Core-Real Estate Investments in times of crisis: Exemplified by the Frankfurt and London office market

Pieper, David A.

Core-Real Estate Investments in times of crisis: Exemplified by the Frankfurt and London office market

by David A. Pieper (Author)

Business economics - Business Management, Corporate Governance

53115

Summary

Currently, the crisis situation is driving the real estate markets around the world. Mainly in focus are so called ,core’ real estate investments: the most stable, nicest looking, most rented out and most ideally located investments. With these investments, investors intend to eliminate almost all risks. But are they really able to do so?
This book takes a closer look at the asset class and investment strategy ,core’ and tries to promote a clearer understanding of what ,core’ really is and what requirements this investment category has to fulfill. Furthermore, a new detention has been developed to narrow down a globally working detention throughout all asset types but mainly focusing on offices exemplified by the London and Frankfurt commercial real estate market.
In further chapters, risks around the ,core’ strategy are analyzed, and the current and past crisis situation's connection with these investments is discussed.
This work is intended to help all real estate professionals, such as investors, fund managers, financial experts and all professionals having to do with major ,core’ real estate investments around the world who would like to get a clearer and more precise comprehension of the matter.

Excerpt

List of Abbreviations

BBSR

Bundesinstitut für Bau-, Stadt- und Raumforschung

BRICS States -

Brazil, Russia, India, China and South Africa

BREEAM

Building Research Establishment Environmental Assessment Method

CBD

Central Business District

CBRE

CBRE Group, Inc, global commercial real estate services firm

CMBS

Commercial mortgage-backed security

DEKA

DekaBank Deutsche Girozentrale

Destatis

Statitisches Bundesamt (Federal Statistical Office of Germany)

DGNB

Deutsche Gesellschaft für nachhaltiges Bauen e.V. (German

Society for Sustainable Construction)

ECB

European Central Bank

EnEV

Energieeinsparverordnung (German Energy Saving Ordinance)

GDP

Gross domestic product

Helaba

Hessische Landesbank (also: Landesbank Hessen-Thüringen)

IMF

International Monetary Fund

ING

ING Group, a global financial institution

INREV

European Association for Investors in Non-Listed Real Estate Vehicles

IVG

IVG Immobilien AG a German real estate company

Immobilienzeitung

JLL

Jones Lang LaSalle a global real estate company

LEED

Leadership in Energy and Environmental Design

LTV

Loan-to-value ratio

NCREIF

The National Council of Real Estate Investment Fiduciaries

NPL

Non-performing loan

Public relations

PwC

PricewaterhouseCoopers is a global professional service firm

RREEF

RREEF Real Estate Company A Member of Deutsche Bank Group

Index of Tables

Table 1: Market Definitions ...6

Table 2: Most demanded market properties ...7

Table 3: Global Real Estate Market Capitalization ...7

Table 4: Prefered current investment types ...7

Table 5: The "house of core", summarized features of a core office investment ...12

Table 6: Correlations of five major office markets ...15

Table 7: INREV Style Classifications by 2011 ...16

Table 8: Volatility of Office Properties in Frankfurt am Main and London ...19

Table 9: Work Force Scenarios ...26

Table 10: European Commercial Real Estate Outstanding Debt ...30

Table 11: Germany Inflation Rate ...30

Table 12: United Kingdom Inflation Rate...31

Table 13: Estimation of Maturing Loans by Deutsche Bank ...34

Table 14: Default rate of US CMBS ...35

Table 15: CMBS Risks for UK and Germany...35

Table 16: Non-Performing-Loans development in Europe ...36

Table 17: Risks summery and their potential effects on core ...37

Table 18: London Investment Analysis ...39

Table 19: London subdivided into districts, colors indication prices and values ...40

Table 20: Europe Attracting Global Real Estate Capital ...42

Table 21: Historical Central London Development Rate ...42

Table 22: Prime yields London compared to gilt yields UK ...44

Table 23: Prime yield compressions in Europe ...45

Table 24: UK real estate values in comparison to previous peak ...46

Table 25: Frankfurt office market divided into districts and rents paid ...47

Table 26: Prime yields Frankfurt compared to gilt yields Germany ...50

Table 27: Crisis development since 2006 ...51

Table 28: Differentiation of crisis types ...52

III

Table 29: Drivers of Financial Imbalances 1999 - 2007 ...55

Table 30: Historical view on crisis and their heaviness ...56

Table 31: Cycles of past and ongoing real house prices and banking crisis ...57

Table 32: UK GDP Per Capita Development...57

Table 33: US core fund real estate historical income and appreciation analysis ...58

Table 34: Real Estate Share of Institutional Investors ...60

Table 35: Alternative Investment to Core Office Real Estate in Times of Crisis ...61

Table 36: Investment trends in Germany for Office and Retail for 2012 ...63

1 Introduction

1.1 Leading-in

"The basis of optimism is sheer terror."

This drastic quote comes with a `core' of truth. Through the last century's history of money

and financial markets the market players were usually driven by the same factors and

financial laws. For once you have to accept more risk if you want higher yields and therefore

you have to pay more if you want a higher security of your invested capital.

