Continental European Property Market Commentary - December 2013
15 January 2014
– Schroders expects the eurozone to see growth of 1-1.5% through 2014-2015, with the main driver being exports. In addition, low inflation should support a gradual increase in real incomes and consumption and the improvement in business confidence should lift investment in Germany. However, high unemployment will continue to weigh on government finances and both France and Italy need to reform their labour laws to boost competitiveness.
– Unsurprisingly, most of the fastest growing cities over the next five years are expected to be in export led economies such as Germany (e.g. Munich, Stuttgart), the Nordics and Switzerland according to Oxford Economics. The other cities which should see relatively strong growth are either centres for international business services (e.g. Amsterdam, Paris), or cities with a heavy bias towards IT / high-tech industries (e.g. Bergamo, Lyon, Toulouse).
– While the stage is now set for a recovery in European office rents, the timing of the upswing will vary from city to city, partly because of local differences in economic growth, but also because of variations in vacancy. Most cities currently have a surplus of office space and some of this will first have to be re-occupied before demand and supply get back to equilibrium. We expect Berlin, Hamburg, Munich and Stockholm which have relatively low vacancy rates to lead the upturn in office rents this year, followed by Brussels, Paris and the other big German cities in 2015-2016. The recovery in southern Europe will probably be delayed until 2017, or even later.
– Although most countries should now see a recovery in consumer spending, probably the key issue facing retail property is the shift to online retailing. Initially, the main impact was on books, music and electronics, but clothing is now also being sold online and this poses a real threat to less dominant shopping centres, given that clothing and footwear tenants typically account for 40-50% of their rent roll. Accordingly, we prefer either shopping centres which dominate their catchment area, or out-of town schemes let to supermarkets, pharmacy, DIY and furniture retailers. We also see growing demand from retailers for flagship stores in big city centres.
– By contrast, logistics is benefiting from online retail. The main impact so far has been on large warehouses for retailers like Amazon, but we expect that demand for smaller units near to big cities will also grow, as the flow of express parcels increases and as retailers introduce same day delivery.
– The availability of property debt improved significantly in 2013, as re-capitalised banks resumed lending and new lenders, such as insurers and debt funds, began operations. Predictably, it is easiest to obtain debt in Germany, Paris and the Nordics and lenders in those markets will lend on non-prime assets, if the borrower has a strong track record. While we expect further growth in property lending over the medium term, the ECB’s asset review could lead to a pause in 2014.
– The weight of capital from global investors means that prime yields on new offices in central business districts (CBD) of Paris, the big German cities and Stockholm are now at 4.25-4.75%. Although this may be justifiable in Munich or Stockholm which have good rental growth prospects, we think that prime office yields in many German cities look expensive. Alternatively, we think that in many northern cities better value can often be found in older CBD offices which may be multi-let, or which have short unexpired terms, or new offices on the edges of the CBD.
– Schroders forecasts total returns of between 6-8% per year on average investment grade property in Europe between end-2013 and end-2016. The cornerstone will be an income return of 5.5%, but we also expect a limited fall in property yields of 0.25% and a modest upswing in rents.
– The main upside risk in the short-term is that the inflow of capital from Asia and the USA results in a sharp fall in yields, boosting capital values in 2014. There are two main downside risks. First, the eurozone economy could stall, so that the recovery in rents fails to materialise. Second, although in most of Europe there is still a large gap between property yields and government bond yields, property could start to look expensive if 10 year bond yields rose by a further 0.5-1%.
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