| Germany comes into the property investor's viewfinder, and Irish investors are eyeing up attractive opportunities there |
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| Irish investors have taken advantage of a rare opportunity to get into the German property market. Elmar Schilling writes that, with German investors off the scene, domestic banks are now looking to foreign investors to buoy up the depressed market - with the added attraction of some real yield growth in the near future. |
The German property scene is quite secretive relative to that in Ireland or the UK. People play their cards close to their chests but we know that in the past few months one Irish property investment group has bought a group of 12 supermarket properties, principally in the western side of Germany showing a yield of around 8.5 per cent.
 | | Irish property investors are being drawn to Berlin |
Another Irish investor has bought a 15,000 sq metres building in Frankfurt and a third has snapped up a shopping centre in the Cologne area showing a 7.5 per cent yield.
Irish investors have been active in the Czech Republic and places further east for a while. But why is Germany such a smart bet now? Germany is part of the European Union and is the leading exporting country in Europe. It has a sophisticated banking system and laws that govern the country, encapsulated in the Civil Code.
Investing in real estate in Germany is so different there than in Ireland. To start with Germany is not a country – it is a Federation of States, each with the responsibility to look after the other one and all the states must seek to work in harmony with each other. In addition, the eastern part was until recently a communist controlled state with all the freedoms for the individual that that entailed. Finally the Code Napoleon applies in most states.
So you have a collection of states, pretending to be a country, part of which were communist dominated and subject to the French civil code system of the late 18th century. And now you want to invest there! So where are the differences that will effect an investor and change his sleep patterns? They aren’t major but look carefully.
Germany is in fact one of the most harmonious countries in the EU and remains the ‘engine’ that pulls the European train. Germany remains one of the safest countries in the world in which to invest into, but for foreigners it was difficult to break into in the past as the yields were unattractive compared to elsewhere as the great Deutschmark forced down rates. The arrival of the eastern part of the country and the immense investment into that region combined with the general business slowdown has changed all that. There was a large amount of tax-driven development in the east – a lot of it appalling - and in the west a great deal of business consolidation. The result was that real estate has looked less appealing than it did to a lot of German investors, who had suffered from a ‘double battering’ of falling rents (from their artifical highs – like so many other Central European countries), rising yields and vacancies in the east, combined with a falling stock market. With a lot of the German investors out of the market and quite a number of forced sales in the offing, the foreign investors have got their first look in for years. At last there is a chance to invest and the German banks are giving preference to the foreign investor over the locals with an added attraction that there could be some real yield growth in the near future.
But there remains the differences. Let us look at the major ones that will effect commercial property transactions:
Leases: Leases may extend to a maximum period of 30 years, after which they can be terminated regardless of the term agreed in the lease. All leases extending for a period of over one year must be in written form. There is no requirement to register a lease.
In general leases are taken for a multiple of five years, offices on the whole are leased for a 10 year term with large retail boxes at 10 to 15 years. Warehousing/logistics vary from anything from five to 10 years. Smaller units in either the retail or office sector are usually leased for five year terms.
Leases generally are taken on the basis of Dach und Fach, however there is no definitive definition of what Dach und Fach actually is. Whilst the landlord is responsible for the roof and the fa?ade, it is often the case that the landlord will be burdened with the replacement of plant and machinery, carpets and other such fixtures and fittings. Much depends upon the negotiations at the commencement of the lease term.
Rents are paid on the whole monthly in advance and are indexed annually to the German CPI. The phrasing of the indexation clause is important to understand as some rents are indexed on percentage increases, whilst others on straightline numerics – this can make a difference as to when the incidence of indexation comes in.
In the office and industrial markets tenants usually accept straight 100 per cent CPI increases. However, in the retail markets, the powerful multiple retailers have been able to keep the increases down by limiting the increases both by percentage increases and by limiting the incidence of the indexation review. Again there is no standard and each lease needs to be reviewed for this clause. Finally on indexation with the older leases the base date is often an older one than the index calculation.