And secondly, capital is shy and driven by fear and only partially rational rather than driven

by emotions. No matter which crisis of for example the 20

century is analyzed, usually

bubbles were often born slowly but steadily, market mechanisms failed and when too much

money was available (often too cheap), prices of certain fields and goods went up drastically,

investors became greedy and at the peak everything was bursting and fear was ruling.

Afterwards, as for example after the dot.com-bubble, investments into these segments were

rare and trust needed to be built up again.

The commercial and professional real estate market theoretically is in this regard not different

from other markets. A usual behavior in times of crises is the wish for more security, more

stable investments, and meaning significantly less volatile and ideally very liquid and

realizable investments on a market. Capital Investments should be "safe havens" and rather

bring little or less money than losing heavily or all.

In the current time of crisis, after the

initialized 2008 Lehman Brothers crash and the following subprime crises, followed by the

global recessions in mostly 2009, some countries 2010 and even today in the days of the

European and global sovereign debt crisis real estate investors are as an international

phenomenon shifting money into secure real estate and on the professional site into "core

commercial real estate" in A-markets. Just recently, the institutional investor's magazine

"I&P Real Estate Global market intelligence for institutional real estate investment" asked

in their current edition: "Is core overheating? Investors mull secondary."

In this book, the

author wants to provide the real estate professionals with a broader view on the highly

discussed topic of commercial (mostly office) core real estate investments in recent times and

general times of crisis and market pressure. Questions looked at and discussed will be the

question of the asset and investment class "core" itself, what it is, what it stands for and how

it can be classified. And secondly, what does "crisis" mean and how is it linked to the

Oscar Wilde, The Picture of Dorian Gray, 1891

Cf. This time is different Eight Centuries of Financial Folly, Reinhart, Rogoff, 2009, p.277 f.; Heuser, Jean,

Bitte neu anfangen Auch wenn die Krise mal Pause macht das Gebot bleibt bestehen: Der Kapitalismus kann

so nicht bleiben, 2012

Cf. IVG Market Tracker Europe, December 2011

cover question in I&P Magazine September / October 2011

investment decisions and the expanded allocation of capital into this asset class, especially in

Europe. Here, the commercial real estate markets of London and Frankfurt will be taken as a

fitting and hopefully transparent example. And finally, the question of alternatives for major

investors will be addressed. The author intends to bring more insight and a clear and

professional look at this wide and complex topic that has become more and more important

and widely discussed throughout the last years and month (latest on the Expo Real in Munich

2011), especially since the further development and the potentially not short upcoming end of

the recent crisis.

1.2 Problem Statement

"If core effectively equates to prime, prime currently equates to over-priced at least in some

markets."

In times of crises, especially today, we are now after first the subprime crisis followed by the

financial crisis and swapping over on the world economies, in the middle of the global dept

crises, Investors around the globe are aiming and even longing for secure havens for their

capital. The real estate asset class "core" is right now playing a major role in the allocation of

capital and liquidity. But are there problems coming along with these investment strategies

and mass-shifting of capital? How are the markets reacting and what is really "core" and can

be considered core? And if core implies lower risk, is this actually true for all phases of a

cycle? Is this true in the current phase? Some market participants are starting to worry about a

new bubble on the core property market. If this is justifiable what results would this have?

Thesis: In times of global crisis / tensions, professional real estate markets and market

participants are reacting differently. This behavior and these investment strategies can cause

difficulties up to contrary results than initially indented; more volatile and unsecure

investment decisions as well as mislead views on the markets.

1.3 Goals of Studies

The goal of this book is to get a more clear understanding and characteristics of the real estate

asset class "core". The author will create a new definition of core, related to commercial

office buildings. The potential risks of core investments against the background of the current

crisis will be looked at in detail. By adding to the book a practical component the author will

have a closer look at London and Frankfurt and their core commercial real estate markets and

possible different developments.

The goal of the study is, to giving the reader a clear background knowledge of what is

understood by core, indented with core strategies and where the potential risks lie.

CF. Expo Real: Weitere Polarisierung auf Europas Gewerbemärkten / 2011

Bill Hughes, quoted from IP Real Estate Global Market Intelligence for institutional real estate investors

(Sept / Oct 2011)

Furthermore this knowledge is intended to be set into connection with the markets (here

London and Frankfurt) and the crisis background that makes the situation possibly abnormal.

Finally, the question will be, if the core-investment strategy is the favorable and logical result

of global crisis or does it come with difficulties and problems recently underestimated that

ought to be answered. Alternatives will be discussed and set into crisis connection as well.

1.4 Approach

In the beginning, the author wants to make aware of the framework in which the book was

written. The paper was mainly created within the last two month of 2011 and first two months

of 2012. During this time and the last years markets, decisions and developments have been

very volatile and can theoretically change a standpoint over night. The author will try to be as

general and universally adaptable as possible, but can only deliver content until the period's

end.

