Lenders need to adapt to changing German market - Study

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Demographic changes, urbanisation and digitalisation are exerting fundamental changes on the German commercial real estate market, and providers of finance will have to adopt new strategies to remain competitive, according to a comprehensive new study on the German market by strategy advisers Roland Berger.

Property lending remains one of the key sources of revenue for German financial institutions, which the Roland Berger strategy researcher put at €535 billion, providing annual revenues of between €5bn and €7bn. However, the low level of interest rates, the strong economy and clear trends such as demographic changes, increasing digitalisation and diverse political initiatives are changing the nature of demand in German real estate financing.

This is making the market more complex and subject to more intense competition, posing new challenges for classical lenders. In their new study - "Betonrausch in Deutschland: Paradiesische Zeiten oder kurz vor der Katerstimmung? - Herausforderungen in der gewerblichen Immobilienfinanzierung" – which appears in German only, the Roland Berger consultants provide a series of recommendations to existing and potential finance providers based on their proprietary analytical model of commercial property lending. The model is designed to prepare lenders to adapt to social and macro-economic changes in the marketplace and enable them to prosper even in a more normalised interest rate environment.

According to Markus Strietzel, partner at Roland Berger, “With even a moderate change in interest rates and a stable economy in the coming years, the market for commercial property lending will grow to about €600bn by 2018, and as such it will remain a lucrative field of activity for lenders. But it is growing more complex and more competitive. Lenders right now need to be anticipating a modest rise in interest rates and positioning themselves accordingly.”

Key trends changing the market:

The key drivers for the current high level of demand are the strong economy and the record low level of interest rates in Germany. Roland Berger partner Klaus Juchem adds, “We’re assuming that low interest rates will prevail for about another two years, after which we’re expecting moderate rate rises. Until then, however, property will remain “concrete gold”.”

Nonetheless, big changes are afoot in the German property market in the coming years – not least as a result of demographic changes. This will see a big rise in demand for elderly-friendly housing, while growing urbanisation will ensure that property prices in the cities will continue to rise. On top of this, landlords will be investing increasing amounts in energy-saving renovation of existing, second-hand properties to comply with regulations.

Asset Categories with their own Dynamics: Different categories of real estate will thus start to show markedly different behaviours in terms of their risk and yield return profiles. Residential property will continue to dominate the market ahead of commercial property although the returns will continue to fall. “Low interest rates are causing even average yields of 3% in top locations to be seen as attractive investments, despite the very high price per square metre”, says Strietzel. The total financing volume in this segment account for €280bn.

At €100bn - €110bn, the second-highest transaction volume is in the office property segment. Offering attractive average yields of 4.6%, the asset class is coming back into favour with investors, although it is still burdened with high vacancy rates and hence higher risks. It is also more exposed to economic volatility than the residential sector. As Strietzel points out, “On top of this, the whole trend towards more flexible forms of work means very different office concepts in the future. Many companies are enabling staff to work from home-offices and cutting back on office space.”

Increasing digitalisation is also exerting a big influence on the demands on property, with the rise in online retailing leading to a surge in the demand for logistics space. Ever more companies need decentralised warehouse space to be able to make speedier deliveries, and these trends are being reflected in rental yields, which can often be twice as high for logistics properties as for residential housing. The field of infrastructure financing, side-by-side with public institutions (PPP Public Private Partnerships), is expected to provide fresh new financing opportunities.

Heterogeneous Investors and Lenders: The current level of investment in commercial property in Germany is about 1,940 billion, of which about 80% is held by private professional investors, not-for-profit housing companies and capital market-oriented investors. These represent the most important clients for bank lenders. “The landscape of investors in Germany is very heterogeneous, and their needs for financial products and advisory services is equally diverse”, says Klaus Juchem.

The market for bank lending is also very heterogeneous, with many differing providers to match various business models, types of financing and regulatory factors. However, the core market of finance providers remains very competitive, with banks and other lenders in intense competition with each other to gain an edge in margins and adequate risk compensation. Providers range from lean and narrow financial specialists to the universal banks with their broad array of products, and to remain competitive in commercial property lending, finance providers will have to offer the optimal mix of strategy, processes and the right product.

Roland Berger’s Analysis model: The high degree of market complexity and differing business model approaches require a differentiated analysis of the goals and positioning of the lenders, as well as considering the effect of trends and their effects on individual property types. The analysis tailors the paths that individual lenders need to follow to determine their success, including individual strategies depending on client groups, the appropriate product range and the optimal level of efficiency in streamlining costs and processes.

According to Strietzel, “Commercial property lenders will have to clearly position themselves to be able to react to the needs of their clients in a faster and more flexible manner. This is even more critical in an interest rate environment that is slowly returning to normality.”

The study (in German language) is available for download at www.rolandberger.de/ pressemitteilungen