This headline hit the news in Germany over the last couple of time. Currently, Cerberus is reported to plan a divestment of their 22,000 appartments, held by Baubecon, the housing association formerly owned by German trade unions. Blackstone has already sold 31,000 apartments.
This is quite interesting since it is really not so long ago that the acquisition of large residential real estate portfolios by international private equity firms was a big topic in Germany. Not only large corporations like Deutsche Bahn sold their residential real estate, but also many communities that simply needed the proceeds to solve their budgetary problems. There were immense concerns about the social implications. Many were afraid that the locusts would simply rise rents and thus make housing something closed to unaffordable.
Rent rises were indeed part of the investors’ business models. The German real estate market has become very popular among international investors over the last two years, due to a combination of developments: German economy was finally recovering, compared to other countries; real estate was undervalued and considered to be managed less professionally. In combination with the low interest rate level, Germany promised very attractive yield gaps. So the plan was to build up large portfolios for economies of scale and synergies, to increase cash flows through rent rises and cost savings, and to leverage the financing highly for high returns on equity. A fast exit with a nice increase in value was expected from IPOs and privatisations of the apartments to their current tenants.
So what went wrong? Many things.
Privatisation to tenants doesn’t go on as expected too. Compared to other countries, Germany has a relatively low proportion of home owners. Many live in rented apartments and many of those are happy as it is. Those who really want to become home owners, have a wide choice and often prefer houses with a bit of garden around. Added to this, many Germany are reluctant to buy any home at all. The high levels of unemployment have caused serious concerns about the personal future and a home loan is a serious financial burden. By now, many are beginning to realise that there is no more ‘job for life’ and that they might be forced to move to another town for a new or better job. Here one needs to know that the housing market in Germany is not as liquid as in other countries. Depending on the location it might become rather difficult to sell a house or apartment in time without a loss.
I have no idea how successful the investors were with their planned cost savings so far. However, the unrealised rent rises and divestment proceeds surely have a heavy negative impact on cash flow projections. To make things even worse, interest rates are rising and thus increase the costs of financing for these highly leveraged portfolios. So the returns are under pressure from two sides. If we add the fact that most of these portfolio deals took place in the form of highly competitive auctions which tend to lead to higher sales prices, it is no surprise that many investors are becoming unhappy with their deals.
So what is the lesson of this story?
- Know your market! Well, I supposed that private equity investors really know their market. I learned that this type of investor does very thorough market research during my Real Estate Investment Banking studies only some months ago. In theory they would do a very detailed due diligence which should cover the question whether the acquisition target really allows any rent rises. However, I also learned that due diligence is an extremely costly thing to do. In an auction, you don’t know whether you will finally make the acquisition or not and so you risk to convert your due diligence costs into sunk costs. Hence, investors are inclined not to spend too much on these things.
- Don’t jump into a market just because everybody else is doing so. Also don’t do that just because somebody else seems to make money there.
- Finally a personal lesson for me: Don’t be excited about a market opportunity just because everybody else is excited. I definitely was excited about the new market dynamics in the German real estate market. How happy would I be right now if I could point you to a former post of mine just to say ‘Well, I have always said that it won’t be that easy.’ Unfortunately, there is no such post.