In this book Frankfurt and London have been chosen because these markets can be taken

exemplary for the discussed elaboration. First, they are in international comparison very

transparent, in particular the London market, additionally they are global and attract money

and liquidity from all around the world and are therefore a good mirror of global investment

decisions. Thirdly, they can be taken as an example of international capital being shifted into

core real estate and the bringing with results. And furthermore, as a last major aspect the

density of global players and decision makers in these two markets can be highlighted and

taken insight from. Here the decisions from "market makers" on capital allocation can be

learned from on future trends, in a positive or negative way. The general approach will be to

get a clearer understanding of "core real estate", in particular commercial real estate and

office buildings, but the inherent idea will most likely be adoptable for other professional

premium real estate assets classes as well. The book will be subdivided into four sections; the

major topic is in the first "core". The current definition, demands of core investors are derived

from a new definition of core and risk concerning the investment strategy will be addressed.

The second main part of the book will be the "example markets". The found knowledge of the

first chapter will here be applied and set into practical context.

The third major arrangement point will be the "crisis". This crucial part will be the "bird

view" on the current crises. Here, the author will try to bring a more detailed understanding

into the real estate market especially concerning core real estate. This part of the book will

first be more general to the topic of the crisis (in terms of a better and more general

understanding of crisis situations and definitions) and will then lead into a connection of crisis

and core real estate and the particular effect of the current exemplified crisis on the core

commercial real estate market. The last major arrangement point will look at what investors of

core investments are engaged in and what the possible alternatives to core investments could

be for suitable them.

It is generally very important to note, that due to the time and space requirements of this work

the details of certain parts cannot be as profound as desired. Due to the enormous richness of

detail and cross-border knowledge needed the crisis chapter will be kept shorter and focuses

on real estate.

2 Classification of the real estate asset class and strategy "core"

2.1 Current definition of core

If looked at the meaning of the word "core" itself simply translates to "centrum" and can

therefore be understood in the sense of real estate described as the centre of a city.

The word

is not legally defined in the real estate science and mostly described either as a portfolio

strategy type or investment intention, for example from private equity funds as shown in

appendix 1. Core is the first of usually 3-4 investment types, core, core plus (frequently left

aside), value added and opportunistic. In the real estate professional scene "core" describes a

type of investment strategy or risk attitude of investors and furthermore classifies the

discussed real estate, mostly into "core office", as well as "core residential" and "core retail"

sometimes industrial and multi-family real estate.

A clear and unified opinion of what

exactly "core" is, can here not be found. American, British and for example German

description of core features vary quite heavily. The US credit rater Realpoint (2010 bought by

Morningstar) classifies for example core real estate total returns between 8,5% and 10%

whereas the German commercial real estate company BEOS AG classifies core returns in

between 5% to 8% which seems to be similar but makes a huge different taken into account

the high investment volumes.

910

In order to classify "core", different sources mean different results, but can shortly be

summed up by a definition of ING core funds: "core funds can be seen as low risk funds that

invest in stabilized, income producing property which is held typically 5-10 years and have

little acquisition / disposal activity after the fund has been invested. Assets in such a fund are

typified by stable income returns with less capital growth."

Found in the literature and

mainly big investors and market player's publications, core comes with certain "must"

features that are mostly judged by risk, stability and volatility aspects. The properties have to

Cf. Webster Third New International Dictionary, 1976.

Cf. Core properties, http://www.ingreim.com/reim/about_us/glossary/#C.

Cf. Defining and Determining Core and Non-Core Real Estate Investment Strategies, Real Point Research,

GMAC Institutional Advisors LLC, 2005.

Cf. Der Markt für Gewerbe- und Industrieimmobilien aus Entwicklersicht, BEOS AG, 2010.

http://www.ingreim.com/reim/about_us/glossary/#C.

be nearly fully leased, which minimizes the risk aspect.

Furthermore, the Loan-to-Value rate

(LTV), the spread between equity and borrowed money has to be usually below 40%.

The

investment has to usually be long term, the market invested in mature and transparent, the

properties of high quality. It is very important that the tenants have to bring a high credit

standing and secure lease agreement.

2.2 Market for office core investments - putting core into general context

The commercial office real estate sector is a more and more unified global market.

Major

investors look quite often at investment opportunities in the global leading financial cities,

such as New York, London, Frankfurt or Hong Kong.

In these markets the office sector

properties are usually categorized by the location and quality. The buildings are theoretically

spread around the cities, often in the central business districts (CBD), the very centre or in the

suburbs (often in the USA).

The markets for core properties mainly exist in the USA and continental Europe. "This is

explained wholly by familiarity and perceptions of risk".

Table 1 shows the typical core

markets around the globe, differentiated by emerging markets mainly different in the risk

attitude of the investors. Generally speaking according to Andrew Braun core markets are

"[...] politically stable, have a stable currency, offer professional service necessary for

institutional investment and are liquid and transparent"

For the European market Baum

continuous with the requirements: "[...] Membership of the EC; membership of the Euro;

political stability; generally having a benchmark (the exceptions are Belgium and

Switzerland); size, quality of professional services; and liquidity"

Table 1: Market Definitions

Core

Developing

Emerging

Opaque

Portugal

Czech Republic

Belarus

Germany

Spain

Hungary

Moldova

France

Italy

Poland

Ireland

Denmark

Slovakia

Sweden

Austria

Baltic States

The Netherlands

Norway

Turkey

Switzerland

Finland

Greece

Belgium

Luxemburg

Slovenia

Source: Commercial Real Estate Investment, Andrew Baum, 2009, p. 361.

