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The Newsletter for Real Estate Clients June 2008

Dissolving information asymmetry

The primary concern in the securitization market will be to resolve the asymmetrical information that has become apparent and to restore confidence between the banks. This calls above all upon the issuers. The securitization market became increasingly complex over the past few years, and it was barely possible any longer to evaluate the underlying assets. This applied especially when, as in the case of Collateral Debt Obligations (CDOs), different Asset Backed Securities (ABS) were rebundled. Such complex constructs are now virtually impossible to sell and are avoided by investors. The key for issuers will therefore be to simplify structures again and to provide detailed information on the underlying receivables and collateral. The better issuers are able to explain their products and the more thoroughly what underlies them is presented, the more likely investors will be to assume risk again.

Investors may also demand an ongoing flow of information on the performance of the underlying receivables and collateral to be able to make a better assessment of the risks. It is a prime task of the banks to check and monitor credit ratings. It would therefore only be consistent if banks were then also to take on this task whenever the economic risks have been passed on. Improved transparency is one of the most important aspects for reviving the securitization market.

Yet own liability for risks is even more convincing than information. Originators are likely to be increasing expected to assume the first-loss position, i.e. to partially carry the riskiest tranche of an ABS on their own books. This reduces the benefit of securitization to banks as they therefore cannot entirely free up their equity. A similar construct is familiar from the insurance industry. Insurance policyholders are asked to accept a certain deductible amount to establish shared interest. Just as securitizations, insurance policies constitute a transfer of risk. Another example is also to be found in the area of closed-end funds. If the initiator invests own capital in a project this will enhance confidence because the initiator thereby has a direct interest in successful completion of the project. In the case of closedend funds, too, there is a gap in information between the initiators and the investors.

ABSs in a wider sense

Standardization is coming to the fore

Along with transparency, standardization of securitized securities will also increasingly prevail in the future. For example, the quality of the underlying assets or the extent of information provided could be standardized. Particularly standardization could reduce the complexity of financial securities. Stock-market trading would subsequently also be possible. However, standardization will be an option for only part of the market because many securitizations are geared specifically to single, major transactions such as property portfolios and business acquisitions.

The rating agencies are also called upon as an important link in the chain. They will in the future have to be more careful and conservative in ascertaining the risks. Yet the basic dilemma that they are paid by the originators remains. Complete neutrality will therefore not be on the cards in the future either. The onus is therefore on investors to themselves assess and evaluate the risks as comprehensively as possible.

No state intervention needed

The lessons drawn here are all directed at the market players. State intervention, for instance in the form of legislative amendments, does not seem necessary to stabilize the market. The first reason is that regulation would require an internationally coordinated initiative, which appears unlikely at the present time. Yet the key reason is that the market can resolve its problems by itself. As in the case of so many innovations, there was initially overheated demand. After the crash investors will operate more cautiously and examine their prospective investments more thoroughly again. This should be enough to spare themarket from renewed volatility. Apart from the transparency rules, regulation would on the other hand tend to reduc market potential and thereby undermine the economic function of the securitization markets, namely to provide optimum spread of risk.

Failure of the banks to act

Calls for state intervention will always arise when the market has supposedly failed to act. Without wanting to go into this debate whether the market failed to act or not this raises the question why the banking industry was so wrong-footed by the developments on the U.S. mortgage market. It should really be part of the banks core business to identify and appropriately spread risk. The following three points may help to explain the banking industrys failure.

1. The housing market

On the one hand, institutions like the OECD had cautioned for some time against the overvaluation of U.S. real estate. Then again, compared with other countries such as Spain and the United Kingdom, there still seemed to be fundamental justification for the trend in prices. Furthermore,real estate prices in the United States are considered to be relatively less interest-rate sensitive because the funding is based mostly on fixed-interest mortgages. Besides, borrowers are adept at switching between variable and fixed-interest deals. Indeed the volatility is rooted less so in the real estate market, but much rather in the mortgage market. Extrapolating past rates of inflation is only part of the problem because it favored the misdirection in securitization and resulted in unsustainable expansion of lending.

Newly issued mortgage loans in the U.S.

