A record final quarter predicted for European property markets

27 Oct, 2006, London

- Commercial investment volumes to reach a fresh high in 2006
- Total returns from prime property to hit their highest level since 1999
- Germany’s growth as a major investment target continues
- Investor interest in new markets and sectors intensifies
- No end yet in sight, with strong activity predicted for 2007

The European commercial property investment market is heading for a record year according to figures released this week by global property consultants Cushman & Wakefield, with investment volumes expected to exceed €211bn, 27% up on 2005.

The first 9 months of the year saw investment jump by 29% over the same period in 2005 and while investment in the last 3 months, at €44.7bn, was marginally down on the second quarter, C&W expect a marked surge over the closing months of the year.

“When we look at deals under discussion or in solicitors hands, together with the volume of stock coming to the market, we are confident there is a record level of business set to be completed” said Michael Rhydderch, head of cross-border capital markets at C&W.

The driving force behind these record numbers is the push by international investors into both new and established European markets. While domestic investment in the first 3 quarters rose 11% on the same period in 2005, cross border investment rose by just less than 60%, driven by international funds, US, UK and Irish investors, and growing interest from Australian and, in some markets, Middle Eastern buyers. Across Europe as a whole, foreign buyers have a 45% share of the market to date, up from 40% in 2005.

“In terms of target markets, the rise of Germany is still very much a key story” commented Rhydderch, with the country seeing its share of investment activity rising from 7% last year to over 22% in the first 9 months of 2006. By contrast, the UK has seen its market share fall from 52% to 36% as the rest of the European market has grown and matured. “As a target for foreign buyers, Germany is now way out in front”, added Rhydderch, “It has in fact overtaken the UK, with €21bn in foreign investment in the last 9 months versus €14bn for the UK.”

According to Rhydderch, “Activity is still very much dominated by Europe’s heavy weights, with the top 5 markets having a 79% share of overall trading. However this is down from 82% in 2005 and buying interest continues to spread to other markets and global regions”. Moreover, with C&W highlighting a demand for diversification as a key driver among current investors – they suggest that interest in new locations and regions is only set to grow in 2007.

Aside from Germany, the big winners in terms of market share this year have been emerging markets such as Russia, Slovakia, Bulgaria and Romania, while a wide range of other markets have enjoyed increases of 50% or more, including Poland and the Czech Republic as well as western markets such as Finland, Spain and Denmark.

“Although there are a number of countries yet to see deal volumes match 2005 levels, given the transactions under way, most are still expected to post a fresh record for the year – with only the UK, Italy and Hungary looking likely to fall short” added Rhydderch.

By sector, offices still dominate, with their market share up from 46% last year to 48% this year, but it is clear that stock shortages have held back activity in retail and industrial markets and new sectors are seeing rising demand, with hotels seeing strong growth and residential and healthcare tipped to see more interest going forward.

“The intense level of demand for European property from domestic and international buyers is readily justified by recent performance” according to David Hutchings, head of European Research at Cushman & Wakefield. Prime European commercial property saw capital growth of 14% in the year to September, with yields falling 48 basis points and rents ahead by 3.5%. “We expect prime property to show a total return of over 15% for 2006” said Hutchings, “up from 12.6% last year and the highest rate seen since 1999”.

“Of course, investors must be cautious of buying based only on historical performance and finding “value” in the current market is becoming harder as yields compress”, added Hutchings. “However, with occupier demand steadily building up, there is clear potential for further strong performance from the right assets”.

C&W do however caution that a re-appraisal of risk is increasingly warranted, with secondary property looking at best fully valued in many markets – particularly at a time when interest rates are rising. “Getting the fundamentals right will be more important in 2007 as tighter spreads between yields and borrowing costs focus attention on income sustainability and growth potential” said Hutchings “ As a result, we expect a significant refocusing of demand onto prime property – with secondary stock becoming harder to sell.”

Looking forward Hutchings continued, “For prime property, we believe yield compression has further to go in Continental Europe – even though it may soon run out of steam in the UK”. The main risks to the sector look to be higher interest rates and an early return of development. “Both are obviously a threat but there appears to be an increasing chance that bond yields and borrowing costs will fall later next year as global economic activity slows” said Hutchings. Hence, with little threat from excess development in most markets, a further good year of performance lies ahead, with C&W forecasting prime total returns of 11% for 2007.

Commenting on the likely pattern of trading activity that could result, Rhydderch said; “An increasing number of investors and owner occupiers are expecting yields to reach their lows in the very near term and as a result, we may see an easing in buying demand and an increase in sales. However there is still a strong depth to active demand and the market has plenty of momentum behind it. On top of this, new sources of demand are likely, with growing investment from Middle Eastern buyers for example, plus a still high level of new fund raisings, new IPO’s and the added potential of corporate activity due to the growth in REIT markets. All of this should ensure there is enough demand to keep activity levels high and while UK deal volumes may moderate, for Continental Europe, if the right quality of property is offered to the market, deal volumes in 2007 could yet challenge 2006 levels."

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