In the latest Bayfield Training Webinar, David Hourihan MSc RE Programme Leader at UCEM and Marvin Reichert, co-founder BlueHill Real Estate present: An Introduction To The Frankfurt Commercial Office Market.

German Office Investment Market Size

First, David explains the five major cities in Germany, namely Berlin, Frankfurt, Munich, Dusseldorf, and Hamburg. Of particular focus is the German office lease terms. In Germany, common lease agreements are based on the German Civil Code, and any additional lease clauses must comply with this Civil Code. Commercial leases are often less regulated than residential leases. Marvin explains that this is the German state’s effort to protect residential tenants.

Commercial leases are usually 5-10 years, with an option to renew for another five years, and they are quoted in Euros per square metre, payable monthly in advance. In contrast, in the UK, it is generally quarterly in advance. The maximum lease term in Germany is 30 years. Each party can thereafter terminate the lease after a statutory notice period. Break options in leases are freely negotiable and typically occur in year 5 of a longer lease. For leases with a minimum lease term of 10 years, rents are adjusted annually in accordance with the German Consumer Price Index. Alternatively, some leases have pre-agreed ‘stepped’ rental increases.

Under German law, the landlord is liable for any maintenance and repairs in a building; however, most lease agreements shift some responsibility for internal repairs and decorations to the tenant in practice. Each tenant will pay towards a service charge for water, cleaning, heating and waste disposal, any property tax, and building insurance in a multi-tenanted building.

Finally, subletting is only permissible with a landlord’s prior consent. If consent is unreasonably withheld, the tenant can terminate the lease.

Frankfurt Office Lettings Sub-sectors

As David explains, Frankfurt is a specialist market primarily in financial and business services, banking, and media. The total office stock in Frankfurt is approximately 12 million square metres. In comparison, Munich and Berlin are 20.1 and 17.4 million square metres, respectively.

Key office districts include Bankenviertel (Banking district), City, and Westend. David clarifies that the Westend, Banking district and the City comprise a large portion of the prime office space.

Regarding prime rents, the Bankenviertel holds the top end at €46 per square metre. This is followed by the Westend, where prime rents are €44 per square metre. In addition, Westend holds many of the hotels, historic buildings, and back-office space.

Whilst the vacancy rate in Frankfurt’s submarkets has crept up higher over the last 12 months, it currently hovers around 4-5%, illustrating the robustness of the market. Similarly, prime rents have held up well.

Frankfurt Office Market Structure

The office investment market structure in Frankfurt provides for interesting analysis. For example, the turnover in Frankfurt investments in Q1 2021 was at an impressive €980 million, which is 15% above the 10-year average. Furthermore, David explains that leading investor interest has been in small (< €25m) to medium (< €100m) sized individual investments. This is in contrast with preceding years where investor focus has been on large, portfolio-focused transactions. Nonetheless, investor sentiment indicates cautious confidence in the long-term characteristics of the Frankfurt market.

In terms of the volume of deals, Frankfurt comes second only to Berlin. As with the other major cities, the dominating sub-sector in Frankfurt is the office market. Specifically, the office investment sector accounted for 77.7% of deals done, up from a 10-year average of 70%. In addition, David contends that there is a healthy mix of investor types in Frankfurt, including institutional investors, high net worth individuals, family offices and REITs. Recent data indicates that roughly 9% of capital invested in Q1 came from international investors. However, he clarifies that capital investment has been evenly split between domestic and international investors in recent years.

To conclude this segment, David ran through a SWOT analysis of the German office market. Beginning with strengths, Germany is ranked 10th out of 99 countries in JLL’s Global Real Estate Transparency Index. Germany is Europe’s largest investment market, with no restriction on foreign ownership of property. Regarding weaknesses, purchases are subject to a real estate transfer tax of between 3.5%-6.5%. Moreover, uncertainty remains as to the UK’s trading relationship with the EU. This is compounded by the current global economic recession. The threats present include the unknown long-term impact of COVID-19, the political uncertainty regarding the upcoming Federal elections in September 2021, and regional tensions among EU member states. Nonetheless, there are opportunities. Namely, the most significant being the influx of office occupiers into Frankfurt post-Brexit.

Frankfurt Office Market Key Trends & Forecasts

The first key trend highlighted by Marvin concerns expectations on rental growth because of the uncertainty of whether it will continue to increase or stagnate on the same level. Secondly, there is also uncertainty regarding vacant spaces. In addition, buildings valued using a cash flow approach are likely to adjust their discount rate to allow for higher risk. Finally, as David notes, the lack of a transparent marketplace has been a problem globally across real estate markets.

Regarding forecasts over the next 12 months, Marvin explains that ESG goals are becoming more critical, reflected in fund mandates and building criteria. For example, Marvin argues a strong preference towards green-certified buildings in the German market. Thus, he believes that buildings that do not follow ESG protocols will see their rents fall in the future.