RPT-Fitch: Multifamily Analysis Includes Market Correction Cushion
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Nov 1 (Reuters) - (The following statement was released by the rating agency)
The high volume of sales of German multifamily housing (MFH) blocks this year indicates that investor demand remains strong, even as prices per square metre continue to rise and prime yields drop below 4.5%. While low yields provide investors with little protection against interest rates normalising, Fitch's analysis of MFH CMBS transactions incorporates a sizeable buffer, which should help stabilise ratings in this scenario.
The first three quarters of 2013 saw EUR8.2bn worth of transactions involving the purchase of more than 50 MFH units. This is close to the high levels seen in 2012 and the full year volume is expected to match last year. Moreover, while activity last year was dominated by three very large portfolio sales, trades in 2013 have mostly been in mid-sized portfolios.
Investors have been attracted to German MFH by its stable operating performance through the financial crisis. The mix of tenant granularity and affordable, regulated rents not only offers downside protection against economic contraction, but post-war history suggests it has also provided a reasonable hedge against inflation over the long term. Furthermore, new supply is likely to remain low because constructing affordable housing is currently not very profitable.
Nevertheless, the regulations restricting rental increases for existing leases dim the prospects of real income growth for sponsors that fail either to make savings in operating costs or invest heavily in the physical stock. The limited upside makes the sector more vulnerable in an economic upturn - similar to some fixed-income products.
The net yield for core multifamily properties is now below 4.5%, according to data released by CBRE in its quarterly MarketView report. This leaves investors with a pickup to German 10-year Bunds of around 2.6% as compensation for the operational workloads involved in maintaining the stock, managing a diverse pool of tenants and contractors, and dealing with challenges stemming from the regulations.
It is doubtful that investors will continue to regard yields lower than 5% - which are closer to 3% in real terms - as adequate when business confidence improves and bond yields rise. To compete with growth assets, defensive sectors like core German MFH would have to offer higher yields than at present. Fitch assumes the rate at which it capitalises rental income for the highest quality assets reverts to 5.75% in its 'Bsf' rating scenarios, which preserves a real yield of over 4%. This is a more sustainable level compared to longer term average yields on 10-year German public sector bonds, both fixed income and index-linked.
The Bundesbank recently asserted that high quality German housing in top cities is some 20-25% overvalued. The 5.75% floor in our prime capitalisation rate assumption means Fitch's ratings are cushioned against a correction of that magnitude, were prime yields to rise to that level from their current 4.5%. This assumption reflects Fitch's "through the cycle" approach, which is designed to ensure ratings are forward-looking and take full account of economic cycles. Such an approach is vital in mitigating the high cyclicality that has historically beset European commercial real estate markets.