Cf. Commercial Real Estate Overview: Performance of "Core" & Non-Core Real Estate, The University of

Chicago Booth School of Business, 2009.

Cf. INREV Style Classification, 2011.

Cf. places & spaces The Real Estate Magazine of Union Investment, The core of a market, 2011.

Cf. Erfolgreiches Portfolio- und Asset Management für Immobilienunternehmen, Lehner, Claus, 2010, p.123.

Cf. PREEF Research, RREEF Global Real Estate Investment Outlook & Market Perspective 2011, p. 1.

Commercial Real Estate Investment, Andrew Baum, 2009, p. 360.

Commercial Real Estate Investment, Andrew Baum, 2009, p. 361.

Ibidem.

Institutional Investors who are often the buyers of core office real estate are normally only

considering the A or B buildings, whereas "B" is a complicated matter, since it can be close to

"A" but pretty far away at the same time. That will be due to further discussions later in the

book.

Table 2 below shows that recently the market for core properties is the most

demanded one, especially in London.

Table 2: Most demanded market properties

Source: places & spaces - The Real Estate Magazine of Union Investment, Issue: The core of a market -

Everyone is talking about core but every investor defines the term differently, 2011

The global core real estate universe, worth $ 8 trillion and growing (latest data available by

December 2005) can be seen in Table 3, showing that Europe as a continent with $ 2,234

billion dollars is the second biggest market only coming after the USA with $ 2,632 billion

dollars.

Cf. Guide to US real estate investing, 2009.

Table 3: Global Real Estate Market Capitalization

Source: Global Real Estate Investment Going Mainstream, UBS, 2003.

Table 4 displays in a PwC conducted survey on European real estate investments, where

institutional money flows, showing a lead for core real estate.

Table 4: Preferred current investment types

Source: Emerging trends in real estate Europe survey by PwC (2011), p.18.

When speaking of core investors and core investment, the classified buyer is not clearly

defined in literature. Since usually most office and core buildings are in the millions (euro,

dollar or pound) considering the purchase price, the typical investors are professional real

estate companies, usually funds (mutual, private pension, state and local retirement,

endowment), banks, insurance companies, foundations and private wealthy individuals, so

called High-Net-Worth-Individuals (HNWI), usually acting through their own wealth

management companies, called "family offices".

Appendix 2 shows a list of the 30 biggest

professional real estate investors in the world, having a total investment sum of $ 458,784.7,

whereas the cutoff level was just north of 6 billion dollars in equity invested. Following with a

classification on the real estate discussed office buildings are usually classified into "Class A"

to "Class C" or more common in the UK, "Greater A" to C buildings. Sometimes they are

called "prime-office space", "premium" or "trophy" real estate as well. In this book only these

Cf. Institutional investors and corporate governance, 1993, p. 667.

types of buildings will be considered since only they can be called "core".

The term "trophy

real estate" is a common, mainly US-real state used term. It is not only used for office but

mainly for exceptional residential properties, such as a penthouse downtown Manhattan. For

the commercial real estate "trophy" goes mostly along with describing "core", but is more

focused on the building, and the awareness of the building within the city, the architecture and

the image as well as the materials used. Additionally, these buildings usually belong to the

newest, most technologically advanced and most sustainable ones. They have to come with

for example a LEED Gold or Platinum certification.

Swiss-Re Building, called "The

Gherkin", built by star architect Norman Foster, is a typical London City trophy building and

also an example for core. Trophy office real estate additionally usually comes with longer

lease periods (typically 5-10 years or longer), higher rents, and tenants with a higher

creditworthiness. The reason for that is, besides the outstanding location and quality of the

buildings, that the landlords / investors have to equip the floor spaces more individually and

build a higher quality for the demanding tenants. That is capital intensive and makes these

longer leases and higher rents necessary.

Core is described as more than just the building,

but a risk and investment attitude and strategy. Trophy buildings have to be always core

though and can thus be used as a simultaneous term.

Research of what in detail is demanded from investors of core commercial real estate has

hardly been subject to heavy analysis yet. In order to know what is demanded, core has to be

defined first, which already states a problem. Secondly, "core" tries to be used as "flexible"

definition that can easily be stretched. Core itself, even for commercial properties, means

talking about offices, retail properties, industrial properties, multi-family houses or bigger

residential properties and even sometimes hotels.

2.3 Requirements to the asset class core

In 2008, a master thesis written about "

Anforderungen an die Assetklasse Büroimmobilie aus Sicht

eines Core-Investors insbesondere unter Einbeziehung der Energieeffizienz

focused on the

demands of core investors, in particular their requests for energy efficient buildings. As for

the typical requirements to core commercial real estate the most important factor is cash flow

stability over a longer time period. Value retention is as well of high importance followed by

liquidity, being able to sell the property even in times of crisis. The asset class itself is of high

importance as well, when buying prime or Grade-A office space a higher level of

transparency and data material is assumed and demanded by the investors. Furthermore,

usually portfolio / investment properties are asked for, not development properties due to the

investors' risk-aversion. The properties itself are usually as mentioned above premium or

trophy real estate, since solvent tenants and low vacancy rates are demanded as well as little

fluctuations and problems with the tenants are to be avoided. The properties are usually of

http://www.ingreim.com/reim/about_us/glossary/#C.

