Continental European Property Market Commentary - March 2014
Although the eurozone still faces challenges, all the major economies are now growing. The key has been a widespread rebound in business and consumer confidence as fears of a currency break-up have receded.
15 April 2014
- Although the eurozone still faces challenges, all the major economies are now growing. The key has been a widespread rebound in business and consumer confidence as fears of a currency break-up have receded. Yields on 10 year Italian and Spanish government bonds now stand at 3.2-3.3%, half their level at the height of the sovereign debt crisis. Consumers have benefited from improved employment prospects and a sharp slowdown in inflation to 0.5%, due to the appreciation of the € against the $ and to falling commodity prices. Schroders expects the eurozone to grow by 1-1.5% through 2014-2015 although growth in export-led economies such as Germany and Sweden should be significantly faster. While there are concerns about deflation, we believe the risk is small and, critically, there is no evidence that purchases are being postponed in anticipation of lower prices.
- Although agents’ data show a general increase in office lettings, we estimate that net absorption is still close to zero in most European cities. The exceptions are Germany, Norway and Sweden where companies are expanding and require extra space. We expect Berlin, Hamburg, Munich, Oslo and Stockholm to lead the upturn in office rents this year, followed by Brussels, Paris and the other big German cities in 2015-2016. We believe that high levels of vacancy in Madrid and Barcelona will delay any upswing in Spain until 2017 or later.
The upturn in consumer confidence has started to lift retail sales volumes in most countries, including Spain and Portugal. The main exceptions are Italy and the Netherlands which continue to suffer from rising unemployment. Over the next couple of years, we expect shopping centre rents to be flat as retailers invest in improving their on-line offer and hold back on opening new stores. In general, we prefer retail schemes which are likely to be relatively internet-immune such as convenience / discount stores, DIY and furniture
units. We also see growing demand for flagship stores in big city centres and tourist destinations.
- Large logistics warehouses are relatively quick to build and there are already signs of an upturn in development in the core markets of Benelux and Germany, which is likely to keep rents in check. Accordingly, we favour smaller industrial units close to big cities where supply is more constrained.
- The total value of investment deals in continental Europe rose by 10% in 2013 to €120 billion, suggesting liquidity is getting back to normal (source: RCA). Although data is not yet available for 2014, the first few months have seen a number of major transactions involving both domestic investors (e.g. Carrefour buying back a portfolio of hypermarkets in France, Deka acquiring the Neumarkt shopping centre in Köln) and foreign investors from the USA and Middle East.
- The weight of capital means that prime office and retail yields in the centre of Paris, the big German cities and Stockholm are now 4.0-4.5%. Although this may be justifiable in Munich or Stockholm which have good rental growth prospects, we think that prime yields in the centre of Paris and many German cities look expensive. Alternatively, we think that better value in the office sector can be found on the edges of the main business districts in the big cities and in the centre of certain regional cities such as Lille, Lyon, Hannover and Mannheim where prime yields are between 5.5-6.0%. Similarly in the retail sector, we favour smaller grocery anchored schemes and big box parks where yields are higher, in the range of 6-7%. While many international investors are becoming increasingly bullish about Spain, we do not think that yields there adequately reflect the risks associated with high vacancy and a household sector which is still heavily in debt.
- We expect total returns on average investment grade European property to average 7-9% per year between end-2013 and end-2017. Capital values should benefit from yield compression in 2014-15 and from steady rental growth from 2015/2016 onwards.
The main upside risk in the short-term is that the inflow of capital from Asia and the USA results in a fall in yields, boosting capital values in 2014. It is also possible that rental growth resumes slightly sooner than we are anticipating. The main downside risk is that the sovereign debt crisis could re-ignite if governments fail to meet targets to cut their budget deficits.
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