German office markets prove resilient

German office markets prove resilient in times of crisis

Office market study: secondary locations particularly crisis resilient

• Office market study by BNP Paribas REIM and bulwiengesa: Many tier-2 and tier-3 locations offer substantial long-term rent price increases
• Risk of surplus space lower in tier-2 markets
• Heidelberg, Ingolstadt, Heilbronn, Ludwigshafen and Bochum all particularly crisis resilient

Office markets outside of tier-1 cities often prove more resilient to crises long term and exhibit low risk of market distortion during economic downtrends. These are the findings of the “Fragile times, robust locations” study, which was recently published by BNP Paribas Real Estate Investment Management (BNP Paribas REIM) Germany in cooperation with analysis firm bulwiengesa. The study takes a look at rent trends in office markets in various submarkets of German cities in terms of their resilience in times of crisis over the past 30 years. The BNP Paribas REIM research team analysed a total of 66 German cities with 198 submarket combinations.

Real estate investors in Germany generally consider the country’s top cities of Hamburg, Berlin, Munich, Cologne, Düsseldorf, Frankfurt am Main and Stuttgart to be the investment markets with the most potential. The office markets in these metropolitan regions enjoy particularly high demand. However, BNP Paribas REIM’s latest study shows that it is actually the country’s secondary markets and the tier-2 and tier-3 locations they contain that prove the most robust long term. These locations exhibit the least distortion in times of crisis.

Tier-1 cities start ranking in 37th place

Tier-2 and tier-3 locations in Heidelberg, Ingolstadt, Heilbronn, Ludwigshafen and Bochum ranked particularly high in the study’s robustness scoring. The top 36 spots were claimed entirely by secondary cities and primarily by tier-2 and tier-3 locations. Although Stuttgart’s City submarket led the pack among Germany’s tier-1 cities, it only ranked 37th out of 198. The findings around average increase in rent prices were somewhat unexpected, with the periphery around the city of Fürth posting a 3.3% increase in rent prices on average per year. “Competition among investors for assets in Germany’s top 7 office markets is fierce. The fact that secondary markets are performing so well in terms of robustness gives investors an alternative,” says Thomas Kotyrba, Head of Research at BNP Paribas REIM. “In the German market environment, which is characterised by its polycentric nature, secondary markets stand out due to their decentralised locations, high resilience in times of crisis and noticeable outperformance when it comes to long-term increases in rent prices.”

Andreas Schulten, Chief Representative of bulwiengesa AG, sees reasons for the robustness of tier-2 locations primarily in the fact that supply tends to be in line with demand. “Investors that are active in the country’s tier-1 cities typically speculate on future demand, and times of crisis can create turbulence. Secondary markets, however, don’t experience the same disruptions, which reduces the risk of excess supply. Another factor that comes into play here is the fact that these markets are characterised by a high percentage of owner-occupied space, which means much of the space is not even being offered for rent.”

Real estate portfolios: Cities in primary locations are not always the way to go

In terms of portfolio strategy, the study provides key insights into the total return of portfolios that incorporate secondary market investments. Portfolios that add attractive, competitive assets in robust tier-3 and tier-4 locations to their investments in secondary submarkets by no means dilute asset-allocation performance. In fact, the study finds that quite the opposite is true. Selective exposure to German secondary markets and their tier-2 locations both increases portfolio robustness and the chances of seeing steeper growth in rent prices. This investment approach can improve performance going forward without investors having to make compromises in terms of their risk/return profile.

Study expands investment horizon

“The findings of our study most likely come as a surprise to many investors, as they contradict the typical expectations that many real estate investors in the German market tend to have,” comments Isabella Chacón Troidl, Chief Investment Officer of BNP Paribas REIM. “The trend until this point has been to add investments outside of the country’s major cities to a portfolio simply for diversification. Our study, however, suggests that these investments can also help guarantee the long-term value of real estate portfolios, even during crises.”

In times that are characterised by supply bottlenecks, political uncertainty and increasing pressure on an already fragile economy, the Fragile Times, Robust Locations study provides real estate investors with meaningful take-aways and points to how important office markets in secondary locations can be when constructing a crisis-resilient portfolio. To get at these results, the research team from BNP Paribas REIM and bulwiengesa looked at three main factors over a period from 1991 to 2021: maximum decline in rent prices per business cycle, the extent and duration of downward rent trends and average rent price during the cycle. The findings were then collected to create a final robustness score. The study therefore provides an overview of Germany’s most robust office markets and answers the question of what role secondary locations play in real estate portfolios. You can download the study from BNP Paribas REIM’s website: https://archiv.bulwiengesa.de/de/studien/studie-fragile-zeiten-robuste-lagen

Sample profile: Heidelberg

Heidelberg claimed the top two spots in BNP Paribas REIM’s robustness ranking: one for a peripheral location and one city location. The city has a population of roughly 160,000 and is characterised by above-average take-up and prime rents of over €16 per sqm. Consulting and financial services, software/IT, and doctors’ offices and medical services have a particularly strong presence in the city. Roughly 63,000 sqm of office space is currently under construction in the Heidelberg market (new-builds and renovation (RA-C)), around 34% of which is currently still listed. In comparison, the average speculative share of office space currently under construction in tier-1 cities comes to 44%.

Sample profile: Heilbronn