Real Estate Outlook for German Office Market

Real Estate

Company Rating Outlook for German office market Price (EUR) PT (EUR) Potential (%) What’s ahead for the office market in Germany? alstria office REIT Buy 12.20 16.10 32.0% The COVID-19 crisis has changed our lives profoundly in many ways. While some parts of the economy have fared well, others faced tremendous difficulties with a sudden DIC Asset Buy decline in demand leading to zero revenue generation – a crisis impact not seen before. 10.24 19.00 85.5% For the real estate market, the consequences of such changes vary across sectors and UBM Development Buy in the degree of visibility and thus, in terms of future outcomes. While the residential 31.00 47.00 51.6% sector developed very well, the distressed retail sector remains under pressure. The office sector however, has not provided a very clear picture of the future and after taking a closer look at the prevailing driving forces, we share our insights and expectations in this report.

. Investment market: The different stimulus packages should ensure that investor confidence in the German investment market, and particularly in the office market, continues to strengthen. With this, the transaction market is expected to pick up again. . Rental market: The incipient economic recovery should have a positive effect on the rental market and, despite all the uncertainties, we expect a moderate recovery in the coming months. . Vacancy: As tenants are expected to remain cautions, with many adopting a “wait-and- see” approach as the pandemic continues, vacancies should increase slightly towards the end of the year as new office space comes onto market. . Rent levels: The pressure on rents could intensify as the year progresses if there is an increase in attempts to push through rent-free periods or expansion cost subsidies . Financing: We expect a decline in new business volume of commercial real estate financing in Germany in 2020. The financing volume of offices should be stable as demand for core office properties (LT-lease, fully let, strong tenants) from equity-rich investors should remain strong. . COVID-19 should not have had much of an impact on the conditions for the financing of core properties owing to banks' focus and strong liquidity from the ECB's TLTRO programme. The financing of other categories (core+, value add, development) will deteriorate. For this reason we expect opportunities in these asset categories for investors with strong equity and liquidity positions or access to financing. . Covenants: The possible lower LTV requirement in new business could lead to lower demand for higher-risk assets as investors with a strong equity position prefer core assets (insurers, pension funds) to secure a stable cash flow. . Credit quality: NPL-volume should rise due to negative cash-flow developments due to tenant insolvencies. This could offer attractive investment opportunities across categories core+, value add and developments due to forced selling. . Remote work: The share of office workers working from home will increase and impact office market by between 10–20%. However, the transition will be gradual and will occur over the medium term and therefore should not impact yields profoundly.

To conclude our report, we applied our assumptions to different business models within the office sector, such as alstria as a portfolio holder, DIC with its hybrid business model (portfolio holder and asset manager) and UBM Development as a developer of office real estate. We believe all those businesses provide different but attractive exposure to the recovery of the office sector. However, we are convinced the current environment offers opportunities for those with sufficient liquidity and low risk of revaluations leading to write-offs.

Authors Analyst Analyst Analyst Andreas Pläsier Simon Stippig Philipp Kaiser [email protected] [email protected] [email protected] +49 40 309537-246 +49 40 309537-265 +49 40 309537-260

S E C T O R N OTE Published 05.10.2020 09:00 1

Real Estate

Outlook for German office market 1 What to look for in the German office market 1 Different risk categories in real estate 3

Commercial real estate market in Germany 4 Investment market 4 Rental market 5 COVID-related decline in demand for office space 5 Flexible office space 6 Vacancy rates still on a very low level 7 Volume of completions still at previous year’s level – pre-letting down 8 Rents unchanged – two cities even showing a slight increase 10

Financing of commercial properties 11 Financing of commercial properties – COVID-19 poses extra challenges but normalisation possible with recovery of domestic economy 11

Remote office as new trend 14 COVID-19 disrupting conventional office real estate? 14 Remote work across sectors 14 Higher flexibility and company-specific factors 15 Cost savings by reducing office-based workers 15 Legal framework for remote work 16 Personal interest of employees 16 Potential future scenarios for the office real estate market 17

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Different risk categories in real estate Core, Core Plus, Value add and Opportunistic

Our considerations of the office market are preceded by a general definition of the various risk classes. In the real estate sector there are different investment styles; and in order to be able to assign suitable properties to these styles, the so-called risk classes or risk categories have become established in the real estate sector. The risk classes provide information on how the risks relate to the yield opportunities of the respective property.

A distinction is usually made between the risk classes Core, Core Plus, Value add and Opportunistic. In order to classify a property, key figures are used to allow an objective risk assessment. Criteria for risk assessment include location, tenant structure, value potential, vacancy rate, solvency of the tenants, debt ratio and expected return

Core and Core Plus assets:

. High-quality existing properties and new developments

. Very high asset quality

. No, or only minor, maintenance investments

. Good to very good location

. Low vacancy rate

. Long-term leases

. Very high solvency of tenants

The aim of Core and Core Plus properties is maintenance, renovation and refurbishment.

Value add and Opportunistic assets:

. Higher vacancy

. Higher maintenance investments required

. Higher value increase potential

The aim of Value add and Opportunisitc assets are to privatise or re-let the properties after renovation, redensification or new construction. Once a property has been upgraded, it should be sold at profit.

Different risk categories in real estate Holding Risk period

Opportunistic

Value add

Core +

Core

Return Source: Colliers, bulwiengesa, Warburg Research

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Commercial real estate market in Germany Investment market RE market defies COVID – impact of lockdown visible in Q2

In the first half of 2020, a total of EUR 41.8bn was invested in the German real estate investment market, of which EUR 29.3bn was in commercial property. Compared to the first half of 2019, this represents an increase of 21%. As in recent years, the office sector was the main driver of this increase, accounting for more than 40% of transaction volume in the commercial real estate sector.