Cf. LEED, or Leadership in Energy and Environmental Design, is an internationally-recognized green building

certification system. Developed by the U.S. Green Building Council (USGBC) and The New York Time, Class-

Consciousness in the Office Building Market, 2011.

Cf. Guide to US real estate investing, 2009.

English translation: "Demands to the office asset class from an institutional investors perspective under the

comprehension of energy efficiency" by Thomas Schick, 2008.

highest quality and location.

The demanded yields are usually 300 to 700 basis points above

government bonds. The Loan-to-Value ratios are usually only up to 50% maximum.

The

newest but mostly strict demand is the one for energy efficiency and sustainability. Green

Building is a mega trend and investors realized that progressively raising energy costs are a

threat to stable cash flows and appreciation.

In detail these trends and requirements to the

asset vary from country to country. National differences, for example in water supply

(Australia vs. Germany) vary sometimes quite strong in detail but are overall similar

concerning the later assigned labels. For the German market discussed in this book the

"Energieeinsparverordnung" (EnEV), the "Deutsche Gesellschaft für nachhaltiges Bauen"

(DGNB) and the American "Leadership in Energy and Environmental Design" (LEED) are

the most important standard-setters for sustainability and environmental standards for office

buildings. The "EnEV" is a law that takes care of energy efficiency and buildings standards

for office, residential and some industrial buildings.

The DGNB and LEED are publishers of

energy efficiency and sustainability certifications that are important for core office buildings

in Germany and the world (LEED). The mostly named reason is the demand for sustainable

buildings by the tenants which therefore leads to a more successful letting and higher reselling

prices.

The investors demand this as well but usually only for new buildings, already existing core

buildings that can sometimes already be 20 years old are very rare with certifications. The fist

building to be certified LEED Gold is this year's awarded building "Main Tower" owned by

the Hessische Landesbank (Helaba) that was intensely adopted to modern standards in order

to get the desired certificate.

In the UK the system and arguments are similar; the most

important certificate there is called "Building Research Establishment

Environmental

Assessment Method" (BREEAM). In the following appendix 3 shown is the number of

BREEAM certificated buildings by end of 2008. A progressive raise can be seen that has been

ongoing until today. An additional and rarely named aspect of the certificate, for example

LEED for core office buildings is the marketing and image effect. A LEED Gold or Platinum

(the highest standards by LEED) might result in a higher selling price, not only by the higher

standards in sustainably and efficiency itself but the demand of clients and investors wanting

to see this standard that therefore almost becomes necessary for core and in particular trophy

properties.

Besides the already above mentioned aspects and demands of core investors to the asset class

Thomas Schick addresses in his thesis in more detail the micro location of the office building.

The following appendix 4 that has been integrated into Thomas Schicks thesis but come

Schick, Thomas 2008, p. 23 and Handbuch Immobilieninvestition, Schulte, Bone-Winkel, Thomas, 2005, p.

32.

Cf. Handbuch Immobilieninvestition, Schulte, Bone-Winkel, Thomas, 2005, p. 30.

Cf. Anforderungen an die Assetklasse Büroimmobilie aus Sicht eines Core-Investors insbesondere unter

Einbeziehung der Energieeffizient, 2008, p. 49 f.

Cf. Verordnung über energiesparenden Wärmeschutz und energiesparende Anlagentechnik bei Gebäuden,

2011.

Cf. Immobilienfonds die Zukunft ist Grün, Cleanteach Magazin, 2010.

Cf. Main Tower ist mehr als ein Leuchtturm-Project, Article Immobilien Zeitung, 8.12.2011.

Cf. Immobilienfonds die Zukunft ist Grün, Cleanteach Magazin, 2010.

originally from Andreas Pfnür and Stefan Armonat showing the success factors of a real

estate investment, led by the location with 52% of 100 points when institutional investors

were surveyed. The infrastructure is here of major importance, since historically

infrastructural connections do only grow slowly and can cause a disadvantage.

Here, the

local public transport and international connections play a major role and only make A

locations as argued by regional economist Christaller who already described in the 1930 this

importance in his "central place theory". Usually core properties are found in metropolis areas

and premium markets due to their inherent perquisites of market liquidity and attracting

premium tenants.

Furthermore important for A-locations are the number, structure and quality of services as for

example computer companies, advisors like tax and law firms as well as property services,

media and PR-Agencies and aspects like the staff catering.

Additionally of high interest for

institutional core investors is the prestige, image quality of the buildings and building

cultivation of the neighborhood.

The attractiveness of the surrounding has to be high in

order to attract premium tenants for the premium buildings. Ideally the location is unique,

well know and very attractive, in the USA these buildings would then often be called "trophy"

(see aspects mentioned above).

Three other aspects should not be left unmentioned ; first, the absorption rate of the office

space in the looked at location, secondly, the level of construction for comparable core

properties, including the ones und construction and ideally knowing the ones shortly

upcoming and thirdly, the vacancy level in the discussed location.