MBS market and Fed key rates over time

2. Wrong incentives due to non-transparent securitizations

The two government-sponsored institutions Fannie Mae and Freddie Mac have for a long time dominated the securitization market in the United States. These institutions buy the receivables from mortgage loans and sell them on the capital market in the form of Mortgage Backed Securities (MBS). They have devised largely accepted standardization in this respect. By statute, however, both institutions are permitted to buy the receivables only from prime loans and these also only for funding real estate up to a value of currently USD 417,000. Not until after the financial market crisis had broken out were these conditions eased. In contrast to prime loans, subprime deals are far more heterogeneous and are therefore difficult to trade on standardized terms, for instance on the stock markets. Subprime MBS are typically traded bilaterally between banks, with the contracts signed being up to 400 pages thick. In addition, there is the fact that a large number of institutions entered the market that all opted for different forms of MBSs and sometimes bundled existing MBSs with other forms of asset-backed securities into new products. This further aggravated the lack of transparency in the market. It seems as though, however, finance intermediaries during times of large liquidity surpluses also shed their accustomed thoroughness in view of apparently profitable investments. Yet the possibility that vendors of MBSs used the murky supply of information to their advantage cannot be ruled out. At least some cases are known in which, without the knowledge of the buyers, receivables pertaining to already renegotiated loan agreements and those facing imminent foreclosure were sold.

The transfer of risk away from the originators to outside investors also created in centive problems. The originators were sparing in the care they would otherwise have applied with the loans they were able to securitize. For their part, the investors either did not recognize the incentive problem due to non-transparent products or knowingly accepted it. This may have been because they took too favorable a view of the housing price trend. In many cases there were also incentive and supervisory problems (principal-agent problems) among the investors, meaning that the ultimate bearers of the risk were unaware of the risk.

3. Inadequate market observation

Not only the banks involved, but also the rating agencies overlooked the risks. Yet it is the task of the rating agencies in particular to identify risks in securities portfolios. In the case of the subprime MBS, however, the probabilities of default were underestimated and the securities given overly safe ratings. The rise in the subprime market and the meanwhile increasingly lax granting of loans in this sector were obviously misjudged.

In essence, therefore, this financial market crisis was also triggered by an information problem. Due to the complexity of the contracts and the heterogeneous nature of the products, there was an asymmetry of information between buyers and sellers of securitization products that in some cases was even two-layered. This is because loan brokers and buyers of the receivables are also likely to have had unequal levels of knowledge.

Classic instruments such as screening and signaling were not used to close the gap in information. Rather, with the sense of upbeat assessment of the market and a high degree of confidence in the market partner, this was in many instances ignored. Against this backdrop, it is explicable that the market for subprime loans was extinguished by mutual distrust as soon as the first major losses were incurred on the market. Outliers of this mistrust even affected the market for covered bonds(Pfandbriefs) even though their standards for the underlying assets are so high that they cannot be affected by the latest developments on the real estate and mortgage market.

Prospects for the real estate securitization market: HSH Nordbanks replies

From a macroeconomic point of view, the idea of passing on credit risks and spreading them broadly by means of securitization transactions makes sense. The equity of the financing banks alone would not be sufficient to ensure a sufficient amount of loan capital. In turn, it is only by using securitization that investors can invest in certain asset classes with the required risk/return profile without themselves having to purchase the directly underlying investment project such as real estate, for example. In future, greater importance will be attached to the transparency of the securitization products and their risks. At the same time, investors will analyze the reputation and track record of the seller of the risk in greater depth. However, this closer monitoring should not constitute an obstacle for the securitization market as such. Rather it offers an opportunity to stabilize the global financial markets and secondly to recall the value of a relationship between banks and their clients based on trust.