Commercial real estate investment market overview

2019 H1 2019 H1 2020 % Change yoy (in EUR m) (in EUR m) (in EUR m) Total investment volume 89,500 34,550 41,800 21.0% Commercial properties total 71,600 23,600 29,300 24.2% Transaction Type Portfolios 21,053 4,248 13,190 210.5% Single Assets 50,576 19,352 16,110 -16.8% Type of use Office 40,500 12,040 12,600 4.7% Residential 17,900 10,950 12,500 14.2% Retail 10,000 4,840 6,740 39.3% Industrial & Logistics 6,500 2,360 3,810 61.4% Hotel 5,000 1,650 1,170 -29.1% Development Site - 1,770 3,220 81.9% Other - 940 1,760 87.2% Source: CBRE, JLL, Warburg Research

That it was still possible to achieve an increase in transaction volume compared to the previous period despite the current corona crisis is predominantly explained by a very strong first quarter. Driven by large portfolio transactions (17 portfolio transactions in excess of EUR 100m, totaling EUR 14.7bn), the transaction volume increased by 97% to EUR 27.8m compared to the previous year (Q1 2019: EUR 14.1bn). Thereof, EUR 18.4bn was attributable to commercial real estate and EUR 9.4bn to “living” (residential properties).

But even the property market was not left untouched by the pandemic. Mainly as a result of the lockdown during the second quarter, the transaction volume fell by 20% compared to previous year’s Q2.

Office properties remain the most popular asset class among investors and reflect the confidence in the stability of the German office market. Even during the lockdown, transactions for core assets in prime locations were observed, such as the sale of Patrizia’s Ericus-Contor office building in Hamburg to Union Investment

Transaction35 volume in Germany (EUR bn)

0 2014 2015 2016 2017 2018 2019 2020 Q1 Q2 Q3 Q4 Average Q1 14 - Q2 20 Source: CBRE, JLL, Warburg Research

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For the moment it looks as if the German economy is slowly recovering after the massive slump in spring. Two arguments support this thesis:

. Short-term real-time indicators: According to CBRE, short-term (sometimes daily) real- time indicators such as the truck toll index, the weekly activity index of the Bundesbank or the mobility data of mobile phone users indicate that the German economy is on the upswing again

. Stimulus package and PEPP: This development is supported by the billion-euro economic stimulus package of the Federal Government and the ECB emergency programme PEPP (Pandemic Emergency Purchase Programme); which was expanded from EUR 750bn to EUR 1.35bn at the beginning of June and will be extended by the end of June 2021 Outlook investment market: These developments should ensure that investor confidence in the German investment market and particularly in the office market continues to strengthen. This market is already considered as a safe haven even beyond the borders of Germany and Europe.

Despite the crisis, the share of international investors remained roughly at the previous year’s level of 47%. Accordingly, investment momentum should continue to increase in the second half of the year compared to Q2 in view of the ample liquidity available in the market. Furthermore German government bonds with a volume of around EUR 150bn and yields of more than 3% are due to expire by 2021. This could increase the demand for property even further as investors decide whether to reinvest in bonds or move into alternative investments such as real estate

Rental market COVID-related decline in demand for office space In the first six months of the year, around 1.28 million sqm of office space was leased or sold to owner-occupiers in the Germany’s largest seven cities (Berlin, Düsseldorf, Frankfurt, Hamburg, Cologne, Munich, Stuttgart). Compared to the first half of 2019, this represents a decline of almost 36% (H1 2019: 1.99 million sqm). However, this is against the backdrop of COVID-19 and the strongest recession since the Second World War. The second quarter contributed around 45% to the half-yearly result despite the lockdown. In our view, one possible explanation is that a significant number of deals in Q2 were already negotiated at the beginning of the year and only closed in the second quarter.

Office space take-up (in sqm)

2019 H1 2019 H1 2020 % Change yoy Berlin 998,500 408,100 329,200 -19.3% Düsseldorf 549,900 260,300 166,900 -35.9% Frankfurt 579,500 279,300 111,800 -60.0% Hamburg 530,000 317,100 167,000 -47.3% Cologne 291,300 162,300 96,700 -40.4% Munich 760,000 426,400 332,100 -22.1% Stuttgart 319,000 142,600 78,800 -44.7% Total 4,028,200 1,996,100 1,282,500 -35.7% Source: JLL, Warburg Research

None of the A-cities could escape the general decline. Only in Berlin and Munich was the decline somewhat below average, whereas Frankfurt recorded a particularly sharp decline.

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. Berlin/Munich: Decreases of -19% for Berlin and -22% for Munich, put these two cities below the average of -36%. In Berlin, the rental of 83,300sqm by Deutsche Rentenversicherung in the Mediaspree sub-market contributed to this result. With a number of other leases, Mediaspree, with around 105,000 sqm, is at the top of Berlin’s highest-turnover sub-markets. In Munich, there were three leases of more than 30,000 sqm by Amazon, KPMG and Kraus Maffei. This also shows that even in such a crisis such lettings are possible.

. Frankfurt: In all other A-locations, office space take-up fell more sharply – the strongest decline was in Frankfurt at 60%. Here, the traditional large-scale lettings (> 5,000 sqm) by the banking and finance sector were simply missing. In the segment up to 1,000 sqm the market remained comparatively stable.

Office take-up strongly correlated to Ifo employment barometer 5000 120.00 4500

4000

110.00 3500

3000 100.00 2500

2000 90.00 1500

1000 80.00

500

70.00 0 Q4 2005 Q4 2008 Q4 2011 Q4 2014 Q4 2017 Q2 2020

Ifo employment barometer (9 month lag) Office take-up Source: Ifo, Warburg Research

Flexible office space

Flexible office space globally has been growing by 25% since FY 2014. However, since Q4 19 growth has slowed, especially as the largest flexible offices space providersd WeWork reduced expansion and focused on the optimisation of its existing portfolio. An additional reduction kicked in with the outbreak of the COVID-19 crisis lowering take-up globally. JLL, for example, estimates that further increases in demand for flexible office space should lead to a market share of 30% by FY 2030. We believe that flexible office space will have an impact on demand patterns, especially as potential space is subleased by tenants with existing rental contracts but lower office space requirement.

Outlook rental market: The beginning of an economic recovery should also have a positive effect on the rental market. Despite all the uncertainties, JLL anticipates a moderate recovery in the coming months and expects office space take-up to reach around 2.8 million sqm for the financial year. This would correspond to a 29% decline compared to 2019.