These aspects will be

discussed in more detail under the market section of Frankfurt and London. In addition to

these requirements to core real estate, three more aspects are often named that sum up as a

package; the architecture, the convenience or usability request and maintenance / operating

costs of a core property. Concerning the architecture, along with the mentioned aspects earlier

like the image, a core property has to meet the balancing act of being unique, distributing an

appealing architectural language but at the same time being plane and timeless due to the long

investment periods of core real estate and the therefore changing demands and needs of the

stakeholders, mainly tenants.

The Frankfurt "Silberturm", former headquarters of Dresdner Bank and once the highest

building in Germany can in this respect be seen as a good example. It is a core / trophy

property built between 1975 and 1978. The property underwent different needs of tenants and

market cycles through more than three decades. Since 2009 it is undergoing complete

modernizations to bring it to an up-to-date market level including a sustainable

Cf. Anforderungen an die Assetklasse Büroimmobilie aus Sicht eines Core-Investors insbesondere unter

Einbeziehung der Energieeffizient, 2008, p. 40.

Cf. Defining and Determining Core and Non-Core Real Estate Investment Strategies, Realpoint Research, p.5.

Ibidem.

Cf. Anforderungen an die Assetklasse Büroimmobilie aus Sicht eines Core-Investors insbesondere unter

Einbeziehung der Energieeffizient, 2008, p. 41.

Cf. Real property valuation in a changing economic and market cycle, Rick Peiser, 1996.

Cf. Anforderungen an die Assetklasse Büroimmobilie aus Sicht eines Core-Investors insbesondere unter

Einbeziehung der Energieeffizient, 2008, p. 43.

modernization. Just recently it has been sold to an IVG led consortium. The tower is mostly

rented out to Deutsche Bahn, a premium tenant.

The usability factor is also of high

importance. Since core properties as discussed earlier before they usually receive the highest

rents and therefore have very solvent and often prestigious tenants. The actual fragmentation

of the buildings, the floor efficiency, flexibility and level of quality for example concerning

natural light, air conditioning, suspended ceilings, double floors for wiring or very important

aspects such as data security systems for financial sector clients that trade and need 100%

reliability are of major concern to the buildings and categorization of core properties itself.

Generally speaking the following aspects are of importance:

Convenience of the architecture

Flexibility of the rooms and floor efficiency

Sufficient parking

Sufficient lift capacities

Sufficient sanitary facilities

Security systems and uninterruptable power supply

Services like representative lobbies

Cafeteria supply and general food and beverages offers

The last aspect of operating costs has become crucial to core investments and office properties

in general during the last years. Due to climate change and global warming requirements and

the awareness of measures against progressively raising operating costs and additional risk

(for example due to flooding) have become very important to investors.

For the London

commercial property market there is for example an extra publication of the Greater London

Authority making aware of potential upcoming future risks due to climate change. Here

investors and owners are being informed about improvement opportunities, threats and risks

to their stock as well as advice in terms of strategic operational cost savings.

The topic of

maintenance costs and climate change is particularly important because of the saving and

prevention capabilities but as well because of the risk aversion of core investors. Knowing

that roughly 80% of the life-cycle costs of a property are coming from the utilization and not

the project development and construction plus the added threats of future uncertainties due to

heavy climate changes give core investors a strong leverage to counter these negative

measures, not only by physical implications like flood protections or solar energy on the roof

but facing changes in laws, legal implications and financing issues.

4445

Appendix 5 shows the

Cf. Big Deals mit zwei Hochhäusern, 2011.

Cf. Anforderungen an die Assetklasse Büroimmobilie aus Sicht eines Core-Investors insbesondere unter

Einbeziehung der Energieeffizient, 2008, p. 44 f.

Cf. Schulte/ Bone-Winkel / Thomas, Handbuch Immobilieninvestition, p. 381.

Cf. Anforderungen an die Assetklasse Büroimmobilie aus Sicht eines Core-Investors insbesondere unter

Einbeziehung der Energieeffizient, 2008, p. 46.

Cf. London's Commercial Building Stock and Climate Change Adaptation, 2009.

Cf. Anforderungen an die Assetklasse Büroimmobilie aus Sicht eines Core-Investors insbesondere unter

Einbeziehung der Energieeffizient, 2008, p. 46.

Cf. London's Commercial Building Stock and Climate Change Adaptation, 2009, p. 46.

threats of London concerning overheating in the summers and flooding due to the surrounding

water for this century.

The results of this chapter can be summarized in a core commercial office property draft,

showing the demands of core office investors and their expectations to the properties. Table 5

has been divided from the "basement" to the "roof" as the two central parts. The markets and

conditions as well as the locations are found on the bottom and are key to an investment, the

body or stories of the building are described by the clientele, the asset type (in this work

office being the focus but the other asset classes been very similar in their demands, just

varying in their individual asset details) followed by the architecture and the whole complex

running around the building most efficiently described by the usability and operation. The

"roof" describes the key demands and expectations around the asset class so far.

