• Transaction volume of €9.6bn (-54% compared with Q1– Q3 21)
• The fewest transactions in a quarter since 2010
• Price adjustments well underway – long-term yields still unclear
• Fundamental data remains positive – essentially no vacancy risk for the foreseeable future
• Large volumes of product coming to the market in the months ahead – transaction volume could rise to €15bn
• The reticence of many purchasers is creating opportunities to build portfolios in a market that remains attractive in the long term

The situation in the German residential market is currently highly ambivalent according to Savills. In the investment market, the changed financial conditions have resulted in significant reticence among investors. In contrast, supply in the rental apartment markets has become even more scarce, which has further improved long-term income prospects from an investor's perspective.

The transaction volume (transactions of at least 50 residential units), stood at just €1.96bn in the third quarter. This represents the weakest three months for investment since the first quarter of 2016. The number of transactions in the last quarter was the lowest since 2010. The transaction volume for the year to date stands at around €9.6bn, which is approximately 54% lower than in the corresponding period last year. Karsten Nemecek, Managing Director of Corporate Finance – Valuation for Savills Germany says: “The volatility in the financial markets is also causing greater uncertainty among investors in the residential investment market. The increased costs of debt capital and bond yields in particular have caused investors to re-position themselves and their investment strategies. While this process is ongoing, many investors are acting very conservatively. Meanwhile, for investors with a focus on consistent, long-term income streams, prospects in the residential market have even improved and we could expect to see a revitalisation of the market.”

Price adjustment process underway
The low transaction activity reflects the currently often protracted negotiations between owners and investors. Owing to the reversal in interest rate policy, Savills believes most market participants are having to recalculate their investments. Nemecek adds: “Within nine months, the ten-year SWAP rate has risen by around 270 basis points and yields on ten-year German government bonds have risen by around 230 basis points. Owing to this constellation, the leverage effect has turned negative within a short space of time. At the same time, the risk-free rate is now at the same level that prime yields on residential property were only a few months ago. These developments mean that yields on apartment buildings must rise.” According to Savills, some investors, including international private-equity firms, are assuming that the increases in SWAP rates and bond yields will be fully reflected in residential yields. Should this be the case, prime yields of around 4.5% could be expected in the medium term. However, there are good arguments against such drastic increases in yields, as Nemecek explains: “In addition to the very good fundamental data, the institutionalisation of the market since the end of the financial crisis also supports the idea that yields will not increase as much as some market participants are expecting. Accordingly, many owners are currently not prepared to sell at significantly lower prices, which is why only a few sales have been successfully completed.” Over the coming months, Savills expects the consequences of interest rate hikes and the positive long-term fundamental data to be invoked and priced in during sale price negotiations. Consequently, the price adjustment process is likely to be further prolonged.

The supply shortage in the rental apartment markets is intensifying
According to Savills, the fundamental data continues to favour long-term engagement in German residential property since rental apartments will remain a scarce and sought-after commodity over the coming years. Matti Schenk, Associate Research Germany for Savills says: “The combination of rising construction and financing costs, the removal of subsidies on new builds and the lower willingness to pay on the part of investors will result in fewer housing completions. It is becoming apparent that the German government's target of 400,000 apartment completions over the coming years will be missed by a significant margin.” Hence, while there is little expected by way of relief in the rental apartment markets on the supply side, demand is likely to be higher than was expected even at the beginning of this year. Recent research from Deutsche Bank predicts that there will be almost 86 million people living in Germany in 2030. Schenk says: “The upward correction in population projections will entail a short-term increase in demand. Since home ownership has become unaffordable for more and more households due to rising interest rates, these households will be active in the rental market instead. For owners of rental apartments, this means there will be practically no vacancy risk in many cities for the foreseeable future and they can count on rental income at least remaining stable.”

In the current phase of high inflation, Savills believes the significantly increased service charges are likely to be pushing the solvency of many households to its limits, making increases in net rents more difficult to implement. Since rising service charges disproportionately impact households with lower incomes, owners of properties of a basic standard could be particularly affected.

Residential property companies are switching to the vendor side – an opportunity for new investors
Savills expects the tug-of-war between the greater scarcity of apartments on the one hand and rising interest rates on the other to continue over the coming months. This will produce many opportunities for investors over the coming months. Schenk says: “We expect significantly more supply in the portfolio segment in the fourth quarter. At the same time, the residential property companies, who have accounted for 41% of the acquisition volume over the last five years, have now switched to the vendor side. With the de facto loss of this purchaser group, there will be greater opportunities for all other investors to increase their residential holdings.” Nemecek continues: “The long-term positive prospects in the occupier markets offer investors the opportunity to enter a market with almost no vacancy risk, long-term rental growth potential and long-term high stability of capital values combined with little competition and higher yields.”

The large product pipeline could result in the market regaining momentum faster than all other sectors. The transaction volume could rise to €15bn by the end of the year according to Savills’ projections. This would be around the same volume invested at the peak prior to the financial crisis. This underlines the status that residential property has since gained in the portfolios of institutional investors.

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Market in Minutes: Residential Market Germany Q3 2022