A further sign of the revival of the letting market is the Ifo employment barometer. This shows a strong correlation with office space take-up. On average, if the index falls or rise by five percentage points, the amount of newly-let office space falls or rises by 10% – with a delay of about two to three quarters. With a falling index from the beginning of the year until Q2 2020, there are signs of a trend reversal at the end of the year. From Q2 2020 to Q3 2020 the index rose by a good 3%. This raises hope for a recovery in the office market at the beginning of next year. That said, we expect some further downward pressure for the coming months, which could offer attractive opportunities for companies with ample liquidity.

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Vacancy rates still on a very low level Even if the sometimes severe slump in office space take-up has selectively led to an increase in vacancy rates in some of the prime locations (e.g. Frankfurt), the vacancy rate of all seven largest cities, at 3.2% at the end of the second quarter of 2020, is slightly below the previous year’s figure of 3.3%. Further stabilisation is coming from the supply side. With regard to the supply available short term, no worrying increase can be identified at present.

Vacancy rates at record low

Q2 2019 Q2 2020 % Change yoy (sqm) sqm % sqm % Berlin 371,500 1.8 379,700 1.9 2.2% Düsseldorf 573,200 6.3 566,500 6.2 -1.2% Frankfurt 700,500 6.1 728,400 6.3 4.0% Hamburg 505,600 3.4 406,200 2.7 -19.7% Cologne 199,000 2.6 169,400 2.2 -14.9% Munich 493,600 2.4 561,900 2.7 13.8% Stuttgart 187,700 2.1 182,700 2.1 -2.7% Total 3,031,100 3.3 2,994,800 3.2 -1.2%

Source: JLL, Warburg Research

However, this confirms the trend, which has persisted since the end of 2019, that the

low-point in vacancies may have been reached and that volumes can be expected to

slowly increase again. Nevertheless, in our opinion, the current vacancy rates in most sdof the A-cities (particularly Berlin, Stuttgart or Cologne) corresponds to full occupancy, as a change of tenant in an office property naturally takes some time, allowing for renovation and conversion measures. When companies are seeking new space, even now, there is still limited choice in terms of modern and flexible new building space of the best quality. And this represents – it must be emphasised again and again – a massive difference compared to the crisis of 10 years ago. At that time, the markets ran into the global financial crisis with an average vacancy rate of over 8%.

18Development of vacancy rates in the top-7 locations

14 12

00 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 Q2 2020

Berlin Düsseldorf Frankfurt Hamburg Cologne Munich Stuttgart

Source: JLL, Warburg Research

Outlook vacancies: We expect a slight increase in the vacancy rate at the end of the

year. According to JLL, the vacancy rate in all top seven locations could climb to 3.6%,

which, in our opinion, is still a very low level. The main reason for this is a slight drop sdin the pre-letting rate for new office buildings.

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Volume of completions still at previous year’s level – pre-letting down In the first half of 2020, office space with a total volume of around 438,100 sqm was completed, almost exactly as much as in the first half of 2019. Of the office space completed in the first six months, only 59,000 sqm is currently still available, or, to put it another way, 87% of all new office space has already been let or let to owner-occupiers. Although this ratio has fallen compared to the first quarter, it is still very high and – so far – is contributing the restraint in the rise in vacancies.

Completions at previous year’s level

2019 H1 2019 H1 2020 % Change yoy

Berlin 237,300 119,400 149,200 25.0% Düsseldorf 115,400 7,300 25,500 249.3% Frankfurt 130,300 1,500 65,300 4253.3% Hamburg 117,100 57,900 53,200 -8.1% Cologne 95,600 16,900 28,800 70.4% Munich 335,600 172,400 110,600 -35.8% Stuttgart 92,700 61,300 5,500 -91.0% Total 1,124,000 436,700 438,100 0.3%

Source: JLL, Warburg Research

Nevertheless, it must be stressed that this is true for the first half of 2020. Compared to

the first half of the year, a significantly lower pre-letting rate can be observed. According

to JLL, a total of just under 615,000 sqm are still in the pipeline for the second half, all sdof which are already under construction. At present, 292,000 sqm of office space is available or 48%. This reflects the currently cautious and “wait-and-see” attitude of users. Cushman and Wakefield even see a potential of almost 1.0 million sqm of new-builds coming onto the market in the second half of the year, and that only in the top five locations (Berlin, Frankfurt, Düsseldorf, Hamburg and Munich). At city level, the volume breaks down as follows:

. The highest construction activity and completion in the second half of the year will take place in Berlin. With an estimated 362,200 sqm, the capital is in the top position. However, on the other hand, the pre-letting rate remains very high at 87.6% . A volume of 212,000 sqm is expected for Frankfurt, of which around 70% has already been pre-let. The remaining 30% could thus potentially increase the vacancy rate further

. Düsseldorf is expected to see a further 96,000 sqm with a pre-letting rate of 73% coming onto market. This also reflects the cautious view of tenants

. In Hamburg, a new construction volume of 133,000 sqm is expected. The Hanseatic city’s traditionally very high pre-letting rate remains at a high level of 83% even in the current crisis.

. Munich is expected to see 221,000 sqm of new office space with a pre-letting rate of 79% coming onto market in the second half

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Expected completions in H2 in the top-five and pre-letting

400,000 362,200 350,000 317,400 300,000

250,000 212,000 221,000 200,000 174,590 148,400 150,000 133,000 96,000 110,390 100,000 70,080 50,000

0 Berlin Frankfurt Düsseldorf Hamburg Munich

Completions Pre-let

Source: C&W, Warburg Research

Outlook completions: Since many tenants should continue to act cautiously and adopt

a “wait-and-see” approach as the pandemic continues, vacancies should increase

slightly towards the end of the year as new office space come onto market, especially sdin cities with pre-letting rates of around 70%. According to Colliers, a further decline in pre- letting rates in the coming years can be expected, so that a further slight increase in vacancies cannot be ruled out. Since the current vacancy rates are at a record low, a slight increase in vacancies would, in our view, be more of a welcome sign rather than a negative sign for the office market.

