European Property Investment Market Update
There’s a lot going on in Europe this year. While last year was fairly tumultuous, 2017 promises much of the same, especially on the political front.
The fallout from the populist movements that have taken a grip across the Northern Hemisphere will continue. Following the charge to Brexit led by the flamboyant, if accident prone, duo of Boris Johnson and Nigel Farage, the world looked on aghast as Donald Trump was elected President of the United States, becoming the most powerful leader in the ‘free world’.
Next on the agenda are national elections in France, the Netherlands, Germany and perhaps Italy. Mainland Europe is also grappling with a colourful array of right-wing politicians hoping to ride their way to power on the back of the populist vote.
The Netherlands has Geert Wilders’ Freedom Party; France has Marine Le Pen leading the Front Nationale, or Marine as she likes to be known in an effort to distance herself from her father’s more extreme politics.
Germany, however, is predicted to be a calmer affair with the stalwart Angela Merkel running for a fourth term as Chancellor.
We believe that speculating about the outcome of this political drama and how it will change the face of the global economy is something best left to economists, a group, like the pollsters, whose predictions have come under increasingly widespread criticism in recent years.
We prefer to look at the facts and use our experience of having spent a lifetime working in real estate in the countries in which we invest to advise our clients on the best strategies to employ at any moment in time.
While the UK and the rest of the European Union work out the details of their divorce settlement, they will remain unavoidably reliant on each other for both trade and security. This is highly unlikely to change despite what some political commentators may say.
For all the hype that Brexit would destroy the UK economy, a look at the facts some six months on reveals a less apocalyptic outcome. Admittedly, we still don’t really know the details of the plan and some may argue it’s too early to tell, but the vote happened six months ago and that’s just the point: life goes on! Oxford Economics is currently predicting UK GDP growth of 1.6% in 2017, which is close to its estimate of 1.5% for the rest of Europe, while it also estimates that Q4 2016 UK growth should come in at 0.6%, which is in line with the previous two quarters.
Our team in the UK has first-hand experience of this. Following the referendum vote in June, we advised one of our clients to suspend the sale of a portfolio when the purchaser attempted a post-Brexit ‘chip’. In December, we brought the same portfolio back to market, selling it for more than the agreed pre-Brexit price. In the meantime, listed real estate share prices have bounced back, the FTSE is trading at an all time high and overseas investors continue to target real estate in the UK.
There have also been large currency fluctuations with the pound falling by 15% on a trade weighted basis since January 2016 and inflation is on the rise with the UK Consumer Prices Index forecast to average 3% for the year overall (Source: Oxford Economics).
What does this mean for investors looking to invest in Europe?
Perhaps the first and most obvious thing to understand is that while the European Union evolves or even disappears altogether, the collection of countries that is Europe will always be there. The EU is a relatively recent organisation, whose roots can be traced back to the end of the Second World War, but which was only formally established on 1 November 1993.
Europe is, and will remain for the foreseeable future, the second largest commercial real estate market in the world, comprising 32.5% of the total global volume (Source: RCA). Six of the top ten largest commercial real estate markets by size are in Europe. Within Europe, Paris alone boasts 40 million square metres of office space, approximately 2.5 times more than in the whole of Australia.
It is also the most liquid commercial real estate market in the world with cross-border capital accounting for 46% of all real estate transactions (Source: RCA).
The opinion of investors appears to support this view. A recent survey by INREV (European Association for Investors in Non-Listed Real Estate Vehicles) revealed that despite a backdrop of economic and geopolitical uncertainty, investors are optimistic about the prospects for commercial real estate.
The industry body estimates that €52.6 billion is earmarked for investment in real estate globally during 2017, an increase of €4.9 billion over last year. Of this, around €20 billion is targeted at Europe.
The UK, France and Germany are expected to attract the lion’s share of that investment with the UK and France coming in as joint favourites, followed by last year’s first choice, Germany.
Important source of diversification for real estate investors
In the current low-yield environment, pension funds and insurance companies are looking to diversify into commercial real estate as a way of accessing reliable, long-term liability-matching returns that used to be provided by the gilt of corporate bond markets.
While most of these institutions have invested in real estate for many years, most likely as part of a traditional core strategy, the level of sophistication in today’s real estate industry means that by moving up the risk curve to core-plus and value-add strategies, these investors are now able to access much higher yielding opportunities.
We estimate that a typical core strategy in Europe should be able to provide in excess of 8% total returns while a value-add strategy will generate between 12% and 14%.
For these investors, Europe is an attractive opportunity not only because of its size, but also because of its structure. As well as being the second largest commercial property market in the world, it is also one of the most heterogeneous, providing investors with access to a collection of idiosyncratic markets, each with its own unique profile of cities, buildings and tenants.
There are currently some really good opportunities in selected European markets to turn good quality assets into core real estate that will generate reliable income and some capital return. For example, we have identified some reposition to core opportunities for shopping centres in parts of the Netherlands and France. In Germany, the spread between prime and secondary office CBD yields is at a long-term high.
Most people who have worked in the industry or have had property exposure for long enough have lived through the highs and lows of various economic and political cycles, and experienced the effects, both positive and negative, on their real estate investments. The political events unravelling in Europe and elsewhere today are no different. The one truism to remember is that life goes on, and property markets endure!