European Real Estate

2010 – A Pan-European Opportunity
 
The recovery in European commercial real estate is now well underway. Fortunately, we are in the early days of the cycle and there will be plenty of opportunities ahead for research-driven property managers. After successfully calling the turn in the UK property market in December 2008, Matthew Richardson, Head of Research European Real Estate, provides his views on the outlook for 2010.

Prime Property is Leading The Recovery
 
The recovery in European real estate began in 2009 with prime quality properties in the most important European markets of London and Paris. This recovery is now spreading out into other major western European cities and investors may have the opportunity to take advantage of an imminent boost to performance from a short-term ‘yield snap-back’ in some of these other markets.

A 'W' Shaped Recovery

As you can see from the chart below, we expect a strong total return from European commercial property in the final quarter of 2009, as the weight of money being reinvested in the market causes a snap-back in yields, which boosts capital growth. This sharp compression of prime yields, which is typical of the initial phase of recovery, is not sustainable. A similar spike happened in 1994, in the recovery from the 1991-93 market downturn. This produced a ‘W’ shaped recovery, which subsequently fed into a sustained bull market.

 

We anticipate the current recovery will take on a similar shape with a strong initial spike in performance, driven by compression of prime yields, giving way to a consolidation phase, before a recovery in the broader market.

The Key Theames For 2010

Capital markets will remain the key driver in the short term – improved risk appetite and increased attraction of “real” assets as investors hedge their portfolios from the potential inflationary results of recent stimulus spending will support investment.

Market values to stabilise – We expect yieldsv to stabilise across major cities in northern and western Europe. Capital values should stabilise for most modern well-let assets and increase sharply for some prime assets.

Improving supply and demand fundamentals – The limited supply of new space will soften the extent of rental income declines.

A different kind of recovery - We are seeing the beginnings of a horizontal recovery across European markets rather than the traditional vertical model. Historically, investors would invest in the prime and then subsequently the secondary areas of their own domestic real estate markets. Now, highly mobile investors are investing across borders to take advantage of prime opportunities in specific locations.

The 'Big Picture' View For 2010

We tend to favour those countries more able to control their own macroeconomic destinies, which are less susceptible to external economic shocks.

The most attractive markets will be UK, France, Germany, Benelux and the Nordics. While now is very much the time to buy property risk, there is no need to take on additional, unnecessary risk (particularly when you are not being paid to) by investing in emerging European or Asian markets at this stage of the investment cycle. Attractive returns are available in northern and western European markets; markets which also benefit from higher levels of liquidity and transparency. Legal title can be quickly and clearly established and independent and established legal infrastructures are in place; something that many bondholders are now more cognisant of in the aftermath of the Dubai debt crisis.

Conclusion

Now that the large capital value corrections are through, risk should now become the friend of property investors. The risk and return environment for property is very attractive at this point in the cycle, although there is little need to take unnecessary risks in peripheral markets. Attractive returns are available in large core markets.

Research will become more important as investment becomes more granular and binary. With many deals taking longer to realise their true value, the ability of property managers to do their homework and hold their nerve will be essential. The best performers will be those that make the right deals, supported by rigorous due diligence and effective management of income risk.

Timeline For Recovery In European Real Estate