Estimated development of completions and pre-lettings in the top seven locations

2,000 700 1,744 618 1,800 1,647 597 1,595 600 1,600

1,400 1,289 500 467 1,200 400 363 1,018 367 374 1,000 309 321 300 293 800 695 270 236 206 198 212 600 164 192 200 171157 160 161 174 173 124 142 141 137 126 126 127 400 102 105 112 89 77 90 100 53 60 49 200 34 35 27 45 0 0 2020 2021 2022 2020 2021 2022 2020 2021 2022 2020 2021 2022 2020 2021 2022 2020 2021 2022 2020 2021 2022 2020 2021 2022

Germany Completions Germany Pre-let Berlin Completions Düsseldorf Completions Frankfurt Completions Hamburg Completions Köln Completions Munich Completions Stuttgart Completions Berlin Pre-let Düsseldorf Pre-let Frankfurt Pre-let Hamburg Pre-let Köln Pre-let Munich Pre-let Stuttgart Pre-let Source: Colliers, Warburg Research

However, the pre-letting rates in 2022 may still change significantly due to the length of the time horizon. Furthermore, project developers are also becoming more cautious. For some, their projects cannot be completed owing to ongoing disruption in the supply chains, which is interrupting construction processes. In addition, some pipeline projects do not even get off the ground, because financing is difficult or because they are becoming less profitable as more equity capital is required. These effects can already be seen in the time lags. For 2021, JLL is currently assuming a new construction volume of 1.9 million sqm, compared with the previous assumption of more than 2.1 million sqm just three months ago.

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Rents unchanged – two cities even showing a slight increase The lower pre-letting rates, with new construction activity remaining on high levels, are not yet having an impact on rents. The current crisis is expected to make tenants more price-sensitive. But as a result of the still very limited supply of modern office space in very good locations, some tenants are still willing to pay prime rents for prime space in top locations. In Stuttgart and Hamburg these prime rents have even risen further.

Prime rents in the top seven locations

Q4 2019 Q2 2019 Q2 2020 % Change yoy

Berlin 37.0 35.5 37.0 4.2% Düsseldorf 28.5 28.0 28.5 1.8% Frankfurt 41.5 40.5 41.5 2.5% Hamburg 29.0 29.0 30.0 3.4% Cologne 26.0 25.0 26.0 4.0% Munich 41.0 40.0 41.0 2.5% Stuttgart 24.5 24.0 25.5 6.3%

Source: JLL, Warburg Research

A year-on-year comparison shows a plus of 3.5%. As long as vacancies in the top

locations do not rise significantly above 5%, there will be a shortage of space, especially

in the attractive and sought-after locations. In combination with a declining pipeline,sd these effects will have a stabilising effect on nominal rents. However, in effective terms, i.e. taking incentives into account, JLL has already noticed a certain pressure on rents.

Outlook rent levels: This pressure could intensify as the year progresses if there are increasing attempts to push through rent-free periods or expansion cost subsidies. Office space users will remain cost-sensitive even after the acute phase of the pandemic and will continue to consider savings in the real estate sector, among other things.

Nevertheless, some companies could moderately reduce the density of jobs in the medium to long term, not only with temporary remote working, but permanently, i.e. either use more square metres with the same number of employees or leave the total office space unchanged with a slightly reduced number of employees. The nature of change in the office space requirement depends, among other things, on changes in the number of employees in the office and on the qualitative and quantitative adjustments in the office.

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Financing of commercial properties Financing of commercial properties – COVID-19 poses extra challenges but normalisation possible with recovery of domestic economy In recent years, the ECB’s low interest rate policy has encouraged an increase in the number of lenders for commercial properties. Several banks with a higher deposit volume increased their loan business to deploy customer’s deposits and to avoid a negative margin. In this competitive environment, new business in the area of commercial property financing in Germany increased to more than EUR 140m in 2019 according to a study by the IREBS property academy.

In 2020, however, new business should have decreased again as, for one, there is likely to have been a tendency towards less new business in the asset classes of retail and office and, for another, banks generally adopted more restrictive guidelines to granting loans in the course of the year. This is unlikely to have been fully compensated for by the financing of sectors like logistics and residential, which gained in relative attractiveness during the COVID-19 pandemic. By the middle of 2020, the decrease in the new business volume was 9% compared to H1 2019. According to a study by the IREBS property academy, new business in the financing of commercial property is expected to decline by 15% on average in 2020. Meanwhile, banks are pursuing very different strategies in the granting of loans. This development should also be explained by a continuation of the restraint seen in the transaction market in Q2 (JLL: Q1 +80%, Q2 -15%).

New business volume of property financing

New business in EUR bn Commercial Residential Total 2010 30 34 64 2011 45 28 73 2012 59 30 89 2013 68 37 105 2014 71 43 114 2015 97 40 137 2016 106 44 150 2017 100 39 139 2018 88 44 132 2019 90 52 142

Source: Source:Warburg Irebs Research, Immobilienakademie, Irebs Immobilienakademie Warburg Research

In the financing of office property, the observable trend towards lower risk in the

granting of credit prevailed in the last months, as during crises in the past. It is easier for

investors to receive financing for core property, which normally offer greater securitysd based on a) longer lease terms, b) higher tenant quality, and c) lower vacancy rates in A- locations, usually in A-cities.

The financing of Core+ and Value-add office properties has become more difficult owing to the preference among lenders for lower risk financing. We assume that this trend will continue in the coming quarters for several reasons including, a) low macroeconomic visibility (e.g. possible insolvencies, speed of recovery), b) continuation of the negative effects of COVID-19 (companies reluctant to change existing office arrangements) and c) a lack of clarity on the effects of other changes, such as remote working and social distancing.

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The financing of project developments should also become more difficult considering the prevailing uncertainty in many asset classes, as well as the low visibility as regards the overall economic development. As already seen during the financial crisis, there was a resumption of the trend to finance only those project developments with a sufficient pre-let rate (~>60%), bringing to a halt the easing of lending criteria seen for several quarters before. According to the IREBS study, the share of all in-house developments in the commercial area shrunk from ~36% in 2016 to 28%.

. Rising financing costs for commercial properties: As already mentioned, with their reduced risk appetite, banks are focusing on the financing of core assets. Strong competition in this market leads to nearly unchanged financing conditions. Consequently, the lower supply for the refinancing of higher-risk assets like e.g. value- add (higher vacancy, ST-leases, capex requirements) has led to rising financing costs for investors and could lead to a temporary decrease in the transaction volume in this asset category. Furthermore, banks are currently taking a much closer look at the details of a financed property and its tenants’ willingness to pay rent over the last months. Larger transactions, in particular, are taking more time. According to JLL, the financing costs for value-add properties and developments increased in Q2 by 100 to 200bps. After speaking to some lenders, we learned that costs were up by ~80bps for Core+ and 120bps for value add in the office sector. In H2 we expect a normalisation of financing conditions but the financing conditions for higher-risk assets should be weaker.

