European Commercial Property feels the pain

2 Jun, 2008, Prague, Bratislava

o European trading volumes fall to €38.7bn in quarter one, back to early 2005 levels

o Stunning growth continues further in Eastern Europe

o Yields rising at their fastest pace in 16 years

o Investors face a growing range of opportunities but are in no hurry for now

o Short term outlook to remain weak but firmer conditions expected in the second half of the year

The full force of the credit crunch is now being felt by the European commercial property market. According to new research released by Cushman & Wakefield, investment volumes in the first 3 months of the year fell 37% on the same period in 2007, while yields rose at their fastest since 1992. With confidence shaken and uncertainty over pricing impacting almost as much as the lack of affordable debt, the market is ready for more to come.

James Chapman, Head of Capital Markets Group at Cushman & Wakefield Czech Republic & Slovakia says: "Investment volumes have been significantly down in the Czech Republic and Slovakia during 2008. The amount of capital invested in Quarter 1 in the Czech Republic was approximately 25% of the total for the same period in 2007. This has been due to increased caution amongst investors. There has been a tendency to wait and see how far pricing would decrease before committing.

“In addition to this, equity has been harder to raise than many investors had predicted and that equity has a higher return criteria than 12 months ago. This has combined with a more challenging debt market to significantly reduce the number of active investors,” adds Chapman.

“We are, however, seeing a number of the more experienced sellers recognising the change in pricing. This realistic attitude has started to attract a group of buyers back into the market. We expect to see a higher volume of completed transactions by the end of Quarter 2. This will demonstrate to the market the new pricing levels and give investors and banks a benchmark in place of what has been predominantly speculation to date,” says James Chapman.

Volumes are expected to increase in the Czech Republic and Slovakia in the second half of the year. A short term full recovery is unrealistic. However, the signs of strong rental growth are now being seen in the Czech market. There is a great opportunity for the well-informed investors who have access to funds.

To date, however, the occupational side of the European market has held firm, with prime rents rising 11% in the year to March. As a result, total returns have remained in positive territory, with an all-sector prime average of 7.1% for Western Europe. The question is whether such performance can be sustained once the economic impacts of the financial market turmoil start to show in job cuts, tighter borrowing and increased risk-aversion.

“We currently expect rental growth to ease to around 3-4% at best this year” commented David Hutchings, head of European Research at Cushman & Wakefield. “However, with markets in general not oversupplied and development being cut back by current trends in financing, building costs and risk appetite, an upturn in the market in 2010 could well deliver strong performance for investors. A growing number of equity investors appear ready to take advantage of this and look set to re-enter the market as soon as financing markets stabilise. As a result, we are still optimistic that the market will recover more rapidly than some seem to expect.”

Deals are taking longer and the due-diligence process is more protracted. Where funding is required, the extra scrutiny put in place by the banks adds further to the delay and uncertainty of transactions actually completing.

Most markets have seen a decline in activity as uncertainty has spread, with only a handful, including Austria, Bulgaria, Denmark and Finland, seeing trading improve on the first quarter of 2007. Spain and the Netherlands also saw an improvement on the back of large portfolio deals. In the UK, after marked falls over recent months, activity has at least stabilised, with the first quarter nearly matching the performance of late 2007.

More opportunistic players are heading East, with Turkey, Russia and the Ukraine experiencing strong levels of activity. With buoyant rental growth, averaging over 30% in the past year, investor interest in emerging markets is high.

Cushman & Wakefield suggest that the economic situation is not, so far at least, as bad as some seem to think. While performance is polarising, taken overall, Europe still looks set to ride out the current global slowdown and avoid recession. At the same time, inflationary pressures should soften to allow the European Central Bank to cut interest rates later this year.

“On balance, the market will see further pain in the months ahead – with yields yet to peak and rental growth slowing – but in the latter part of the year, a firming in economic confidence allied to an increased supply of opportunities, should be the catalyst for a steady recovery in activity”, concluded Hutchings. “We currently expect total trading of €180-190bn, some way down on the 2007 record, but ahead of recent performance.”