Investors expectations higher

The interest of institutional investors in securitized real estate loans has by no means disappeared. Instead, investments in credit risks based on the real estate market are appreciated and made use of by many investors as an attractive possibility for diversifying their investment portfolio. The fact that investors have been acting with restraint on the securitization market since autumn 2007 is not the expression of a general lack of interest in the product. Instead it has become clear that the financial instruments available no longer meet the expectations of todays investors. The fact that extremely complex product structures have clearly not been sufficiently analyzed and adequately evaluated even by reputable rating agencies has brought about a funda-mental change of attitude among investors. Whereas in the past they apparently depended largely on the relevant ratings, today they want to be able to analyze and assess the structures and, in particular the risk constellations involved, in detail themselves. An increasing number of investors approach HSH Nordbank wishing to have packages with real estate credit risks put together in line with their own ideas. This shows that investments in traditional securitizations(above all highly complex CDOs) no longer come to fruition due to the lack of clear and transparent product structures.

Survey: Does the financial crisis also entail opportunities?

Risks must be recognizable A lively securitization market will evolve once again in the foreseeable future as long as two fundamental prerequisites are fulfilled: firstly, in the future securitizations must be structured with greater clarity and transparency than in the past. This means above all that the underlying risks and their distribution must be clearly recognizable. Secondly, when granting loans banks will have to keep a closer eye than in the past on whether and to what extent they generate loan portfolios capable of being se-curitized in the process. It goes without saying that today investors pay much greater attention to the credit rating of the borrowers of the loan to be securitized, to what extent they themselves have ontributed equity and how the loan agreements are set up. The trust required for a securitization transaction can best be brought about for a loan with moderate, rather conservative loan-to-value ratios and clearly defined contractual conditions and where the properties financed offer clear tenant structures and stable cash f lows.

HSH Nordbank preparing for new requirements

Some international banks have practically discontinued lending due to refinancing difficulties through the securitization market. Some have even announced their intention to withdraw from regional sub-markets. In contrast to this, HSH Nordbank continues to offer real estate loans capable of securitization on the basis of the conviction firstly that investors for these products will return. Secondly, we are convinced of the quality of our customers and their investments.

IMF estimate: Potential losses in the financial crisis

Together with a partner, HSH Nordbank operates a platform for mezzanine loans, in which external investors will also be able to participate in the future. Here the platform investments have not set a target of 20 percent return as then the product risk would have to be correspondingly high. Instead the platform invests in conservative junior loans with a firstclass risk/return profile. These are primarily
loans granted for conservative real estate investments with average equity of 15 percent.

The investor profits from the transparency of the product. There are clear investment
criteria and an investment committee that has to approve every investment. One vote against an investment is sufficient for it not to be purchased by the platform. The target investments are properties that are able to securely bear their financing burden, i.e. interest and principal payments, and are able to survive a certain amount of volatility in the market. Conversely, speculative investments are not a focus of the investment strategy. Nevertheless, investors can expect a target return of between ten and twelve percent. The question of an exit does not arise for the platform as the loans are repaid at the end of their term.

Trends on the Asia-Pacific REIT market

In the Asia-Pacific region REITs are an established investment vehicle that has experienced a substantial upturn over the past few years. Asian REITs accounted for 28 percent of global REITs in 2007 in terms of market capitalization. This positive trend was boosted above all by the strong growth of the Asian real estate sector, demand by private local investors and growing demand by international investors. At present, REITs are being traded on the stock markets in Seoul, Tokyo, Hong Kong, Bangkok, Kuala Lumpur, Singapore and Sydney. REITs are also scheduled to be launched on the stock markets in Mumbai and Shanghai.

In a joint study, HSH Nordbank and HSH Real Estate submitted the Asia-Pacific REIT market particularly in Japan, Singapore, Hong Kong and Australia to a closer analysis.

42 REITs make Japan the largest market in Asia

Japan with 42 REITs

J-REITs have been available to investors since 2001. Japan is the largest REIT market in Asia with market capitalization totaling USD 45.7 billion (end of 2007). The Tokyo Stock Exchange REIT index now comprises 42 companies. In 2007, two REITs were floated on the stock market ten less than in 2006. There are further plans for the launch of healthcare REITs, whose investment focus will be on hospitals and assisted- living accommodation. Moreover, there are plans to allow J-REITs to invest in overseas assets in the future. Last year the average dividend return came to 3.8 percent, up from 3.3 percent in 2006.

