Survey Office Market: Investment Opportunities in German Secondary Locations Client: DEMIRE - Deutsche Mittelstand Real Estate AG Frankfurt am Main, March 2019 SURVEY bulwiengesa OFFICE MARKET: INVESTMENT OPPORTUNITIES IN GERMAN SECONDARY LOCATIONS TABLE OF CONTENTS Page PRELIMINARY REMARK 1 1 EXECUTIVE SUMMARY 2 2 SOX – SECONDARY-OFFICE-INDEX 4 3 FOCUS SUBJECT: THE OFFICE REAL ESTATE MARKETS OF GERMANY’S SECONDARY LOCATIONS 6 4 PERFORMANCE POTENTIAL OF SECONDARY LOCATIONS 13 SUMMARY OF FINDINGS 14 ANNEX PROPRIETARY INFORMATION The results and figures presented in this survey have been conducted led to disclose the survey or parts hereof (always citing the source) for on the basis of existing and compiled sources according to the best of the purpose agreed at the time the survey was commissioned. The re- our knowledge and with appropriate care. 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Only the client is entit- bulwiengesa AG Eschersheimer Landstr. 10 Vorstand: Aufsichtsrat: Hauptsitz: Berlin HypoVereinsbank München 60322 Frankfurt am Main Ralf-Peter Koschny Bernhard H. Hansen Rechtsform: AG BLZ: 70020270, Kto.: 4410433058 Tel. +49 69 75 61 467-60 Thomas Voßkamp Hartmut Bulwien USt-ID: DE 164508347 BIC: HYVEDEMMXXX Fax +49 69 75 61 467-69 Charlottenburg HRB 95407 B IBAN: DE13700202704410433058 © bulwiengesa AG 2019 – P1812-5074 SURVEY bulwiengesa OFFICE MARKET: INVESTMENT OPPORTUNITIES IN GERMAN SECONDARY LOCATIONS PRELIMINARY REMARK Source of the Data The German property company DEMIRE (Deutsche Mittelstand The survey draws on the real estate market data on record in 1 Real Estate AG) has commercial real estate holdings in mid- the RIWIS information system and other sources (e.g. Deut- sized cities and in up-and-coming locations on the periphery of sche Bundesbank) for the purpose of raising awareness for, German metro regions. To raise awareness for, and increase and the transparency of, Germany’s secondary locations. the transparency of, so-called secondary locations, DEMIRE asked bulwiengesa to conduct an analysis of selected cities in Overview of secondary locations Germany, this being the third edition of the survey. The focus of this edition of the survey is on the office segment. The secondary locations analysed in depth (cf. also Chapter 3) are mapped in the chart below. The survey covers a total of 31 cities. As far as the size of the floor space stock goes, the analysis includes not only major markets like those of Bonn and Essen with a total office stock of more than 3 million sqm RAC each but also smaller cities like Kempten and Stralsund whose floor space stock amounts to less than 350,000 sqm RAC. This survey is also the first that will use an index (SOX – Sec- ondary-Office-Index) that was developed by DEMIRE and bul- wiengesa in order to rate the environment for office properties in the Class A and secondary locations. The index will be intro- duced in detail in Chapter 2. Survey Structure The survey now before you divides into four chapters that are thematically interlinked. It starts with an Executive Summary that outlines the return / risk representation of the secondary lo- cations. The second chapter, as suggested above, is dedicated to the Secondary-Office-Index (SOX). Next, the secondary lo- cations will be discussed in detail in Chapter 3. It will compare them to the Class A or "Big Seven" cities. Parameters used for this comparison include the trends in office occupancy, in office vacancy, in office employment and in office take-up as well as construction activity, transaction volume and net initial yield. Source: © NAVTEQ Having profiled the market environment in the secondary loca- tions in its third chapter, the survey will discuss the yield upside of value-add properties in the secondary cities in Chapter 4. The survey concludes with an overview table listing the most significant office market performance indicators in the 31 sec- ondary locations that were examined. 