European commercial property off to a strong start in 2007 according to Cushman & Wakefield

6 Jun, 2007, London

- Trading volumes ahead of 2006 average
- Yield compression continues
- Rental growth accelerating
- REITs to be a focus for increased activity

According to global property consultant Cushman & Wakefield, the European commercial property investment market saw €55.7bn of assets traded in the first quarter of 2007, some way down on the €77.9bn traded in the final three months of 2006, but 7% up on the opening period of last year.

Expectations for the likely out-turn for the year overall have strengthened due to a combination of fresh allocations of new money to the market and a modest increase in the supply of available property, as some owners judge the time right to take-profits.

“Many felt that we had seen the peak of the market in 2006 after such a strong final quarter but in fact the year has started strongly and the mood across our offices in Europe is generally more optimistic, with most now expecting a stronger level of trading this year than they did back in January.” commented Michael Rhydderch, head of the cross border capital markets team at Cushman & Wakefield.

This comes despite an increased sense of caution in parts of the market with respect to pricing. As yields have continued to fall, (dropping a further 10 basis points in the first quarter for prime property), against a backdrop of rising short and long term interest rates, investors have been focusing more on quality real estate that can deliver and sustain income growth over time.

“While investors are still keen to find active management opportunities, secondary property in some areas has seen expectations adjusted.” said Rhydderch. “More deals are being delayed or renegotiated as investors get comfortable with some of the risks they are taking on. The dominant characteristic of the market is still one of excess demand. For a prime asset in most countries we’d expect to get 5-10 active bidders coming forward. However, 12 months ago that might have been 10-15 bidders so whilst it’s still highly competitive, the balance of power is now slowly levelling out.”

Notwithstanding this increased awareness of risk, more investors continue to target new markets – with cross-border investors accounting for nearly 59% of activity in the opening quarter as against an average of 48% for 2006 as a whole. Non-European players are a key part of this, with rising demand from North America, strong ongoing interest from the Middle East, and now increasing interest from a range of Far Eastern investors.

European demand is also strong, with ongoing Irish and UK interest, plus renewed buying demand from some German funds. At the same time however, a growing number of European funds are also casting their eyes further afield – notably towards Asia.

Looking forward, one potentially major source of new capital coming to the market may be from the REIT sector – with Germany and Italy now confirmed to be joining the UK in launching REITs this year.

“While the market may take a little time to find its feet – as we have seen in the UK – we expect REITs to be a major driver of activity over the next 2-3 years.” said David Hutchings, head of European Research at C&W. “New vehicles are set to be launched, targeting domestic and pan-European assets, and they will be joining a market which is already highly competitive for property with secure income streams and good growth potential. We expect more such vehicles to specialize by sector to try to gain a competitive advantage but at least in the short term, they will also be looking over their shoulders to see who may be eyeing them up for a takeover. M&A activity in this market has only just begun.”

By sector meanwhile, offices continue to see the lion’s share of activity, accounting for nearly 50% of trading volumes in the opening quarter, but interest in other sectors including emerging areas such as hotels and residential, is also strong. Indeed, it is a lack of stock more than a shortage of demand which has prevented other market segments posting a higher level of activity and hence yield compression continues across all sectors to tempt vendors to come forward.

Not all markets are seeing the same trends of course, with trading volumes dipping in certain areas, such as the UK, Norway, Poland, Sweden and Belgium. For some markets this is simply a reflection of the timing of deals but it is clear that the UK in particular is facing a slowing in activity as the market adjusts to the negative yield gap between debt and property.

The strongest gains in activity have been seen in Western Europe as more investors focus on markets with more stock to meet their needs. Compared to average quarterly trading volumes in 2006, the first quarter saw a strong increase in activity in the Netherlands, Finland and Italy but the biggest boost to overall numbers – helping to compensate for the fall in UK activity – has been an increase in activity in France (up 24% on last year’s quarterly average) and Germany (up 17%). Among the Emerging markets, Turkey has seen the strongest gains in activity but most are expecting to post higher volumes for the year overall.

Secondary cities, across Europe, are attracting more interest, meanwhile, as investors face a tight supply and low yields in the larger markets.

“For many foreign investors, this is the first time they have focussed on some of Europe’s smaller cities and we anticipate a further steady increase in demand in these locations over the next 1-2 years, with a focus on well-let property.” commented Rhydderch.

“Whilst the UK market is now stabilising and there is some evidence of a cooling in residential markets in one or two areas in Europe”, added Hutchings, “the commercial property market in Continental Europe is still enjoying buoyant conditions, with yields falling, rental growth picking up and strong inflows of new investment.”

With prime rents growing on average at an annual rate of 10.2% across Europe in the opening quarter, the performance outlook for the year is very promising. The stronger economic upturn is being reflected in improving consumer sentiment and, as a result, both retail and office markets are moving ahead – with annualised growth of 11.2% and 12.1% respectively in the opening quarter. A steady rise in construction costs will add to the pressure on rents, helping to justify the levels of yield now being paid.

“The economic backdrop for 2008/9 is looking somewhat uncertain as we wait to see how ingrained inflation is becoming and hence what we can expect for interest rates.” cautioned Hutchings, “ However the short term picture is very positive and we are looking forward to a potentially record year for investment volumes of over €240bn, 7.7% ahead of last year.”

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