Singapore as Asian REIT hub

In 2002, Singapore followed Japans example by launching the S-REIT. The city state is one of Asias leading REIT markets. Over the past few years, the number of S-REITs has increased steadily: from seven in 2005 to a total of 20 REITs by the end of 2007. In the past year alone, five new REITs have been listed. Singapore is developing into a REIT hub in Asia. It is here that the first cross-border REITs were listed, which invest in retail real estate in Indonesia, for example. Another REIT recently invested in Japanese residential properties. The number of S-REITs is expected to increase to 30 by the end of 2008. Market capitalization came to nearly USD 19 billion at the end of 2007. The focus is particularly on the asset classes of office, retail and industrial real estate. Last year the dividend return came to 4.3 percent.

Singapore: 20 S-REITs with a marketcapitalisation of US$ 18.7 billion

Positive long-term trend

Hong Kong a comparatively small REIT market

Hong Kong established the H-REIT in 2003. Its performance has been more subdued in comparison with Japan and Singapore. Market capitalization came to USD 8.7 billion at the end of 2007. In the past year, only two new REITs were floated on the stock market. The dividend return in 2007 totaled 5.4 percent. The REIT market in Hong Kong is to be expanded substantially.

Australia with liberal regulation

Australias stable economic and political performance has made the country into a preferred target for international investors. Market capitalization of Australian REITs came to approx. USD 104 billion at the end of 2007. The country is comparatively liberal in its regulation of REITs. For example, it does not limit the property or project-development portion in a REIT. The average yield on the A-REIT came to around 7.5 percent in 2007. Due to the comparatively small size of the domestic real estate market, there is increasing demand from Australian investors for investment opportunities in Europe, the United States and the Asia-Pacific region.

Long-term trends

Prices on the Asia-Pacific REIT markets are trending up over the long term. Moreover, they are outperforming the corresponding local stock-market indices. Following a prolonged phase of sharp price gains, the markets entered a consolidation phase in 2007, during which investors have corrected their very high expectations. All four indices observed reported a slight increase in April. For international investors, the strong rise in prices in the past is put into proper perspective. For example, some of the spectacular price gains have been reduced by the unfavorable trend in exchange rates (Australia being the exception).

The trend in the ratio between net asset value (NAV) per share and the price of a REIT in Asia lags behind that in Europe and the U.S. However, no large discounts have been applied. At present, REIT prices range in the area of the NAV.

An important trend on the Asia-Pacific REIT market is the increasing size of REIT portfolios. This trend together with the expected new IPOs will lead to greater demand for commercial properties in the core and core-plus segments and serve to provide the real estate markets with a sustained boost.

Hedging interest-rate exposure through portfolio swaps

For businesses that refinance themselves on the global credit markets, the trend in interest rates constitutes a risk factor. The increased risk sensitivity of banks and rising interest margins that were observed over the past few months may increase the refinancing costs for property companies considerably. Accordingly, interest-rate hedging strategies designed to reduce interest charges are of great importance. For a business, the main question here is whether it should seek long-term refinance at a fixed interest rate or short-term finance at variable rates.

An optimum interest-rate hedging strategy minimizes a companys average liquidity costs and the interest-rate risk. For example, one possible strategy would involve the comparison of different refinancing options. To do this, several credit portfolios with different fixed-term interest rates are set up. The first portfolio is hedged in full using an interest rate fixed over a prolonged period. In the other portfolios, the fixed-interest portion is gradually reduced while at the same time the variable portion is increased. Finally, the last portfolio is fully subject to a variable interest rate. These portfolios are observed over a prolonged period using historical interest rates, and their performance compared. From this comparison the optimum ratio between fixed and variable rates is then determined. This approach follows Markowitz portfolio theory, which states that the risk of an efficiently structured portfolio is smaller than or, at most, no more than equal to, the average risk of the individual properties in the portfolio.

Portfolio swap with opportunity benefit from efficient interest-rate mix

The comparison shows that the individual portfolios differ considerably in terms of their efficiency. All in all, portfolios with a mix of fixed-rate and variable-rate financings financings perform best. Interest costs and interest cost volatility improved when compared with portfolios which included only one interest rate.