In the office and industrial sectors tenants on the whole meet the full cost of rates and insurance of the property. However, in the retail market again the powerful multiples have been able to pressure developers into accepting the cost of rates and insurance. The only good point of this is that the incidence of rates (grundstueur) is considerably less of a burden than in Ireland.
Sales and purchases: Agents will quote prices based on a multiple not a yield. These multplies are based on the gross rent receivable and not the net income. Frequently if you ask vendors what their net income is, they have no idea of the average costs per annum of maintaining their property. The agents to whom you will be expected to pay a fee, will have even less idea and will be unable to understand what you mean by net income; similarly if you explain to them that you will have to add the costs of purchase to the purchase sum to arrive at the net yield they will look at you as though you had just arrived from outer space and were speaking Martian.
Ownership: Most property is owned outright, but there are other rights such as erbepacht, which is a ground
lease, usually where the church or a city is the landlord. At the end of the term the building on the site will revert back to the landlord for a pre-agreed compensation to the head lessee. Care needs to be taken in buying a leasehold to ensure that the property is correctly amortised, in any event the capital gain is effectively lost.
All property is held in the Cadastral Register, a relic of Napoleon’s attempt to create a French based EU.
Unlike most European countries that have adopted the Cadastral system, the German system works well, due in the main to the efficiency of the notarial system. However, sales/purchases can be delayed by registration, but the issue of priority notices in the Land Registry does avoid this. The Cadastral system reduces the endless disputes found with the British system on boundaries, rights and easements.
Finance: Germany has a very sophisticated banking system. This is usually where overseas buyers first discover that Germany is not a single country, but a group of federal states. There are the major German banks well-known internationally. However, the most powerful banks in the country are the Sparkassen or the Landesbanks. These are the local state banks, who are the main lenders into the real estate market in general.
The raising of debt is no major problem, but these local banks are not that sophisticated in structuring issues such as non-recourse, amortisation rests, cash-sweeps, bent interest curves and other such vehicles. On the other hand, the LTV is more dependent upon the underlying real estate’s value than the covenant or income drive and this can often help the debt profile to the advantage of a borrower.
An interesting feature in the current market is that German banks will lend more readily to foreign purchasers and be more creative than if they are lending to a local borrower.
Fees: This is where most professionals need to sit down before reading this. German estate agents are generally incompetent, arrogant and ignorant and as result the level of their fees range from two per cent to seven per cent of the acquisition or sale price, which is usually met by the purchaser. Although it is not unusual for the agents to charge these fees to both parties.
Legal fees, excluding the notary are between 0.50 per cent to one per cent, depending upon negotiation and it is essential to appoint a solicitor in larger commercial or residential transactions. The notary fee will add a further 0.50 per cent, but it is based on a sliding scale dependent upon the transaction price of the property.
Transfer Tax (Stamp Duty) is set at 3.5 per cent, but if the sale is by way of a company transaction whereby at least 95 per cent of the shares are sold (together with 100 per cent of the income) then this fee can be avoided if the balance of the shares are transferred after four years.
There are the other usual fees for structural and environmental surveys and these are on the whole about one third less.
So the differences are relatively small on the surface, but quite critical:
• Lease terms mean that a German yield of 10 per cent will mean to an Irish investor a net yield after costs of closer to 8.5 per cent
• Erbepacht can mean that the investor will lose the right to the property at the end of the term, and even if compensated, it will not recoup the possible capital gain
• Dach und Fach/ means that a landlord can find himself facing some pretty high bills from the tenants occupation, this can be avoided with a new lease, but more difficult when inheriting and existing one
• Fees, especially those of the local agents can drive up the blood pressure and erode the net yield still further
There are no restrictions on purchasing property in Germany, but caveat emptor still applies there as anywhere else, as there are a lot of canem out there. |
Elmar Schilling is a partner with Cyril Leonard GmbH.
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| Article appeared in the January 2005 issue.
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