German investment strategy explained at AFIRE meeting.

On June 23, the Association of Foreign Investors in U.S. Real Estate (AFIRE) held a meeting at the Plaza Hotel in New York City. The speaker was George von Werz, a German Board member who discussed investment activity and sentiments in his country.

According to von Werz, the fall of the Berlin Wall brought a whole shore of different problems, necessitating considerable investment activities in connection with rebuilding of a part of Germany which had been neglected for more than 40 years. One of the major problems was the privatization of companies. More than 14,000 companies which were state-owned had to be turned back to private ownership. This has effectively been completed. More than DM200 billion has been invested by the private sector and about 1.5 million jobs have been preserved.

The second task that needed to be completed was the return of the more than five-million properties to private owners and to communities that had been taken by the state over the course of the Communist years. More than two million claims were filed, of which at this point about 1.5 million still remain unsolved. The slow progress of privatization is caused by a score of problems, ranging from factual to legal, to moral (records were not kept, or purposely destroyed, condemnations during the Communist years followed earlier dispossessions by the Nazi regime, seemingly bona fide acquisitions were made by successive purchases over the years, etc.).

According to von Werz, domestic capital was soon joined by foreign investment in a United Germany which began this way: First, the Swedes, who began in 88 and '90 when their domestic restrictions were lifted, bought without the necessary discrimination. The Dutch have always invested in Germany and are, to some extent, to be considered insiders. The French came in when they saw the opportunities that a unified Germany presented, but left very quickly to solve their problems at home. The Japanese never really entered the market because of the problems that they had in the States, and the British were more often sellers than buyers because of their worldwide property problems. All in all, the German property market continued to be largely dependent on domestic capital.

Although it is only a fraction of the US real estate market, property investment in Germany is very much dominated by local players and much less accessible not only for investors from abroad, but even from out of town. A Munich-based investor like TMW could for example not get the inside deal in Hamburg were it not for the backing of its shareholder banks that provide local entry - a big contrast to the US market, which is so much more transparent.

But even without major foreign investment, the German market saw tremendous amounts of investment capital over the last few years, according to van Werz. Strong investor demand drove up prices and rapidly rising rents seemed to support the ever-increasing property values. Germany was viewed to be at the crossroads of a new vibrant European economy that now included Eastern Europe as well. And things looked euphoric. Everybody thought the German property market couldn't go anywhere but up, while most real estate markets worldwide were fairly depressed.

"We Germans sometimes have a tendency to see things in a lop-sided way - they are either fantastic or very bad," von Werz said. "At that time it all looked fantastic. The cost of unification however started to mount very quickly and resulted soon in a steep tax increases."

On top of the already steep German rates, which go up to 53 percent, this made life rather difficult for German taxpayers.

"We used to live in an environment which was extremely stable. Our vacancy rates were very, very low and if they reached 2 percent or so, it made people already quite nervous," recalls von Werz. "The stability was caused by a variety of factors: conservative banks who restricted the availability of debt capital, a highly regulated environment with a long and arduous process to obtain building permits and a very stable, locally committed tenant base were probably the most important reasons for the stability."

All this changed rapidly with the opening of East Germany. Banks were more or less swept away by the undiscriminating investment craze and the anti-development restrictions in West Germany were either ignored or non-existent in East Germany. Pent-up consumer demand caused the West German retail chains to rush into this new market without much concern for the long-term viability.

The number of German investors who went against the cycle by looking at opportunities abroad and who invested in the US over the last few years is quite small; far more was invested by German private investors in the London market, which presents itself not only geographically closer to home, but which, because of its typical long-term leases, seems to provide the long-term stability that the conservative German investor desires. These investments are viewed like the purchase of a bond, and the attractive returns available in London until about a year ago made the overlook the fact that market rents were dramatically lower than those paid by their tenants.

It has to be remembered also that US investments that were made in the lates 70or early-80s, when the fear of socialism was the main motivation behind these flight-capital investments, obviously in most cases did not meet the expectations, and along with many other foreign investors, the Germans were rather disenchanted with the US real estate market. Only few corporations like Bertelsman and only a limited number of private investors seized opportunities and made smart investments. Most everyone else tried to capture the tax benefits at home before they cease to be available, which will be at the end of 1996.