HSH Nordbank has developed the portfolio swap with opportunity, i.e. a swap transaction that is geared particularly to this efficiency benefit. It thus constitutes an alternative product for hedging a loan portfolio. In this portfolio swap, the existing interest payment is swapped for the payment of a portfolio interest rate. This portfolio interest rate is an interest-rate mix: instead of fully variable refinancing via the threemonth Euribor, only 40 percent of the loan portfolio is refinanced variably using the three-month Euribor. For 60 percent of loans, interest-rate hedging is carried out on the basis of the ten-year constant-maturity swap rate.

The constant-maturity swap (CMS) is a version of the interest-rate swap. In a interestrate swap, a borrower swaps the variable interest rate on his loan against a fixed rate which is set at the time the contract is concluded. This swap transaction enables the borrower to hedge himself against the risk of interest-rate changes. Unlike a normal interest- rate swap, in a constant maturity swap (CMS) the long-term fixed interest rate is adjusted to a longer-termreference interest rate at regular intervals. Thus the 60-percent interest portion of the portfolio swap with opportunity is adjusted to the ten-year CMS rate once a quarter.

Portfolios with a mix of different fixed-interest rates are the most efficient

Interest-rate limits hedge the portfolio

Interest rates retain an attenuated flexibility

By aligning the two interest rates to the portfolio interest rate, the fluctuation range of lending rates is reduced. At the same time, the option remains to participate in current interest-rate movements in an attenuated form. For example, there is an opportunity to benefit from falling interest rates. At the same time, however, the risk of rising interest rates remains.

In order to limit this risk, as a next step an interest rate ceiling can be set through the purchase of an interest-rate cap. This cap refers to the entire portfolio, i.e. to the 60-percent and 40 percent interest portions. The interest-hedging portfolio can be designed in a premium-neutral way through the additional sale of an interest-rate floor. The interest- rate floor, which also covers the entire portfolio, at the same time creates a lower limit for the interest rate. This floor constitutes the minimum interest rate to be paid even when market rates have actually dropped lower. The interest-rate ceiling and floor form a range within which the portfolio interest rate can move freely in line with the reference interest rates. If movements go beyond the range, interest payments are limited by the interest-rate ceiling and floor. This means that the market movements within a specified range can be tracked with a substantially reduced risk and a lower fluctuation range.

Participating in falling interest rates

The following example illustrates how the portfolio swap with opportunity works: for a loan portfolio with a volume of ten million euros, an interest-rate cap of five percent and a floor of 3.5 percent are set. 60 percent of the total, i.e. six million euros, is subject to the ten-year CMS rate (10Y CMS) and adjusted every three months. The remaining 40 percent, i.e. four million euros, is subject to the three-month Euribor (3M Euribor). In the baseline scenario (scenario 1), the 3M Euribor is trading at 4.3 percent and the 10Y CMS at 4.5 percent. This produces a portfolio interest rate of 4.42 percent. If, for example, the reference interest rates fall the 3M Euribor to four percent and the 10Y CMS to 4.4 percent (scenario 2) then the loan portfolio benefits as well: the portfolio interest rate drops to 4.24 percent.

However, if pronounced interest-rate fluctuations occur where the reference interest rates rise or fall to beyond the range (scenario 3), then the interest-rate ceiling and floor come into play, thereby hedging the portfolio.

Real estate indices: The real estate world in numbers

Just a few years ago, it was almost impossible to track trends in the real estate sector. In the meantime, however, numerous indices have emerged, allowing forward-looking projections to be made. Yet, the individual indices have little in common, focusing as they do on various markets, evaluating different data or using unique calculation methods. Accordingly, it is almost impossible to compare the indices with each other.

A predominance of indices for listed real estate companies

Most real estate indices track the performance of listed real estate companies. Whole families of indices have arisen over the past few years, one of the best known being the German Real Estate Stock Index (DIMAX). Calculated by Bankhaus Ellwanger & Geiger, the index tracks all companies listed in Germany which generate at least 75 percent of their earnings from real estate business. It is frequently compared with the DAX, which tracks the 30 largest German bluechips, to determine the relative performance of the real estate sector.

The bank has since also supplemented this index with the EPIX and the ERIX. The EPIX tracks the performance of the largest German real estate stocks, while the ERIX is devoted to the largest European real estate investment trusts (REITs).

