“I definitely expect prices to come down”

Mr Bütter, how are rising interest rates affecting Union Investment Real Estate’s business activities?

Higher interest rates are having less of an impact on our retail funds than on our institutional business, because the retail funds are mostly unleveraged, so their margin doesn’t tighten due to the rise in interest rates, unlike capital market vehicles. In the institutional market, by contrast, the business model is obviously designed around using leverage. But at present there’s no positive leverage effect because the achievable initial yields are below the cost of borrowing. That means it’s not worthwhile doing a deal. 

When will interest rates fall again?

There are indications that borrowing rates in the EU will climb to around 4 percent and then plateau. Any higher than that and the eurozone would face significant turmoil. The crucial question for our business is when purchase prices will have gone down to the point where we can achieve positive leverage again. We have to be patient for now.

Does that mean you’re not making any acquisitions at all on the institutional side at the moment?

We’re finding some opportunities, but they are few and far between. Most sellers are still asking yesterday’s prices for tomorrow’s products, so negotiations are currently taking longer. 

And when will prices start falling?

I definitely expect prices to come down, otherwise sellers would be left sitting on their products. In Germany at least, the price decline for residential properties will be significantly lower than on commercial properties. The crucial question is just how patient we need to be. I expect a return to functioning markets by the end of 2022 or the early part of 2023, with attractive conditions in at least some regards. Inflation and interest rates will be key factors in determining when is the right time to act. If we end up slipping into recession, the market environment will change again quite radically anyway.

How do you rate the opportunities for acquiring development projects?

On the one hand, there is less new product than in the past because a lot of projects have been shelved. On the other hand, there are fewer active players on the buyer side than just a few months ago. Equity-rich investors such as Union Investment will find it easier to make the running than private equity investors, who work with higher leverage.

Are you still doing forward deals?

Yes – under three conditions: the developer must be extremely creditworthy and able to guarantee that it can deliver the project on schedule and within the agreed budget. Secondly, the price has to be right. And thirdly, collateral must be provided to cover the risk of the developer being faced with higher construction costs. We refuse to accept price escalation clauses and are not prepared to renegotiate contracts. It’s the developer’s job to price in the risk of price rises. Construction costs have always been part of the developer’s business risk. And I’ve never seen a developer offering a discount on the purchase price because the cost came in lower than expected. Developers have been earning good money for many years now, so I certainly hope they’ve built up some reserves for tough times. 

Are capital pipelines shrinking in the institutional business?

Yes, they are – for two reasons. Some investors need to reallocate capital in response to the stock market slump. Yields on alternative investments, such as ten-year government bonds and corporate bonds, are now so attractive that these products are competing with real estate. But both factors are short-term in nature. Institutional investors are parking their money and playing a waiting game. I’m confident that capital will flow back in as soon as property prices have returned to normal.

Interview by Christian Hunziker