1 RIWIS = bulwiengesa’s proprietary regional information system for Germany’s real estate industry © bulwiengesa AG 2019 – P1812-5074 Page 1 SURVEY bulwiengesa OFFICE MARKET: INVESTMENT OPPORTUNITIES IN GERMAN SECONDARY LOCATIONS 1 EXECUTIVE SUMMARY Trend in Office Take-up The office take-up is an indicator for the attractiveness and ac- No analysis of the German real estate market would be com- tivity of a given market. The booming economy has pushed de- plete without a discussion of the economic cycle in which it is mand for office space both in the Class A cities and in many embedded. For this reason, bulwiengesa – in collaboration with secondary markets to a high level. The ramifications are obvi- DEMIRE – developed the SOX (Secondary-Office-Index) which ous when looking at the vacancy rate which lately dropped well tracks the environment for office real estate in the Class A and below the fluctuation reserve as a result of the subdued build- secondary markets. This survey will take a close look at the of- ing activity of recent years. The pent-up demand has led in turn fice market performance indicators for the period 2009 through to an upward rental trend. 2018 that are used by the SOX. The analysis returned the fol- lowing findings: Investment Market Trend in Average Rents On the commercial investment market, office real estate re- The robust economic situation has resulted in job growth – and mained the most coveted asset class in 2018. It is in this asset office employment benefited from the trend more than other that roughly 52 % of the commercial property investments were categories. The subsequent rise in office space requirements is transacted. The persistently keen demand – in a time of limited also reflected in upward rental growth. Apart from the Class A supply – has sent net initial yields on a nosedive to new all-time cities, the secondary locations achieved substantial rent in- lows. In addition to Class A cities, the focus of investors has creases in their own right during the analysis period. lately shifted to include secondary locations. In 2018, they at- tracted c. 23 billion euros in investments. The aspects that make such secondary locations a winning proposition are Trend in New Office Completions higher yields combined with more stable rent rates. Secondary locations tend to be characterised by a demand- driven volume of new construction. Speculative construction projects (i.e. developments pursued without forward commit- Risk- / Return-Representation ments) have become the exception. This ensures a balanced In the present survey, the Class A markets and secondary mar- relation of supply and demand, and therefore helps to prevent kets were also studied with respect to their stability of income market upheavals. and the achievable return on investment. The outcome is rep- resented in the chart on the next page. It reveals that every one of the secondary locations examined has a higher yield upside Trend in Vacancies than the Class A markets. The bracket of achievable net initial The vacancy rate is an important indicator for the condition of a yields extends from 4.0 % in Bonn and Freiburg (B.) to 6.7 % in given office market. In the wake of the robust economic devel- Stralsund. By contrast, the weighted average net initial yield opment and the growth in office jobs, many office markets re- achieved in Class A cities at the moment is around 2.97 % only. port full occupancy now, and not just Class A cities like Munich or Berlin but even secondary locations. Due to the demand- The stability of income in most of the secondary locations is driven building activity in the secondary locations, there is no also reflected in a rent volatility: Dortmund, for instance, has a reason to expect the strain on the regional office markets to very low spread of average rents, which minimises the risk of ease in the coming years. rent corrections on the market side. Conversely, Class A cities like Berlin and Munich – but also places like Kempten and Leip- zig – combine market fluctuations with a comparatively high rent volatility. Trend in Office Employment The economic growth of the past few years has fuelled the To put the return potential and the earnings risk in relation, a creation of white-collar jobs in Germany. In the time between quotient of yield and volatility was created. It is mapped in the 2009 and 2018, the Class A cities registered a growth of chart on the next page. As the chart suggests, cities like Bonn around 20 %. Some of the secondary locations generated even and Dortmund have very favourable relations, whereas the faster growth. And the years to come are projected to bring a Class A cities (Berlin, Munich and Hamburg) but also the sec- further increase in office jobs in virtually all secondary loca- ondary locations of Leipzig range at the bottom of the list be- tions. The currently strained situation on the office markets – cause of their massive rent fluctuations.