Global Property Research (GPR), which specializes in calculating real estate indices, offers the GPR indices, a further family which tracks listed real estate companies. The GPR 250 Index observes the worlds 250 largest companies in terms of market capitalization, while the 15 largest European companies are combined in the GPR 15 Index.

The FTSE Group, which emerged from a joint venture between the Financial Times and the London Stock Exchange, also has its own family of indices. At the core is the FTSE EPRA/NAREIT Global Real Estate Index, which plots the performance of listed real estate companies around the world. In addition, FTSE calculates numerous individual indices concentrating on specificaspects, e.g. specific regions. However, the extent to which trends in the real estate markets of individual countries can be compared with each other in this way hinges to no small degree on the statutory and economic conditions in the individual markets. The stock prices of and, thus,trends in real estate companies react to a more pronounced extent to market fluctuations than to rental returns or real estate prices, for example.

DIMAX with upside potential

BulwienGesa Real Estate Index: Real estate sector on an upswing

Conclusions vary according to the data base

Another group of indices assesses the condition of the real estate sector by reference to trends in real estate returns. The best known indices of this type include the BulwienGesa German Property Index and Deutsche Immobilien Index (DIX), which is calculated by Investment Property Datenbank (IPD). Both indices measure rental returns and changes in the value of German commercial, office and residential real estate.

Yet, the question as to whether or not the indices in this group are comparable with each other is even more pressing than in the case of the indices which track listed real estate companies. Thus, while the BulwienGesa German Property Index indicates a return of 10 percent for 2006, the DIX yields a figure of only 1.3 percent for the same year. The reason for this difference is to be found in the data on which the indices draw. IPD calculates the DIX on the basis of the returns achieved on real estate held by around 50 insurance companies, real estate funds and pension funds in their portfolios. On the other hand, BulwienGesa collects data in 125 German towns and cities for its German Property Index.

The Hypoport house price index (HPX) offers another method for tracking the state of the real estate market. This index identifies trends in the average purchase price of various types of residential real estate. Comprising three individual indices cove-ring new and existing fully and semi-detached homes as well as owner-occupied apartments, Hypoport derives the data for its house price index from its own Internet platform via which it arranges real estate finance. However, the index covers only residential buildings and thus only a small part of the real estate market.

One index which tracks both returns and prices is the BulwienGesa real estate index. In addition, it not only includes purchase prices and rental returns for residential real estate but also the rentals of office and retail space as well as the purchase prices of commercial property. In this way, it is able to provide a more comprehensive view of the real estate sector.

A glance at the real estate clock

Real estate consulting company Jones Lang LaSalle has developed an instrument which shows at a glance the phase of the business cycle which a market has reached at any given moment. Known as the real estate clock, it permits comparisons of the overall market as well as individual parts and regions. The real estate clock is based on a comparison of the current top rentals with historical figures in a given region. Thus, depending on the region and market, it is possible to calculate a figure determining the position on the real estate clock. However, this clock only provides a reading for a given point in time and does not offer any indication of the speed or direction of market trends.

Opinions in numerical form

These indices are supplemented by the results of opinion polls performed by banks, real estate agents and investors in particular.The resultant indices primarily reflect sentiment in the real estate markets. Prominent examples of these include the King Sturge Real Estate Market Index and the DTZ Real Estate Barometer. Here as well, the extent to which the results can be compared in different surveys depends on the underlying data. Thus, for example, a survey of foreign investors does not necessarily have the same results as a poll of domestic market participants.

A glance at the real estate clock

Munich: one of the most stable real estate markets in Europe

Munich is maintaining its position as one of the most attractive real estate markets in Germany. According to a survey among international real estate investors, together with Hamburg the city on the Isar numbers among the five most popular locations for investment in Europe. In a study jointly conducted by PricewaterhouseCoopers (PwC) and the Urban Land Institute (ULI) last year Munich was already regarded as one of the most promising real estate markets with a particularly bright future being seen for the market for project developments. In this category Munich ranks third after Moscow and Istanbul.

