People trying to rent an office in many German cities have most likely encountered the difficulties associated with the task: Very little choices, sky-high rents, vacancies are scarce. The best solution to relax the situation: New space entering the markets by way of new construction – however, that’s the weakness palpable in most German towns. Even today, there’s by far too little new construction to satisfy rising demand for space – and if interest rates will be raised by central banks next year, as many experts fear, new commercial real estate developments tend to subside even further since higher prices for capital can serve as a drag for financing investments.
Already way too little new construction
Customers and renters would be the most disadvantaged. Currently, the prime rate set by the European Central Bank (EZB) is at 0.0% - unchanged since March 10, 2016 when it was lowered from 0.05%. Despite this rather stable supply of cheap money, new construction was way too little to improve commercial real estate developments effectively in German key markets such as Munich, Stuttgart, Hamburg, Cologne, Düsseldorf and Frankfurt. Vacancy rates in those cities sank continuously during that time period. Dr André Helf, CEO of COLLECTION Business Center Group, offers an analytical viewpoint: “It is very difficult to find new space and re-shape it for our clients’ needs. We are constantly looking for suitable commodities in different markets since we’d like to expand and offer our business centers in various cities. We are monitoring all developments in the commercial real estate market, including financing options, but unfortunately there is way too little new construction. If interest rates rise, financing options most certainly will become more difficult to negotiate. Investors have little choice but financing their interests with the best possible economic deal. If they have to pay more for capital, it’ll lower their profit margins and the incentives to invest.”
Prime rate trend going upward
Prime rates are on the rise in various G20 countries already, as in the United States where the Federal Reserve set the rate at 2.25% on September 26, 2018, up from 2.0%. In Canada, the prime rate was raised to 1.75% on October 24, 2018, up from 1.5%.
“We shouldn’t forget that there are many foreign investors in the German commercial real estate market – many of them earn their money in their home markets, which, of course, encompass the United States and Canada as well as many Asian countries where interest rates are also rising,” explains Dr Helf, “in the long run, rising interest rates are rather toxic for the real estate market as whole.”
EZB: Lower interest rates exit with Draghi
In Europe, the EZB has already declared to end the glut of cheap money supply. Many critics of the low prime rate policy have long demanded a change of course, since inflation is rising within the EU as well. Albeit, the EZB has determined during its last session on December 13, 2018, that there would not be a drastic end to the low interest period – rather, money supplies are to be contracted by limiting dealing with bonds. However, political pressure to raise rates is building continuously, and Germany makes no exception: Wolfgang Schäuble, former Finance Secretary and now President of Parliament, is one of the most outspoken critics of Draghi and has often wondered why interest rates haven’t risen since 2016. Andreas Bley, Chief Economist of Germany’s powerful Bankers’ Association, has been quoted by several media outlets: “The current EZB prime rate is much too low.”
Mario Draghi, current head of the EZB, is well-known for his reluctance to raise interest rates. His tenure will end on rotative terms in October of 2019, though. Many ecologists are expecting a rather drastic interest rate hike when his successor, who has not been named yet, will take office. Financing new commercial real estate construction will most likely become much more difficult then – resulting in harsh times for renters and start-up founders whose capital cover will be more volatile when rents go up.
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