Table 5: The "house of core", summarized features of a core office investment

Core Property Major Criteria's

Stable, non volatile, cash orientated and risk

averse operating properties

High grade of market liquidity

Internal Rate of Return (IRR) of up to 11%

(about 4% to 7,5% for Germany)

Cash-flow stability, with little income and

tenant changing fluctuation

Longer lease periods usually 5-10 years

Premium tenants with high solvency

Minimum vacancy of 0% to max 15%

Loan-to-Value (LTV) ratio of maximum

40-50%

Classified in stable and positive market

surrounding

Distribution of income / appreciation 90%

to 10 %

Capital Structure offers almost

independent investor control / usually large

transactions

Goal: long-term maintenance of value

Strategy "Buy to hold"

Holding period: long term (8-15 years or

longer)

Certified with e.g. LEED, DGNB etc.

Core Property Usability & Operation

High demands to quality, flexibility and efficiency

High-grade floor efficiency

Flexibility to floor design and outline

Efficient number of lifts and timing

Individuality to the property

High standard of property security

Uninterruptable power supply and data and

internet connections

Sufficient parking and close public

transport connections

Sunlight optimization

Service offers such as prestigious entrance,

staff catering, fitness club, auditorium etc.

Central control rooms

High level of tenant satisfaction

Sustainably operating costs

Core Property Architecture

Usually prestigious trophy buildings which attract

premium tenants with high demands to flexibility

and building standards

Pregnant buildings often with prestige

Appealing architecture but at the same

time plane and timeless

Usually operating properties, no

construction or development phases

Highly sustainable, usually demanding

efficiency certifications such as LEED,

DGNB or BREEAM

Technologically advanced

Newest or newer year of construction

Alternative utilization option

Core Asset Types

Secure transparent asset classes in a relevantly

sizeable market with best quality in best locations

and fully let.

Office

Retail

Logistic (more rarely, often excluded, due

to restricted alternative usage, less liquid

market and short-term lease agreements)

Residential / Multi-Family homes

(depended on the individual market)

Core Clients

Professional Investors with real estate, financial,

insurance, private wealth or state background

funds (mutual, private pension, state and

local retirement, endowment)

banks

insurance companies

foundations

private wealthy individuals / family offices

Core Property Location

Only, prime, secure and long lasting stable

locations.

Usually within the Central Business

Districts (CBD)

In the prime office locations of a city

Nationally and internationally very well

connected by transport and infrastructure

In a service-structure surrounding such as

IT-services, law, tax and food and

beverages offers

Prestigious locations with positive images

Core Markets

Europe and USA as well as main international

financial hubs such as New York, London,

Frankfurt, Hong Kong etc.

politically stable and mature

stable currency

professional investors service

liquid

transparent

having a benchmark

sufficiently large

Source: Own declination, in dependence upon Union Investment Places & Spaces Core Issue, Handbuch

Immobilien-Investition, Realpoint Research, INREV, NEPC Consultants and questionnaires answered.

This core demand analysis is of major importance in order to understand the later analysis and

question of improved core investments in times of crises, because if the demands are met and

they fulfill their job, theoretically they should be somehow crisis resistant.

The following chapter will take the results above one step further and will try to generate a

new and more detailed description of the asset investment / portfolio strategy "core" in order

to get a better understanding of how the market situation in London and Frankfurt recently is

and the crisis can be understood more clearly now and how the definition might be useful for

future analysis.

2.4 New definition of "core"

In order to get an additional idea of the definition and ideas around core the author created a

small questionnaire that can be found in the appendix. The questionnaire consisted of five

questions around the topic of a core definition, risks, alternatives and the crisis. Besides the

results of the scientific research and current existing material on the market, these answer

provided the author with an additional understanding of the asset class core that does not

come from the textbook. The companies chosen, the detailed list can also be found in the

appendix, represent a profile of real estate experts from Germany, the UK and Europe being

close to the topic "core". These experts either have an agent, advisor, research, bank, investor,

newspaper, developer or fund background and different experiences with the topic. Core, as

discussed under the previous chapter, can be subdivided into different aspects, such as the

markets, locations, clients, asset type, architecture, usability and finally the major criteria

demanded by the investors towards the asset. Core, as for the results of the author could be

translated as "risk averse, secure investment" which is arguing too short though. Generally,

the author tries to find a generally acceptable definition, especially due to the different market

backgrounds, risk attitudes of these markets, investors and globally different expectations to

this asset class. It could be argued that core in Germany will always be different to core in the

UK, since for example the English have a far more open attitude to Loan-To-Value levels

than the Germans, or the Americans used to have a more relaxing attitude about sustainability

criteria than the Germans but the international markets for core properties are more and more

unifying and harmonizing in terms of the demands to the asset due to global harmonization.

The major financial markets for instance, like New York, Hong Kong, London and Frankfurt

are already showing tendencies to be similar, which does not mean that global office markets

are completely correlated, not even close as Table 6 shows, but the core market is a much

smaller and usually much more demanded market by less investors and more internationally

active companies that have a high preference on a similar product (with mostly financial

background) and are aiming for security in A markets, and usually not the players on heavy

market circles.

Table 6 displays that some markets seem to be correlated but others are not

at all, diversifications are therefore not always easy (for today and the past).

Cf. I&P Real Estate Magazine, The core conundrum, Mansell, Greg, 2011, p. 25.

Table 6: Correlations of five major office markets

Source: Originally CBRE, JLL, taken out of Deutsch Bank Research Presentation of Dr. Tobias Just at 2.

