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February 11, 2017

European property market update

Europe’s political environment has filled a lot of newspaper columns over the past 12 months. Elections and, in the case of Brexit, a referendum, have all generated volatility in financial markets. Of course while some investors see this volatility as a risk, others see it as an opportunity. It is the depth and diversity of Europe’s real estate market across a variety of countries, cities, regions and sectors which makes it possible for investors to pursue a broad range of investment strategies, whatever their attitude to risk.

Focus on European cities

Following the UK’s decision to leave the EU last year, investment in German real estate overtook the UK for the first time, a trend which has continued into the first quarter of 2017. Despite this, London has seen increased levels of activity from Chinese investors, who continue to invest in the city, attracted by a combination of factors including the post-Brexit devaluation of the sterling and confidence that London will ultimately retain its position in the world order.

It is the strength of GDP growth in Europe’s major cities that is attractive to property investors. The dominant feature of the last 20 years has been the capacity of city economies to grow faster than the national average. Over the past decade, the three largest German cities have seen GDP growth 15% higher than the national average. London’s economy has expanded at an annual average rate of 2.9% compared to 1.2% for the UK and in Milan, growth is nearly double that of Italy.

Germany is the fourth largest economy in the world

Germany’s economy continues to grow and recorded a 1.8% rise in GDP in the final quarter of 2016, making 2016 the strongest performing year since 2011. Looking ahead to the rest of this year, GDP is predicted to grow by a further 1.5%, boosted by a recovery in exports and healthy consumer spending.

E-commerce continues to be an important driver of growth in the logistics and industrial sectors across Europe, with the popularity of these sectors particularly acute in Germany, leading to some yield compression. The country’s geographical position at the heart of Europe means that it is an important transit corridor and logistics hub for nine neighbouring countries, with more goods passing through Germany than any other country.

In 2016, take up of warehouse and logistics space totalled 6.75 million square metres, which exceeded the previous year’s record by 10%. Much of this demand (69%) was for space outside of the top five markets of Berlin, Dusseldorf, Frankfurt, Hamburg and Munich. The increased focus on regions like Stuttgart and Cologne was due to a lack of supply in the major centres.

Infrastructure in France

French GDP grew by 1.1% in 2016 and is forecast to increase to 1.4% in 2017. 2016 was also significant because it was the third year in a row that real estate investment exceeded €22 billion.

While domestic investors represent the most important source of capital in France, accounting for 67% of the total, the country also attracts capital from a diverse range of international investors: other European countries (16%), US (9%), Asia (5%) and the Middle East (2%).

The country is set to benefit from several large infrastructure projects, which are likely to create some interesting opportunities for investors, especially in the regional office markets.

These include the ongoing Greater Paris Project, which is a vast undertaking to strengthen Paris’s status as a 21st century metropolis, as well as the planned upgrade to France’s high-speed rail network (TGV), which will reduce journey times between Paris and some of the regional cities. For example, in 2017, the office market in Bordeaux is predicted to experience similar benefits to those already seen in Lyon and Marseille.

Italy has caught the eye of investors

Italy is the fourth largest country in Europe, the fifth largest exporter and the fourth largest consumer.

In the last four years, it has caught the attention of international investors. At a macro level, this is due to a more stable political environment and the implementation of much needed structural reforms. For real estate, changes to legislation have made it easier for landlords to lease property and changes to regulation have opened up the debt market to institutions other than the traditional bank providers.

While yields have tightened on traditional core assets, investors are starting to opt for more core+ and
value-add strategies, particularly in cities like Milan.

The office sector has been by far the biggest recipient of capital, followed by the retail sector. Milan is currently the most in favour with investors generally opting for large single asset purchases, while the Rome market is in recovery mode with investment levels increasing since reaching a low point in 2014.

Occupiers looking for the ‘complete’ package in the Benelux

There are some attractive opportunities in the Benelux office sector, particularly in the five core cities of Brussels, Luxembourg, Rotterdam, The Hague and Amsterdam. We have observed a polarisation in this market with some occupiers becoming focused on micro-locations as they look for the ‘complete’ package, incorporating good access to public transport and local amenities like housing and entertainment. Finding the best locations is a key issue for many occupiers as they look to retain high quality staff.

Investment volumes, specifically in the Dutch market, have been on the increase since 2012, reaching more than €14 billion in 2016. Most of this activity has been in the office sector where yields have tightened over the past two years, with up-take coming from the IT sector.

Denmark and the Nordics

Denmark is the smallest of the Nordic countries with its population concentrated in Copenhagen. Investment into the country’s real estate market totalled €8.62 billion in 2016, of which the majority was invested in the office market.

Across the Nordics, there is a diverse return profile by region. For example, the core and value-add markets in Sweden are tightly priced, whereas in Finland there is a greater spread between core and secondary yields, which creates an opportunity to manage assets to core. A trend towards longer lease lengths in Finland has also made it more attractive to overseas institutions.

An understanding of regions and sectors is the key

The European market is broad and deep, which allows for diversification across various regions and sectors. Cromwell’s European presence is strengthened by extensive local market knowledge, which allows us to identify opportunities specific to each city, and to react to various market influences independently.

Cromwell Property Group CEO, Mr Paul Weightman believes diversity across asset classes is important for investors to get a foothold on the Europe story:

“Each market has a different fundamental. Retail in France is more challenging; Germany, we think, has been very highly priced in terms of office. In Italy, we’re just starting to see more economic activity, particularly in the north, which will flow on
to improved demand for real estate.”

Despite short-term volatility brought about by political events or fluctuations in the economic cycle, the reality for many investors is that the size and depth of the European commercial real estate market will ensure it remains an important part of their overall real estate allocation. As the investment cycle evolves, they may switch investment strategy, but familiarity with the European market and the diversity it provides will help to ensure it remains attractive.