. Lower LTVs expected in 2020: The trend of lower Loan to Value (LTV) should continue in 2020. The average LTV in new business of commercial real estate financing decreased from 61% in 2018 to 59% in 2019. A further reduction based on the lower risk appetite of banks to ~57% (WRe; IREBS-study ~58%) seems likely in 2020. Considering the low level of visibility as regards the economic recovery, we assume that this trend will continue in combination with the implementation of more covenants.

. This behaviour of banks, which is driven by economic parameters, might be partly offset by the possibility of more active lending to achieve volume targets within a bank’s refinancing via the ECB TLTRO programme (targeted longer term refinancing operations). Banks will benefit from an at least stable credit loan volume. Besides sound refinancing conditions (-50bps), banks achieve a further benefit of up to 50bps if the portfolio volume is unchanged or growing. The ECB compares annual volume development between March 2020 and end of March 2021.

. Headwind for NPL volume – possible opportunities for property buyers: The NPL volume with domestic commercial properties was stable in 2019 at EUR 1.4bn (IREBS). Against the background of already known insolvencies and a possible significant rise after the resumption of the obligation to disclose insolvency from January 1 2020, we are expecting a meaningful increase in the next 15 months until the end of 2021. The pressure from the refinancing of property loans with deteriorating operating figures (vacancy, lease duration, capex needs for new requirements e.g. ESG, social distancing) could lead to a rising number of forced sellers. This could lead to rising transaction volumes again with office properties in the categories of core+, value add and developments.

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Conclusion:

. We expect a decline in new business volume of commercial real estate financing in Germany in 2020 based on lower transaction volumes, more restrictive requirements (LTV, covenants) and more cautious sentiment towards the sectors of retail and hotel. The financing volume of offices should be stable as demand for core office properties (LT-lease, fully let, strong tenants) from equity-rich investors should remain strong.

. COVID-19 should not have had much of an impact on the conditions for the financing of core properties owing to banks’ focus and strong liquidity from the ECB’s TLTRO programme. The financing of other categories (core+, value add, development) will deteriorate, in our view, owing to: a) rising insolvencies, b) capex needs, c) cancellation or reduction of space by tenants or, d) lower pre-lettings will reduce attractiveness of these assets and could increase pressure. The possible impact on property valuation

could also lead to covenants breach. For this reason we expect opportunities in these asset categories for investors with strong equity and liquidity positions or access to financing.

. The possible rise in a bank’s requirement for a lower LTV in new business could lead to lower demand for higher-risk assets as investors with a strong equity position prefer core assets (insurers, pension funds) to secure a stable cash flow. This could create buying opportunities for more opportunistic investors.

. The NPL volume should rise due to negative cash-flow developments for owners due to tenant insolvencies. This could offer attractive investment opportunities in properties in the categories core+, value add and developments due to forced selling.

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Real Estate

Remote office as new trend COVID-19 disrupting conventional office real estate? The requirement to work from home, if possible, necessitated by the COVID-19 lockdowns, has brought to life a new broad-based trend towards greater workplace flexibility. With accelerated digitalisation of work places during the past months, the stage was set to conduct meetings remotely and for productive collaboration on a practical basis. However, as yet, there is no legal framework for remote work in Germany and this will be necessary to clarify complex regulatory issues. Moreover, the opportunity for remote work varies in intensity across sectors. Not surprisingly, the IT and communication sector saw the highest share of employees working from home, while on the opposite end of the scale, the opportunity for remote work was naturally far lower in sectors such as manufacturing or health and social services. There are various potential outcomes as to how remote work will be adopted in Germany, and what effects it will have on the office market. For the time being, we believe that office vacancy will increase gradually over time due to a trend towards remote work. However, we also think determining factors for office space take-up are the underlying economy, and consequently the share of employment. Remote work across sectors COVID-19 will have consequences for the office real estate market in Germany. During Q2 20 about 61% were working remotely. Before the COVID-19 pandemic, the statistics were exactly reverse. However, the share of employees working from home differed widely across sectors due to stark differences between the sectors able to offer remote work for their office workers. A survey conducted during the first week of April 2020 found varying degrees of remote work across sectors. It ranges from 59% of employees

working from home in IT and communication to 27% within the sector of art, entertainment and vacation. In general the service sector is one segment where digitalised work can be more easily applied and therefore a part or full transfer to remote work is feasible. As German GDP has a share of 70% of services, a larger share of remote work across respective sectors is likely. Hilmar Schneider, director of the IZA institute for the future of work (Institut zur Zukunft der Arbeit) in Bonn estimates huge potential for an increase in remote work within the service sector that can be undertaken digitally. The varying degree of remote work among sectors during the first week of April is shown in the following chart:

Remote work share across economic sectors

59% 54% 48% 46% Sectors which are by definition 39% 37% difficult to implement remote work 33% 28% 27% 18% 18% 13% 11% 11% 9% 7% 6% 0%

Source: IWD, Warburg Research

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Higher flexibility and company-specific factors Six months into the COVID-19 crisis, the sudden change towards working remotely has accelerated digitalisation and, surprisingly, showcased high levels of productivity. With announcements as early as in May by American technology companies such as Google, Twitter and Facebook that they intended to allow their employees work remotely until at least the end of 2020, the larger German companies too made changes to their remote work policies. At the end of August ~ 50% of DAX companies’ employees were still working remotely. Initially forced to send employees home, some of the companies implemented a clear plan for employees to return to the office over time while others announced long-term changes implying higher flexibility for employees to choose their place of work. The following list gives some examples of long-term changes already announced as well as the situation at the end of August 2020.

