GERMANY Trends and Developments Contributed by: Carsten Loll, Otto von Gruben, Ivo Veit Wanwitz and Sebastian von Hornung, Latham & Watkins
Trends and Developments in Germany’s Private Equity Real Estate Market Market overview Germany’s private equity real estate (PERE) market remains a key player in European real estate investment, despite recent economic challenges. Interest rate hikes, inflation, and geopolitical tensions have significantly impacted deal volumes. Transaction volumes dropped by over 50% in 2023 compared to previous years, yet Germany remains the third most attractive real estate investment market globally. As inves - tors adjust to new capital costs, opportunities in distressed assets, preferred equity structures, and high-growth sectors such as data centres and residential real estate play a vital role in the transactional landscape. Investment structures: preferred equity and key players Preferred equity investments In Germany’s evolving real estate market, pre - ferred equity has become an increasingly vital financing tool. As traditional bank lending tight - ens due to stricter regulations and risk aversion, investors are turning to alternative financing methods. Preferred equity, with its debt-like fea - tures, offers a hybrid solution, by blending debt and equity characteristics. It provides investors with priority returns while granting developers access to necessary capital without giving up full ownership. This shift is particularly evident in sectors like residential real estate, where demand remains robust and stable, but financ - ing conditions with traditional methods have sig - nificantly worsened. The rise of preferred equity aligns with the broader trend of alternative financing gaining prominence in Germany. While mezzanine loans have long been a popular choice for bridging financing gaps, preferred equity is gaining trac -
tion due to its unique benefits and flexibility. It often comes at a lower cost than common equi - ty and can provide a bridge financing solution. Although preferred equity investors frequently do not share in the full upside of the property, a mandatory minimum return is a common feature. Key legal aspects of preferred equity investments • Principal and debt service – capital contri - butions can be structured with mandatory monthly returns (hard pay), accruals (soft pay), or a combination. • Preferred (investor) shares – offer dispropor - tionate dividend rights and potential minimum dividends, with tag-along rights in case of common shareholder exit. • Common shares – receive excess net cash flow after preferred distributions, with poten - tial caps. • Security and remedies – often unsecured, preferred investors retain contractual rights to control assets upon default, enforced judi - cially rather than through foreclosure. • Call/put options – regular and default options at predefined dates and returns, with liquid - ity and default put options to third parties or co-shareholders. • Governance and control – shareholders’ agreements include reserved matters, dead - lock mechanisms, and board representation rights, along with customary information rights and warranties. • Covenants and protections – include prop - erty management undertakings and financial covenants like loan-to-value (LTV)/loan-to- cost (LTC) ratios and operational milestones to safeguard investor interests.
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