Executive MBA Real Estate IRE|BS, 2011

This can be read in many publications around the globe, for instance Chris Staveley, Head of

EMEA JonesLang Lasalle Moscow, stating: "Overall trading levels remain influenced by

limited supply of sought after prime core assets and the absence of any move into assets that

are perceived to carry more risk..."

Prof. Dr. Kerstin Wellner, who is researching on

correlations of office markets around the globe shows that certain markets are indeed

correlated but with different national yields. As seen in appendix 6 Germany is a stable and

very little volatile market, which again can be another indication for the actual very strong

demand on core properties in Germany as a safe haven. Prof. Wellner's research displays

some heavily correlated markets, such as the USA, Sweden and Australia and non-correlated

markets in between Germany, Canada and the USA which can be seen in appendix 7.

Generally these figures are correlations over the whole market and all asset strategies, such as

Munich value-add up to Frankfurt core and do not say anything in detail about the core

market correlation which is probably stronger due to the mentioned aspects above. Due to the

analysis international diversifications are more effective than regional diversifications but at

the same time overall asset type diversifications are less effective than international

diversifications.

Getting back to the improved definition of core, a more detailed view on this strategy is

necessary in order to understand the crisis reactions and look more skeptical on purchasing

decision. When looking at most of the questionnaire's answers to the question of what core is,

for the interviewed persons mostly the answers are not detailed as such, but almost everybody

demands stable cash-flows, a long term perspective and high security of the asset.

Furthermore along with the literature excellent locations are demanded, as well as tenants

with a high credit-worthiness, a young age of the building, meaning no upcoming

Cf. JLL, Moscow office rents are one of the highest in Europe, London, Moscow, 25th October 2011.

Cf. Immobilienportfoliomanagement (Quantitative Methoden), Prof. Dr. Kristin Wellner, 2011.

modernization costs as well as a low vacancy rate and a green / sustainable standard.

Additionally, demanded are mature markets, a sufficient size of the market with the necessary

transparency, furthermore only quality buildings are looked at with investment strategies only

investing up to a maximum of 50% LTV's depending on the market looked at.

Coming back

to the problem of a non-unified core definitions and therefore difficulties in literally speaking

about the same concerning correct risk allocations and investment strategies, even the rather

short number of questionnaires showed sometimes vast differences. For Stefan Scholl, head of

European transactions at the German fund "Deka" for example only markets can be core that

are mature and bring roughly a volume of 150 m. arguing that only in such a market the

liquidity standard of the core asset can be met.

On the other hand according to Uwe

Schoessow, from the transactions team at "KARG", one of Germany's biggest family offices,

it is recommendable to invest into smaller cities rather than investing into 1 B or 2 A locations

of bigger markets.

Another example of sometimes heavier differences can be derived from one of the most well-

known definition of core, coming from the "European Association for Investors in Non-Listed

Real Estate Vehicles" (INREV), defining the standard core for non-listed real estate vehicles

such as closed-ended funds. The following table 7 shows the difference between the mostly

three named investment strategies, core, value added and opportunistic (core-plus comes in

many publications after core, but is not any more commonly used) strategies.

Table 7: INREV Style Classifications by 2011

Source: INREV STYLE CLASSIFICATION pdf. 2011, Page 13

For all parts different specifications can be found. The loan-to-value amount can for example

go up to 50% according to Karl-Werner-Schulte, Stephan Bone-Winkel and Matthias Thomas

in their book "Handbuch Immobilien-Investition" mostly orientating their definitions towards

the "National Council of Real Estate Investment Fiduciaries" (NCREIF) and American Realty

Advisors, as well as Aberdeens Property investors.

On the other hand other publications do

even show different perquisites towards gearing in one paper, such as an internal IVG core

definition document presented to the author by courtesy of Dr. Thomas Beyerle showing

Cf. places & spaces -The Real Estate Magazine of Union Investment, Issue: The core of a market - Everyone is

talking about core but every investor defines the term differently, 2011, p. 7; Questionnaires.

Cf. Questionnaire Stefan Scholl, see appendix.

Cf. Questionnaire Uwe Schoessow, see appendix.

Cf. Handbuch Immobilien-Investition, 2nd edition, p. 32.

Details

Pages
Type of Edition: Originalausgabe
Year: 2013
ISBN (PDF): 9783954895052
ISBN (Softcover): 9783954890057
File size: 5.1 MB
Language: English
Publication date: 2013 (June)
Keywords: Core Financial crisis London office market Real estate in times of crisis Frankfurt office market

Author

David A. Pieper (Author)

David A. Pieper is a young real estate professional from Berlin, Germany. After finishing his Bachelor in Real Estate Economy at the Berlin School of Economics and Law, he completed his Real Estate Economist degree at the International Real Estate Business School (IREBS). He graduated in early 2012 as Executive MBA in Real Estate, cooperating among others with the Harvard Graduate School of Design and the University of Hong Kong. Besides the topic of ,core' real estate investments, David A. Pieper focuses on the German residential real estate market, in particular Berlin and luxury real estate.

Core-Real Estate Investments in times of crisis: Exemplified by the Frankfurt and London office market

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David A. Pieper (Author)