Long-term changes and current status of German companies Examples of long term changes announced

wants to offer its 140k employees to work remotely on 1-2 days per week, long Siemens term

before the Covid-19 pandemic offered 50% of workforce remote work, Vodafone increased to 70 - 80% for post pandemic time

wants to offer more flexibility for remote work and questions if DB needs as Deutsche Bank much office space as before

intends 30% reduction of office space, long term up to 40% of 150.000 Allianz employees world wide should work from home

Employees in office as of August 2020 implemented plan with phases to return to office beginning of June, currently Bayer only 40% are allowed to be in the office at the same time Volkswagen Covid-test on company / factory (Werksgelaende) Adidas at most 50% do work from headquarters in Herzogenaurach Eon at most 50% capacity within Essen headquarters Fresenius at most 50% capacity within Bad Homburg offices Vonovia at most 50% capacity within Bochum offices Continental at most 50% capacity within Hannover offices Heidelberg Cement around 50% do work remotely 30% of employees are in the office at the Hamburg complex, no plan to ask Beiersdorf employees back

Source: Companies named, ARD, Handelsblatt, DW, Warburg Research

Cost savings by reducing office-based workers

There are various estimates as regards the possible cost savings of reducing office space. Additionally, it is claimed that emissions can be reduced with less commutingsd and lower office space capacity. In regard to annual cost savings in company overheads, Eurocrest Berlin estimates a potential reduction of up to 20%. Taking the example of Vodafone, it is estimated that within the Düsseldorf headquarters at Ferdinand-Braun- Platz 1, 50% of space could be reduced, saving around EUR 4m per annum. While this seems highly attractive at first, the practical execution could be very complex as the office tower was specifically built for Vodafone in FY 2012 and splitting space to lease to another company is difficult. Taking into account first estimates on per-employee savings in Central Business Districts (CBD), for instance in Frankfurt, the figures reach EUR 15,000 per office space per employee. However, the cost savings are a one-sided argument, as the cost of setting up a permanent office space and infrastructure within the home of employees is not taken into account. Currently, we do not have estimates for a better cost benefit analysis to gain clear insight and support for future trends.

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Nevertheless is it surprising how low office capacity utilisation was before the COVID-19 pandemic. Including illness-related absence from work, business travel, and holidays, the actual usage of office space reached 65%, while it decreases to only 25% with three days per week spent working from home.

Long-term changes and current status of German companies

65%

50%

40%

25%

Without remote work 1 day per week remote work 2 day per week remote work 3 day per week remote work

Source: ARD, DZ Bank, Warburg Research

Besides actual cash savings, the reduction of CO2 emissions is evident and beneficial.

As 68% of Germans drive their cars an average of 17km to work, a 20% share of remote

work could save 1.7bn kg of CO2 emissions per year. While this might not seem to sd suggest a strong argument in favour of working from home, the increased awareness of climate change and political focus on emissions could lead to more incentives going forward.

Legal framework for remote work So far there is no legal framework for remote working in Germany. However, the German Minister for Employment announced the intention to introduce a law permitting either permanent work from home or for a number of days of the week. It is expected to be proposed to the legislative branch in autumn. With a legal framework in place, important guidelines would be implemented to clarify a complex situation with regard to time of work, work safety and labour law. However, binding regulations for companies will likely result in additional costs for the employer. For instance if the employee can chose to

either work full-time from home, or for a number of days a week, a fully-functioning work place would have to be installed in the respective home office. The legal requirement would range between 8–12 sqm of workspace, a desk measuring 160x80 cm and an office chair. New contracts would have to be drawn up to put in place the necessary framework, costs, data protection laws and regulated work time. A clear legal framework issued by the government could implement a right to remote working and therefore give employees the right to choose. This should increase the potential for employees to be flexible to work remotely or in the office and is the basis for demand-changing effects.

Personal interest of employees From a personal perspective, the lockdown and forced remote work caused by the pandemic brought sudden complications for households. Evident in most cases is the lack of office space in private residential apartments, especially given that living space is so constrained in most of the larger cities. This leads to a lack of private work space

where work time can be undertaken uninterrupted. Especially families with children experienced difficulties of the sudden changes, as schools and pre-schools were closed during lockdown. Additional problems mentioned included a lack of private IT infrastructure. However, remote working seems to have generally been welcomed and evidence suggests an increased feeling of wellbeing.

On a personal level a study conducted by Daniel Kahneman and colleagues in 2004

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suggests that commuting was one of the least enjoyable activities regularly undertaken. Additionally, evidence from the British Office for National Statistics suggests that “commuters have lower life satisfaction… lower levels of happiness and higher anxiety on average than non-commuters”. This suggests a higher likelihood of an increase in working from home in future. However, the long-term consequences of reduced social interaction between employees have not yet been evaluated and should balance remote work with time spent in the office. According to study undertaken in June 2020 in Germany, more than 70% of those surveyed wished to increase their share of working from home but only 18% named potential home office as an impediment for returning to their company’s offices. A mix of one to two days per week of remote work seems most likely and would not translate into a spike of vacancy in German’s office markets.

Potential future scenarios for the office real estate market JLL estimates office demand based on three scenarios post-COVID, that is defined by no pandemic-related restrictive regulations, either on travel or social distancing:

Potential outcomes for office space demand

Scenarios Homeoffice

Bear Base Bull

Remote work as major Remote work as choice Remote work irrelevant trend "employees chose to "office remains the "most employees work work from home on some central place of work" from home" days" → 30% reduction of → 15% reduction of → 5% reduction of capacity in the office capacity in the office capacity in the office

Social Distancing Social Distancing Social Distancing social distancing social distancing social distancing regulations remain regulations no longer regulations remain in broadly in place relevant place in full extent → 10% additional space → no additional space → 20% additional space needed for individual needed, but slight per epmloyee needed employees expansion of common

-23% -10% +14% occupied office space occupied office space occupied office space

Source: JLL, Warburg Research

The scenarios incorporate various determinants of office space, such as spatial-use

concepts, property requirement, choice of location by sector and employee, and style of

communication. The quantitative impact of such changes would be longer term andsd gradual. JLL concludes that a moderate reduction in office space will be the consequence but overall, office space will retain its importance as a place for people to meet.

Another study by NAI Apollo estimates that office space in a city will decrease by 10– 20%. Taking the office market of Frankfurt as an example, the researchers estimate around 28,500 to 68,000 of current office work space could be unused going forward. It would translate to lower office space demand in the range of 1.08m to 1.4m square metres or a reduction of 10% to 14% of Frankfurt office space. However, the change will take years to materialise and does not take into account broader economic development.

