Nadin Heinich: How has the German real estate market changed since February 2022?

Jürgen Fenk: The market was caught completely off guard—not only by the magnitude of the interest rate hikes, but above all by the speed at which they occurred. Never before have interest rates risen so rapidly. At the same time, construction costs soared as a result of disrupted supply chains: initially as a consequence of the COVID-19 pandemic, and later exacerbated by the war in Ukraine. Most projects had been planned under the previous market conditions—and suddenly became too expensive.

With refinancing costs rising to three or four percent instead of close to zero, many developments were no longer financially viable. The same applied to exit strategies: investors demanded higher returns because fixed-term deposits and other investment options had once again become attractive in a higher interest rate environment.

The biggest challenge, however, lay in existing assets. Falling property values created financing gaps that could only be bridged through additional equity or high-interest mezzanine financing. Investors and developers with strong balance sheets were able to absorb these losses—many others were not. And the more projects remained in development whose exit strategies no longer worked—because rising construction costs could no longer be offset by higher sales prices—the more difficult the situation became across the board.

Nadin Heinich: How do investors assess risk?

Jürgen Fenk: We distinguish between four different categories: Core, Core+, Value-Add, and Opportunistic. Capital is allocated across different risk-return profiles. Investors seeking lower risk accept lower returns. The more risk they are willing to take, the higher the potential return—but also the greater the risk.

In numerical terms, core investments currently generate returns of between four and five-and-a-half percent, depending on the asset class. Core+ investments typically range from five-and-a-half to eight percent. Value-Add and Opportunistic acquisitions generally target entry yields of between nine and fifteen percent, and in some cases well above twenty percent.

Since interest rates began rising in mid-2022, opportunistic investors have shown particularly strong interest. They are typically private equity firms, increasingly joined by sovereign wealth funds from abroad—professional investors who deliberately seek out distressed situations. They demand higher returns because they compare real estate with alternative asset classes. Especially when a significant share of their portfolio is already invested in property, any new investment has to deliver compelling returns. Are they finding what they are looking for in Germany? Not really. There is still a considerable gap between the returns investors expect and what is realistically achievable here, as prices remained too high for too long.

Nadin Heinich: What are examples of opportunistic investments? The Elbtower?

Jürgen Fenk: Perhaps. Opportunistic investments include projects where construction has come to a standstill because the developer ran out of money, properties acquired through insolvency proceedings, or distressed residential portfolios that require substantial repositioning or refurbishment. The asset, the loan, or the owner is under severe financial or time pressure, meaning the property can no longer be held, refinanced, or sold under normal market conditions. This leads to significant discounts. Creating value under these circumstances is hardcore asset management—and certainly not something everyone can do.

Nadin Heinich: Where is capital currently being invested in Europe and Germany, and to what extent?

Jürgen Fenk: That is a complex question—there are specialists who spend their entire day analysing exactly that. There is no shortage of capital, particularly in the private equity sector. A large share of it is looking for high returns. At the beginning of the crisis, the greatest opportunities were primarily in the United States: a large market, numerous large-scale projects, and high liquidity. The U.S. market recovered much more quickly than Europe. Americans tend to deal with problems more decisively and move on. In Germany, by contrast, people often take a long time to acknowledge that conditions have changed—and even longer to accept them and develop solutions.

Nadin Heinich: Why is that?

Jürgen Fenk: Because many German banks have substantial exposure to real estate, financing projects worth billions of euros. When they have to reduce valuations and write down assets, those losses hit their balance sheets directly. Instead of clearing the books quickly and starting afresh, the adjustment process in Germany tends to be much slower. This is also due to long-established valuation practices, the Pfandbrief system, and the structure of Germany’s open-ended real estate funds.

Nadin Heinich: Which phase of the cycle are we in now?

Jürgen Fenk: We have moved beyond the denial phase and entered the solution phase. I sense a much stronger spirit of optimism. Capital is beginning to turn its attention back towards Europe.

Nadin Heinich: Is that also related to the unpredictability of Donald Trump?

Jürgen Fenk: Diversification is essential for investors. They want to avoid concentration risk and not rely too heavily on a single market. That is one reason why Europe is coming back into focus. Over the past twelve months, Spain has been the darling of many larger private equity investors, particularly in student housing, residential real estate, and logistics.

Nadin Heinich: Do you expect investors to return to Germany as well?

Jürgen Fenk: International investors rarely look at Germany in isolation. Japanese, Australian, or Canadian investors typically invest globally before narrowing their focus to Europe. Germany is also considered a demanding market because of its complexity. You need to understand several different cities—Munich, Hamburg, Berlin, as well as Frankfurt and Düsseldorf. That is why international investors often enter the market through experienced local operating partners.

Japanese investors almost always start in the United States before moving on to Europe, particularly London. That makes sense in the office sector because they are looking for very large investment opportunities. Coming from cities such as Tokyo, they are accustomed to investing in billion-euro projects. Those opportunities exist in the United States, in London, and perhaps in Paris. Germany, however, offers comparatively few projects where they can invest €500 million or more in a single transaction.

