The world of European real estate investment
Europe represents approximately one-third of the global commercial real estate market, dwarfing Australia as an investment destination. Just one European city, London, has approximately the same volume of office space as the entire Australian market (24.8 million sqm versus 25.1 million sqm). Knowing what is happening, where and why is crucial to successful investing.
European trading volume of €305 billion for the 12 months leading up to and including June 2018, was up 6.7% on the comparative period between Q3 2016 and Q2 2017. This period included the record-breaking final quarter of 2017 where capital inflows into the European property market hit €117 billion.
Investor activity appeared to pause for breath in Q1 2018, with €58.9 billion transacting across all sectors, and was followed by Q2 2018 trading volumes of €59.1 billion. This brought the total capital invested in Europe, across the first six months of the year, to €118 billion.
Domestic and cross-border capital had a, more or less, equal share of activity over the first six months of 2018. Looking at international capital in more detail, global cross-border capital accounted for 27% and continental activity the remaining 23%.
Global uncertainties don’t seem to be deterring investors, many of whom have faith in the positive economic environment and relatively healthy occupier markets. Performance does, however, vary between country, city and sector.
The weight of capital targeting real estate has seen yields come under a sustained period of compression, with prime yields on the whole at historic lows across the majority of cities in Europe. There are some areas where a further tightening in pricing could happen, such as good quality office buildings in peripheral areas of Tier I locations, but rental gains are likely to be the main driver of future capital value growth.
Conversely, parts of the retail sector have seen a softening in yields as the sector deals with the changing habits of consumers and the continued rise of e-commerce.
Confidence in the occupational fundamentals is benefitting the office sector with €26.6 billion invested into the sector across Europe in Q2 2018. This was an increase of 19.5% over the slower Q1 2018, bringing the first-half 2018 trading volume to €48.8 billion.
Demand for office space continues to be spurred on by job creation, GDP growth and a decline in the unemployment rates across the majority of European cities. However, this has a knock-on effect as the tightness of the labour market is beginning to constrain corporate expansion which may see active demand for space ease back. So, while there is robust demand overall, there is a focus on good quality space and some polarisation across European cities. Occupier activity has eroded availability and with the replacement of space lagging, this has pushed down the average vacancy rate across the significant European office markets to around 6.5%, with very few locations reporting a vacancy rate in excess of 10%.
With Europe suffering from a general lack of quality supply and with speculative deliveries constrained over the last few years, this is providing some room for rental growth, although notably the rate of acceleration has begun to slow. Until construction catches up, tenants will need to be flexible in their demands with several markets landlord controlled.
Prime rental rates in some CBD and city centre locations are under sustained upward pressure as occupiers look to trade up their accommodation. The desire for quality space has pushed up rents to the point that many occupiers are needing to look to well connected, non-CBD and more peripheral locations. Serviced office providers will continue to cushion the blow of the lack of space and provide short-term solutions for clients in need of space, typically in central locations.
Strong demand for offices is continuing to put downward pressure on yields, where in many markets values are at or near historic lows. The trends seen in the occupational market are being mirrored in the investment sector where tight pricing is narrowing the yield gap between primary and secondary locations.
At a European level there is a roughly 50:50 split between CBD and non-CBD office assets transacted. However, variances appear at a country level. For example, in the UK, activity was heavily weighted towards CBD offices accounting for 70% of all first-half 2018 activity. Other examples of this trend were seen in Belgium and Sweden. In France, the contrary is true, with 73% of first-half 2018 capital flows in the office sector going to the non-CBD market. Denmark and Finland follow suit with non-CBD locations proving more popular.
Despite a slight slowing of investment volume across Europe based on the comparable period last year, widespread sub-10% vacancy rates, and yields hitting historic lows indicates a positive economic outlook through the remainder of 2018 and into 2019.