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Clearly, a change in office demand will occur in the future and we regard a reduction of office space in the range of 10-20% as reasonable. Important for pricing changes in yields, rent levels and vacancy will be the timing of implementation and supply factors such as new development, change of use of office space and conversion of office space to other usage such as residential real estate. The most important factor at play will be German economic development.

Conclusion:

We believe that the desire for flexible remote working – where possible – will increase and will therefore have consequences for the dynamics within the office real estate sector. We believe that, ceteris paribus, the higher share of employees working remotely will have an impact on the demand side for office space. But implementation of the change will be gradual, allowing new supply to adjust. Therefore the direct impact on office property yields should be subdued. However, those effects will be outweighed by the overall reduction of office space and we believe that the vacancy should increase going forward. Growth drivers such as the economic development and, with it, the increase in employment should be more of a deciding factor for office space take-up.

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DIC Asset (SDAX, Real Estate)

Value Indicators: EUR Share data: Description: Buy NAV (WRe): 12.00 Bloomberg: DIC GR Property holding company and DCF: 7.00 Reuters: DICGn investment manager for German real EUR 19.00 SotP: 19.00 ISIN: DE000A1X3XX4 estate

Market Snapshot: EUR m Shareholders: Risk Profile (WRe): 2020e

Market cap: 825.2 Freefloat 55.9 % LTV: 51.7 % Price EUR 10.24 No. of shares (m): 80.6 DIC-Gruppe 34.1 % Equity Ratio: 37.4 % Upside 85.5 % Freefloat MC: 461.5 RAG-Stiftung 10.0 %

Ø Trad. Vol. (30d): 1.15 m

Ample liquidity and development expertise offers opportunity to grow In our view, DIC Asset is well positioned despite the current uncertain environment and the possibility of a more challenging German office market. As our outlook for the office market points out, the German office market may face some modest risks and necessary changes but should also offer attractive opportunities for real estate specialists. With upside of c. 85%, we reiterate our Buy recommendation for the stock. . Investment market: We expect the transaction market to gradually pick up during the second half of the year. Taking the recent acquisitions into account, the acquisition volume for DIC’s commercial portfolio stands at EUR 188m (FY target range: EUR 200–300m) and for the institutional business at EUR 293m (FY target range: EUR 500–800m). As DIC has ample liquidity (cash on balance of ~EUR 416m and high equity commitments from its investor base) the company is in a good position to take advantage of market opportunities in H2 as they arise, both for its commercial portfolio and its institutional business. . Financing of office properties: In our view, COVID-19 should not have had much of an impact on the financing conditions for core properties. With a comfortable LTV of 44.3% (H1 2020), the company should not face any problems. The financing of other categories (core+, value add, development) will deteriorate. For this reason we expect opportunities to arise in these asset categories for investors with strong equity and liquidity positions or access to financing. Given its strong liquidity position, we believe that DIC Asset could also benefit from this. Since the acquisition of GEG, development expertise is available in-house. The acquisition of a “refurbishment under cashflow” property in the region at the beginning of September underlines our view. . Remote work: Necessitated by COVID-19, remote working would seem to be a lasting trend and, in our view, the desire among office workers for the flexibility of working remotely, if possible, will increase. This has consequences for the dynamics within the office real estate sector. The share of people working from home may increase by 10-20% but the implementation of such change will be gradual, allowing time for new supply to adjust. Therefore the direct impact on office property yields should be subdued. For the time being, space reduction by tenants is not yet reflected in the company’s business performance. With an increase in the letting performance of 55% yoy, the second quarter was strong despite the COVID-19 lockdown. The company is also seeing a rising trend in lease extensions, which signals that the majority of its tenants do not intend to reduce rental space, despite the recent increase in remote working. Overall, we believe that DIC Asset is well positioned and we regard the investment case as fully intact. Its hybrid business model was able to prove itself even during the months of crisis. Despite the possibility of an even more challenging German office market, we see various growth opportunities for this attractive office player. We stick to Buy.

FY End: 31.12. CAGR in EUR m (19-22e) 2016 2017 2018 2019 2020e 2021e 2022e

Total income -2.3 % 473.79 381.88 241.60 364.21 301.61 323.25 339.18 Rental income 111.2 109.7 100.2 101.9 97.6 111.8 122.7 Change yoy -18.7 % -1.4 % -8.6 % 1.7 % -4.3 % 14.6 % 9.7 % Real-estate 21.54 20.82 33.64 62.88 83.18 89.60 94.13

management fee EBIT 1.4 % 77.3 76.6 76.9 112.0 101.5 112.9 116.9 FFO I 4.9 % 47.0 60.2 68.0 95.6 95.2 105.9 110.3 EBT -2.7 % -23.4 70.5 55.9 97.9 78.8 87.9 90.1 Net income -1.7 % -28.2 63.6 47.7 80.7 67.1 74.5 76.7

EPS -5.4 % -0.41 0.93 0.68 1.12 0.93 0.94 0.95

FFOPS I 0.9 % 0.69 0.88 0.96 1.33 1.32 1.34 1.37 Rel. Performance vs SDAX: DPS 0.0 % 0.40 0.64 0.48 0.68 0.60 0.66 0.68 Dividend Yield 4.7 % 6.6 % 4.9 % 6.2 % 5.9 % 6.4 % 6.7 % 1 month: -9.1 % NAVPS 10.99 12.03 12.65 10.95 12.00 12.80 14.60 6 months: -24.7 % Price / Book 0.8 x 0.8 x 0.8 x 0.8 x 0.8 x 0.8 x 0.8 x Year to date: -34.6 % P / NAVPS 0.8 x 0.8 x 0.8 x 1.0 x 0.9 x 0.9 x 0.9 x

Trailing 12 months: -26.5 % FFO I-Yield 8.1 % 9.1 % 9.8 % 12.0 % 12.9 % 13.1 % 13.4 % LTV 64.6 % 55.5 % 47.7 % 51.5 % 51.7 % 51.6 % 51.8 % Company events: Equity Ratio 31.6 % 35.4 % 36.0 % 36.6 % 37.4 % 37.5 % 37.2 % 28.10.20 Q3 Guidance: FFO of EUR 94-96m

