Back to basics for European real estate ?

8 Aug, 2007, London

- European trading volumes rise strongly in the second quarter
- Cautious but positive sentiment despite recent financial market turbulence
- Yields are stabilising quickly but rental growth has accelerated
- An increasing emphasis on fundamentals for successful investment

The European commercial property investment market saw €59.6bn of assets traded in the second quarter of 2007, 5% up on the first quarter’s total of €55.7bn, and nearly 23% higher than the same period in 2006: the record year to date for commercial property trading in the region. The figure for the first half of 2007 stands at €115.3bn.

Cushman & Wakefield also predicts that this trend will continue, with total trading volumes for the year now predicted to exceed €243bn.

Foreign investors are in the ascendancy, with their share of the pan-European market rising from 42% in the first half of 2006 to 58% in the first 6 months of this year. “In a number of markets, local investors have stood back but foreign players have been more than willing to take their place” commented Michael Rhydderch, head of the Cross Border Capital Markets team at C&W, “We’re seeing strong demand in particular from Middle Eastern, Irish, Australian and American investors who are using little debt and are looking for long term, secure performance.” Spanish buyers are also strongly in evidence, in core Western markets as well as Central & Eastern Europe, while German buyers have made a notable return to the acquisition trail.

The UK, Germany and France remain the top markets for investment, accounting for 69% of property traded in the last quarter. “Trophy assets have been in particularly strong demand” added Rhydderch, “with Paris, London and now German cities subject to strong interest for top quality, prime buildings and other European capitals seeing a similar trend emerging”.

However, the research cautions that performance levels for most markets have now peaked – with yields largely stable in the second quarter - and with a marked degree of turbulence in the wider investment market globally, investors are growing more cautious over pricing and are focussing on assets that can deliver sustainable income growth.

“For the last few years it’s been easier to make money than lose it in the real estate market ” commented David Hutchings, head of European Research at C&W, “but now we’re in a new environment and investors need to focus closely on the fundamentals if they are to make successful investments.”

In the first 6 months this year, prime yields across Europe, East and West, dropped by a further 16 basis points but the fall in the second quarter was minimal (just 2 bp). In secondary markets meanwhile, yields have risen as investors focus more on quality assets. The UK has seen a 25-50bp rise while other areas of Europe have seen a 10-25bp increase for weaker stock. “Higher borrowing cost and bond yields are undoubtedly impacting on investors” warned Hutchings, “but equity investors have the upper hand and current prime pricing in a market of rising rents is not a concern so long as bond rates don’t move back and stay at a higher rate.”

Debt-backed buyers meanwhile are being forced to consider riskier propositions to reach the returns they seek but in the wake of recent concerns in the global credit market, tougher bank lending criteria are emerging. “Riskier, highly-leveraged deals are going to remain difficult to put together for at least the next few months” cautioned Rhydderch, “ however the volatility of the financial market generally is reminding investors of the rationale for including property in their portfolio, eg lower risk and a secure, relatively long-term income stream. Hence whilst the flight to quality may continue, we’re optimistic that demand for the sector is set to remain strong.”

Prime rental growth accelerated to 8% in the year to June, led by strong increases in both office and retail markets. Central Europe saw the best office market growth, at 18%, while Eastern Europe was ahead in both retail and industrial markets.

“With a stronger level of activity in the underlying economy we expect prime European property to continue to see good rental growth this year “said Hutchings, “and even though economic growth may ease in 2008, a shortage of supply and higher building costs will combine to deliver further very respectable levels of rental growth going forward”. C&W’s current all-sector prime rental forecasts are for a 7-8% rise this year and a 6-7% increase in 2008.

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