After bright year for German property deals, some see clouds

By Kathrin Jones

MUNICH, Germany (Reuters) - Germany's once staid property market is celebrating a banner year of surging investment and billion euro deals but some voices at the sector's annual Expo Real meeting in Munich warn the good times won't last.

Rock bottom interest rates have driven investors to seek higher yields in real estate. They are increasingly competing for a limited supply of properties in top locations, driving up prices and trimming returns.

Office and retail space in Frankfurt, Munich and Berlin is especially sought after. Rising prices for prime locations are tempting many to risk investment in cheaper properties with higher vacancy rates or in smaller cities.

The trend is reminiscent of 2007 before the financial crisis, officials attending the Expo said, with buyers reluctantly digging deeper in their pockets and banks extending credit to avoid losing market share to competitors.

"The real estate market will remind us at some point that it is cyclical," said Thomas Koentgen, co-head of the covered bond lender Deutsche Pfandbriefbank , the successor institution to Hypo Real Estate, which collapsed in the crisis.

Many investors have not realized that real estate is a long-term business and not suitable for short-term deals, he said.

"We are dealing with increased risk; a wary eye is appropriate," Koentgen said.

Another manager at the Expo put it more bluntly: "There are a lot of speculators about."

Ultra-cheap credit conditions fueled by the European Central Bank's quantitative easing program fueled the boom.

Calculations by the advisory and brokerage house JLL show the transaction volume in Germany so far this year at just over 32 billion euros ($36 billion), an increase of 46 percent over last year.

And those figures capture only commercial property deals, not the multibillion-dollar mergers in the residential sector such as the bid by Deutsche Wohnen for peer LEG Immobilien .

For now, those paying the typical price of 22 times rental income for property are still earning annual returns of 4.50 to 4.75 percent but this is already below the long-term average of 5.25 percent and the trend is down, officials said.

Real estate investors generally look at the spread between government bonds and property returns to gauge if markets have becomes overheated.

The lower the spread, the less attractive property has become for investors. Real estate assets are less liquid than government bonds and come with management costs attached.

Georg Allendorf, responsible for the business of real estate funds at Deutsche Bank , said he remains hopeful for 2016.

"I don't think that yields are going to fall further," Allendorf said.

Germany's Bundesbank said last year it did not see a bubble building in the real estate market but more recently it has said it needs to keep a closer eye on developments.

Meanwhile, those institutions providing finance to the property sector look set to stoke activity further, with insurers and pension funds increasingly backing lending alongside traditional banks and covered bond lenders.

"For banks there is huge competition to acquire business in the face of low margins," said Oliver Beyer, a property analyst at law firms Simmons & Simmons.

($1 = 0.8883 euros)

(Editing by Keith Weir)

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