In summary, opportunistic capital is available. We are also seeing the first signs that core capital is returning to Germany. Insurance companies and pension funds have traditionally played a major role in the market, and Germany has always been less opportunistic than countries such as Spain or Italy. We are gradually emerging from the bottom of the cycle, although not across every segment. Banks have resumed new lending. There is still distress in the market—among borrowers, banks, and open-ended real estate funds—but in some situations we are already seeing the first signs of renewed competition, and residential prices are beginning to rise again. A classic market recovery is driven above all by two factors: time—and psychology.

Nadin Heinich: We have been talking about asset classes, investment logic—and cities. Do money and the city always go hand in hand?

Jürgen Fenk: Urban development inevitably brings together different, and sometimes conflicting, perspectives. The challenge is to reconcile them in a way that ensures a project is not only architecturally convincing and enhances the urban fabric, but also remains financially viable. In the end—apart from certain publicly funded projects—it has to be profitable. Private capital rarely flows into ventures that offer no return; philanthropists are the exception. When Klaus-Michael Kühne sponsors the opera house in Hamburg, it is essentially a gift.

The same applies where symbolism takes precedence over profitability. In Pudong, Shanghai, enormous office towers are completed every year. That would hardly be possible here. Why? Because it would not be profitable. In China, however, most developers are state-owned. These towers cost a fortune to build, and I know of several where the financial return is actually negative. They are built nonetheless because they serve as powerful symbols for the city.

In most cases, however, investors expect a financial return—and that does not always align with the ambitions of cities or architects. Finding a viable consensus is therefore one of the central challenges of every development. Can the process take too long? Can participation become excessive? Probably. I’m not referring to landmark buildings, but to standard development projects. Every additional month means interest costs continue to accrue. In some cities, such as Hamburg, cooperation between all stakeholders works remarkably well. Berlin, on the other hand, remains a much more challenging environment, not least because of the complex interaction between the boroughs and the city government.

Investors have to decide whether to allocate capital to equities, infrastructure, or real estate, and they must justify those decisions to investment committees—whether sovereign wealth funds or pension funds—that expect minimum returns. Ultimately, everyone has a mandate to generate value. Take Vonovia, for example, Europe’s largest residential real estate company. As a publicly listed DAX company, its primary responsibility is to create shareholder value and generate returns for its investors. At the same time, it naturally has a social responsibility. But being Germany’s largest owner and developer of residential property does not mean it is expected to provide housing at lower prices than everyone else.

Nadin Heinich: Germany is investing heavily in defence and military infrastructure. What does that mean for the real estate market?

Jürgen Fenk: When the special infrastructure and defence funds were announced, I think the real estate industry celebrated too early. It will take time before that money actually reaches the market. The demand for affordable housing remains enormous, and I am convinced that housing will eventually benefit from the infrastructure investment programme. The defence fund itself is only indirectly relevant to real estate: if the German economy returns to growth, demand for real estate will grow as well. Construction, on the other hand—which alongside real estate is the Zech Group’s second major business—is already booming. We are building industrial facilities, projects for the federal government and the armed forces, as well as tunnels, bridges, roads, prisons, schools, and much more.

Nadin Heinich: Let me return to the bigger picture. Has the real estate market now adapted to the many uncertainties it is facing? How do you price geopolitical risk? For decades, Europe did not have to think about war.

Jürgen Fenk: Everyone in the industry knows that real estate is cyclical. Is everyone disciplined? No—and that is precisely why many market players are no longer around. There will always be new risks. The next one could be climate-related. We may recognise these risks, but we rarely price them in adequately. That is exactly what risk management is about.

This brings us back to risk-return profiles. Investors who take less risk accept lower returns. Those who take greater risks require higher returns because the probability of failure increases. At the moment, many uncertainties are converging—far beyond the real estate sector itself. How will the war in Ukraine evolve? What happens in Iran? How unpredictable will Donald Trump remain? Geopolitics is just one of many risk factors, but it has a significant influence on investment decisions.

Nadin Heinich: More specifically, are Japanese and American investors looking at Europe differently now? Are they more likely to invest in Spain than in Poland? And what about the reconstruction of Ukraine, which will eventually become a major issue?

Jürgen Fenk: The Japanese were never particularly active in Poland—and probably not in Spain either. American investors are currently also rather cautious when it comes to Central Europe. In Poland, by far the largest market in the region, we have seen international capital withdraw since the pandemic, and even more so since the outbreak of the war in Ukraine, despite the country’s economic fundamentals remaining stronger than those of most European markets.

When it comes to rebuilding Ukraine, however, the Americans are well ahead of the Europeans in their approach. They commit capital earlier and think much more opportunistically. They do not wait until a conflict is over. While we are still discussing what might happen, they are already on the ground.

Europe increasingly finds itself in a kind of isolated position—caught between China and the United States. Of course, that is unsettling. But mindset is a crucial driver of investment decisions. Real estate is an extraordinarily psychological business. It is not always easy to remain optimistic every morning. But giving up is not an option. Perhaps we should adopt a more American perspective: “There is no security on this earth; there is only opportunity.”