The study says that Germany scored points for its manageable risks and a continuing positive consumer climate. With its broad-based economy, Munich benefits particularly from current economic growth as well as being relatively resistant to crises in weaker phases. In Europe Munich is even considered to be the most stable market after Paris while the boom cities of Moscow and Istanbul come in a poor 27th and 23rd, respectively.

Investments at record level in 2007

Investors upbeat outlook was reflected in record figures in 2007. The transaction volume on the Munich real estate market climbed to O 6.7 billion with investments increasing 37 percent yearonyear. At O 3.2 billion, almost half of the investment volume was accounted for by portfolio transactions. Although the average volume per transaction fell from O 42 million to O 34 million, at the same time the number of transactions increased by almost 70 percent compared to the previous year, to 197. This year experts expect the investment climate on the Munich real estate market to remain upbeat. However, as institutional investors will probably sell fewer large-volume portfolios, the transaction volume will no longer reach the record level of 2007.

Among the most important investors in 2007, accounting for almost 40 percent, were equity and real estate funds. Here, more than two thirds of buyers came from abroad. On the seller side project developers led the field with a share of almost 30 per cent. The proportion of foreign investors on the seller side increased substantially from 9.1 to 16 percent.

Almost three quarters of transactions were investments in offices, followed by project developments with 14 percent. Locations in all parts of Munich were in demand. Just under half of investments went to Munich inner city as well as to the periphery of Munichs city center and 25 percent to secondary locations. A quarter of revenues were likewise generated in the surroundings of Munich. The sustained strong demand is resulting in stable prices on the Munich market. The current initial net returns on fully leased Munich office properties in the inner city stand at 4.6 and 5.2 percent, on the periphery of the city center at 5.5 and 6.7 percent and in the surroundings at 6.7 to 7.7 percent.

Good prospects for 2008

For 2008 the investors interviewed by PwC and ULI see the greatest investment opportunities in retail properties and hotels. 54 percent recommend buying retail property and as much as 59 percent hotels. But office and residential properties remain attractive in the view of investors. The study maintains that this is due above all to the citys growth potential and the fact that Munich has to date played such a minor role in the respective portfolios.

Investors confidence is underpinned by the figures from the office rental market. According to these, office space takeup increased by 15 per cent on the pervious year in the first quarter of 2008, to 226,100 square meters. This means that Munich has maintained its position as the office rental market with the highest revenues in Germany. At the same time these figure point to a robust economic performance, which is also likely to benefit the retail sector and the demand for residential properties.

Investors believe in project developments in Munich

New building needed in all segments

The strong demand for real estate in all segments has given a marked boost to construction activity in Munich. According to Jones Lang LaSalle (JLL), the Munich market accounts for around one third of all completions in the office sector planned in Germany for 2008. As stated, most of the 321,000 square meters of new space has already been leased. Only some 76,000 square meters are on the market for speculative investors. Upmarket new buildings will continue to be in demand. In the estimation of JLL, the vacancy rate is likely to decrease to almost eight percent this year.

Hotels and retail properties are particularly in demand

The supply of top-class retail space is still very thin in Germanys favorite shopping city. Space is highly sought after in the city center, above all in the area of the pedestrian zone around Kaufinger Strasse and Neuhauser Strasse, but there is hardly any available. In 2007 the top rent here increased by 7.7 percent to O 280 a month per square meter. In other locations too, top rents are increasing rapidly for example by more than 20 percent to O 200 per square meter in Theatinerstrasse. Supply bottlenecks and growing demand will lead to increasing rents in this segment too in 2008.

Housing construction is one of the most important objectives of Munich politics. More than 50,000 residential units have been built in the city area since 1990. In the past ten years alone, the population has increased by around nine percent to 1.29 million. The strong demand for residential property means that rents are continuously rising especially in popular districts like Schwabing or Isarvorstadt. In very good locations rents of between O 13 and O 17 per square meter are paid and in good locations of between O 11.50 and O 13.50. Numerous large projects, such as the Ackermannbogen, Nymphenburger Höfe or Stadterweiterung Freiham, are intended to ease the situation on the housing market in the future. Nevertheless, it can be expected that the increasing number of residents and households will result in a housing shortage, raising the prospect of higher rents.

Munich is one of the leading places for investment

/ Source: HSH Nordbank

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