher than 2012. In a growing, competitive and unique environment like the Berlin market, investment in real estate can follow two opposite approaches.
There are large traded portfolios, usually made by more than 3,000 units, built over many years and cyclically transferred among significant institutional investors. These portfolios can be bought at significant discount by different ways (for instance, through direct acquisition or takeover of the owning entity), and their significant size can provide relevant diversification and large-scale benefit in day-to-day management. However, I believe this approach might be considered as the equivalent of index investments in equity markets – their return is often mostly linked to the overall relevant market sentiment.
The opposite approach is to build a portfolio from the very beginning, which Optimum does, through a careful selection of properties deemed to be undervalued and, therefore, with a significant upside. I believe this approach represents the best way to exploit the potential of a still growing and non-homogenous market like Berlin, where specific and notable opportunities can be found.
On the other hand, it requires a specific structure and expertise to reduce due diligence and execution time to the lowest possible, because the best properties often stay on the market for as little as one or two weeks. Furthermore, besides a deep knowledge of the market and acquisition expertise, an active approach during the optimisation phase is needed when, through property management and careful investments in renovation of the properties, the upside of the portfolio can be fully realised.
Either way, for the next few years Berlin’s real estate market will continue to attract a growing number of investors, both retail and institutional, looking to benefit from its dynamic and unparalleled opportunities. As of today, the market still has a lot of potential, but the catching up process with its German and European counterparts has begun.