Valuation in a disrupted market

While the COVID-19 pandemic has prompted massive uncertainty in German real estate, there has been no widespread crisis and no sign of a general price decline. However, it would be wrong to say that it has not affected the market at all: for valuers, differentiation has become more crucial than ever.

A lack of transactions in individual asset classes initially meant there was limited market information available to valuers when preparing an appraisal. This situation was aggravated by inconsistent market activity, making the valuation more demanding because significantly more research had to be done than before the pandemic – property valuation should  be based on the facts and evidence, reflecting what is actually happening in the market. 

This uncertainty has been exacerbated by the different trends for different types of property and by the subjective perception of the players in the market, as the evaluation of the Deutsche Hypo Real Estate Climate revealed. The need for more extensive analysis of the market for a specific use makes the valuation of a property more complex, and even within property types there are serious divergences.

Rents and purchase prices continued to rise, even if these rises varied somewhat by region. This may be because the economic consequences of the pandemic have been partially averted or at least postponed by government support such as financial relief and short-time work. Interest rates are still low, and the desire for safe investment opportunities remains high.

Even in the residential segment with its traditional high transaction volume, there is often little daily information available on transactions. When making an assessment, therefore, valuers will want to look at the general trend in values to orient themselves. According to bulwiengesa's RIWIS database, between the first and third quarters of 2020, residential property values in German class-A cities (top seven cities by transaction volume) did not suffer from the effects of the pandemic. 

The average multiples (ratio of market value to gross rental income) of apartment buildings increased across the board, with increases ranging 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 am 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, although stagnation was observed in Cologne and Munich. Rents for new-built flats rose across the board on average. Munich continued to increase slightly, at +0.5% on an already high price level, while the highest rate of increase was recorded in Berlin at +3.5%.

However, increasing flexibility does not necessarily lead to an actual reduction in office space. After all, even those who work in the office for three days a week rather than five must still be able to occupy a workplace, so the outcome for offices is as yet uncertain. Occupiers could save money by reducing floorspace, but there may need to be greater investment in that space in order to maintain cleanliness, booking systems and so on. Moreover, there was a shortage of supply before the pandemic, especially in the big cities. The big cities' economic performance indicates that – so far at least – government-initiated measures such as financial relief and short-time work have been able to mitigate the economic impacts of the pandemic.

Due to the demand shock, rental turnover collapsed in spring 2020, but from the third quarter onwards a clear recovery was noticeable. Nevertheless, at the end of 2021 we saw a decline in turnover of 20%–40% compared to the previous year. Because of the strong position of the market before the pandemic, the most important German office locations have yet to be badly affected. However, in some cases – especially in the less-established locations – weaker rent levels can be observed.

The fundamentally positive situation in the class-A cities is reflected in the key indicators of the office markets there. For example, prime yields have remained largely constant since the first quarter of 2020, while prime rents for office space in these locations also remained largely the same across the board from the first to the third quarter of 2020, fluctuating by no more than around 50 euro cents in one location or another.

It is vital for valuers to be able to interpret this data correctly: even if the nominal rents have remained constant, one cannot draw conclusions about the effective rents from this. When analysing the leases, one has to take into account rent-free periods and other incentives offered by the owner that lead to a reduction in their total income.

The latter were already affected by structural changes such as increased online retail before the outbreak of COVID-19, which is further accelerating those developments. It can be assumed that the turnover physical retail lost to online shopping during the pandemic will not be completely regained in the future. Consequently, significant price declines can be assumed for such property types.

Local supply and specialist stores, on the other hand, were able to benefit from the 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 as asset value rises. 

The gross yields of specialist stores have peaked at around 4.5%, and remain stable. Again, the available information must be carefully weighed and interpreted. The market situation for shopping centres looks less rosy, however – in this segment, the peak gross yield is currently around 5.5%, and a further increase is to be expected. 

Turnover rental arrangements are also found in the market, but the tenant needs to make enough turnover to afford this. This ratio is usually called the 'effort rate' and helps to assess whether the tenant can pay the rent in the long run.

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 around 25% in a year-on-year comparison up to the third quarter of 2020 according to bulwiengesa AG research.

Analysts assume that occupancy rates equivalent to those from before the pandemic may only be achieved in 2023 or even 2024. It is 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 therefore decreased significantly. Transaction volume between the first and third quarters of 2020 fell by around 37% compared to the previous year. However, distress sales have not yet been observed; investors that are willing to buy are hoping for acquisition opportunities to come onto the market at favourable prices.

Analysis of the key figures for hotels in more detail suggests that, even with the low occupancy rate expected in the coming year, operators could achieve a reasonable profit. The rent level is decisive – where hotel assets are empty or owner occupied, a market rent level is assumed for valuation. With a correspondingly low rent level, the hotel operation can still make an adequate profit 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.

It is more important than ever to take a close look at the property, its location, the concept, the economic viability, rental and lease conditions and so on to carry out extensive market analyses. 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.

Marcus Badmann is managing director of bulwiengesa appraisal GmbH
Contact Marcus: Email

Related competencies include: Valuation