ESG compliance now driving market valuations in Germany

There’s uncertainty over valuations but absolute clarity on what investors in the German market do not want, delegates heard at Real Asset Media’s Germany Investment briefing, which took place recently at Greenberg Traurig’s offices in London.

“I am not seeing a green premium yet, but there’s definitely a brown discount for non-compliant assets”, said Markus Beran, Head of Origination International Investors, Berlin Hyp. “The values of those properties have dropped significantly and will continue to drop, as the few transactions there are in the market are ESG-driven”.

Photography by Karla Gowlett

There is an increasing polarisation between modern or refurbished assets that tick all ESG boxes and older stock that is not energy-efficient and could soon become obsolete.

“European regulations on ESG are having a huge impact on the entire real estate industry”, said Florian Rösch, Chair, Real Estate Practice Group Germany, Greenberg Traurig. “In Germany there are clear winners with good assets in good locations, who are able to get financing, and clear losers with non-ESG-compliant assets in secondary locations that are becoming stranded and need refurbishing”.

Lenders are increasingly being asked to finance the transformation of buildings to comply with new regulations but also to meet investors’ and tenants’ demand. The office sector has seen the most activity.  

“ESG is a challenge because office stock is fairly old in Germany’s big 7 cities”, said Oliver Kummerfeldt, European Real Estate Analyst, Schroders Capital. “There are great opportunities for refurbishment, as there’s not enough ESG-compliant office space and the pipeline is not expected to meet future demand”.

Berlin Hyp has encouraged and financed the transformation of offices for many years, before regulations and targets came into force.

“We’ve been trying to incentivise the refurbishment of existing assets and that’s why transformation loans are a big focus for us”, said Beran. “Banks don’t make the market, investors do. We cannot drive sentiment, but we can facilitate this type of activity, as long as the buildings have the potential to get to a certain level”.

Transformation means upgrading buildings to make them ESG-compliant, but also repurposing assets that are no longer needed into assets that are in demand. The main example of this has been converting old offices into much-needed residential.

“There’s a strong push to re-use and refurbish rather than demolish, and there are Government programmes supporting this trend”, said Rainer Nonnengässer, Senior Managing Director, Head Germany & Netherlands, AMRO Partners. “We’ve already seen a lot of repurposing obsolete office buildings into residential and more will be done on this front in the next five years”.

It is a considerable investment, but one that tends to pay off as “green” assets are worth more and can command higher rents.

 “On the one hand there are surveys showing that investors are prepared to pay up to 30% more for ESG-compliant assets, while on the other hand there is a very high risk of having stranded assets”, said Tobias Schultheiß, Managing Partner, Blackbird Real Estate.

This applies to acquisitions and to rents. “Demand for prime space supports prime rents, and that’s good news for investors”, said Kummerfeldt. “Occupiers are prepared to pay more for space that supports their business and their ESG targets”.