A n a l y s t A n a l y s t Philipp Kaiser C OMMENT Published 05.10.2020 20 Andreas Pläsier [email protected] [email protected] +49 40 309537-260 +49 40 309537-246

Real Estate

Company Rating MC EV P / E P / B Div.yield ROCE Analyst Price (EUR) PT (EUR) Potential (%) EUR m EUR m 20e 21e 22e 20e 20e 20e Tel.

alstria office REIT Buy Andreas Pläsier 12.20 16.10 32.0 % 2,166.6 n/a n/a 17.0 x 16.5 x 0.7 x 3.5 % n/a +49 40 309537-246

DIC Asset Buy Philipp Kaiser 10.24 19.00 85.5 % 809.7 n/a 11.0 x 10.9 x 10.6 x 0.8 x 6.0 % n/a +49 40 309537-260

UBM Development Buy Simon Stippig 31.00 47.00 51.6 % 231.6 843.0 8.8 x 7.2 x 6.3 x 0.7 x 7.1 % 3.6 % +49 40 309537-265

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SOURCES

All data and consensus estimates have been obtained from FactSet except where stated otherwise.

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Company Disclosure Link to the historical price targets and rating changes (last 12 months)

alstria office REIT 3 http://www.mmwarburg.com/disclaimer/disclaimer_en/DE000A0LD2U1.htm DIC Asset 5 http://www.mmwarburg.com/disclaimer/disclaimer_en/DE000A1X3XX4.htm UBM Development 5 http://www.mmwarburg.com/disclaimer/disclaimer_en/AT0000815402.htm

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INVESTMENT RECOMMENDATION

Investment recommendation: expected direction of the share price development of the financial instrument up to the given price target in the opinion of the analyst who covers this financial instrument.

-B- Buy: The price of the analysed financial instrument is expected to rise over the next 12 months.

The price of the analysed financial instrument is expected to remain mostly flat over the next 12 -H- Hold: months.

-S- Sell: The price of the analysed financial instrument is expected to fall over the next 12 months.

“-“ Rating suspended: The available information currently does not permit an evaluation of the company.

WARBURG RESEARCH GMBH – ANALYSED RESEARCH UNIVERSE BY RATING

Rating Number of stocks % of Universe

Buy 134 65

Hold 54 26

Sell 12 6

Rating suspended 6 3

Total 206 100

WARBURG RESEARCH GMBH – ANALYSED RESEARCH UNIVERSE BY RATING …

… taking into account only those companies which were provided with major investment services in the last twelve months.

Rating Number of stocks % of Universe

Buy 34 87

Hold 3 8

Sell 0 0

Rating suspended 2 5

Total 39 100

S E C T O R N OTE Published 05.10.2020 25

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EQUITIES Matthias Rode +49 40 3282-2678 Head of Equities [email protected]

RESEARCH Michael Heider +49 40 309537-280 Thilo Kleibauer +49 40 309537-257 Head of Research [email protected] Retail, Consumer Goods [email protected] Henner Rüschmeier +49 40 309537-270 Eggert Kuls +49 40 309537-256 Head of Research [email protected] Engineering [email protected] Stefan Augustin +49 40 309537-168 Andreas Pläsier +49 40 309537-246 Cap. Goods, Engineering [email protected] Banks, Financial Services [email protected] Jan Bauer +49 40 309537-155 Malte Schaumann +49 40 309537-170 Renewables [email protected] Technology [email protected] Jonas Blum +49 40 309537-240 Oliver Schwarz +49 40 309537-250 Telco, Media, Construction [email protected] Chemicals, Agriculture [email protected] Christian Cohrs +49 40 309537-175 Simon Stippig +49 40 309537-265 Industrials & Transportation [email protected] Real Estate [email protected] Felix Ellmann +49 40 309537-120 Cansu Tatar +49 40 309537-248 Software, IT [email protected] Cap. Goods, Engineering [email protected] Jörg Philipp Frey +49 40 309537-258 Marc -René Tonn +49 40 309537-259 Retail, Consumer Goods [email protected] Automobiles, Car Suppliers [email protected] Marius Fuhrberg +49 40 309537-185 Robert -Jan van der Horst +49 40 309537-290 Financial Services [email protected] Technology [email protected] Mustafa Hidir +49 40 309537-230 Andreas Wolf +49 40 309537-140 Automobiles, Car Suppliers [email protected] Software, IT [email protected] Ulrich Huwald +49 40 309537-255 Health Care, Pharma [email protected] Philipp Kaiser +49 40 309537-260 Real Estate [email protected]

INSTITUTIONAL EQUITY SALES Marc Niemann +49 40 3282-2660 Maximilian Martin +49 69 5050-7413 Head of Equity Sales, Germany [email protected] Austria, Poland [email protected] Klaus Schilling +49 40 3282-2664 Christopher Seedorf +49 69 5050-7414 Head of Equity Sales, Germany [email protected] Switzerland [email protected] Tim Beckmann +49 40 3282-2665 United Kingdom [email protected] Lyubka Bogdanova +49 69 5050-7411 Ireland, Poland, Australia [email protected] Jens Buchmüller +49 69 5050-7415 Scandinavia, Austria [email protected] Alexander Eschweiler +49 40 3282-2669 Sophie Hauer +49 69 5050-7417 Germany, Luxembourg [email protected] Roadshow/Marketing [email protected] Matthias Fritsch +49 40 3282-2696 Juliane Niemann +49 40 3282-2694 United Kingdom [email protected] Roadshow/Marketing [email protected]

SALES TRADING Oliver Merckel +49 40 3282-2634 Marcel Magiera +49 40 3282-2662 Head of Sales Trading [email protected] Sales Trading [email protected] Elyaz Dust +49 40 3282-2702 Bastian Quast +49 40 3282-2701 Sales Trading [email protected] Sales Trading [email protected] Michael Ilgenstein +49 40 3282-2700 Jörg Treptow +49 40 3282-2658 Sales Trading [email protected] Sales Trading [email protected]

MACRO RESEARCH Carsten Klude +49 40 3282-2572 Dr. Christian Jasperneite +49 40 3282-2439 Macro Research [email protected] Investment Strategy [email protected]

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