Consolidation in the European shopping mall market reflects an ongoing flight to quality. Lynn Strongin Dodds reports

European shopping centres may not seem an obvious choice in today's turgid economic climate, but high quality prime assets in strong catchment areas continue to generate a buzz. The sector is expected to outshine its office, logistics and industrial counterparts, although volume will be below 2011's stellar levels.

Jones Lang LaSalle (JLL) is predicting a final-year tally of around €20bn, down from 2011's €31.6bn. Volumes in the first half were about €7bn, down from €15.3bn from the same period last year, and below the first half five-year average of €10.3bn. Activity gained pace as the year progressed with direct investment in retail real estate jumping 29% to €3.9bn in the three months ending 30 June from €3.1bn in the first quarter.

The main reason for the decrease is that "last year included a handful of mega deals such as the €1.9bn Trafford Centre and €1bn Westfield Stratford in the UK and €700m Centro in Germany," says Jeremy Eddy, head of European retail capital markets at JLL. "These impacted the numbers in 2011 and similar deals have not been in evidence this year."

By contrast, the deal sizes in 2012 have been smaller, with the largest including Union Investment's €174m purchase of the Europa Galerie in Saarbrücken (pictured) from Credit Suisse Euroreal, and Unibail-Rodamco's €190m acquisition of major stakes in Ruhr Park in Bochum and German shopping centre owner Management fur Immobilien (mfi) for about €383m.

"The market started relatively slow and picked up a bit in the second quarter, says Eddy. "The demand has not tailed off but the focus has narrowed on core markets such as UK, Germany, France and Poland. Investors are also looking much more carefully at the dynamics in the cities rather than the geographies."

Germany is especially attractive since, unlike France and the UK where Paris and London act as metropolitan beacons, the country boasts five to seven attractive cities: Berlin, Frankfurt, Stuttgart, Cologne, Düsseldorf, Hamburg and Hanover. Combined they have the potential to become one of Europe's biggest retail markets, especially as the regulatory framework has become more favourable with longer opening hours and more diversified shopping formats.

According to Neil Turner, head of property fund Management at Schroders, Germany is one of the most undeveloped countries in terms of retail space with 130 square metres of shopping centre space per inhabitant versus a European average of 250 square metres. "Its economy is strong and consumers are not in debt unlike in other countries such as the UK and Spain," he says. "The big question though is whether the psyche of the German consumer can change. They are not quick to buy the latest gadget or fashion but either save or spend their money on residential properties. It is a brave move by Unibail-Rodamco but it still remains to be seen whether there will be a consumer boom in the country."

Andy Watson, head of core funds and separate accounts for continental Europe at LaSalle Investment Management, says: "In Germany, relative income returns can still look attractive for many players, as prime shopping centres yield, say, 4.5%, compared to the 1-1.5% on long-term bonds. However, I also see increasing opportunities in France where three longstanding trends are being revisited: new supply is no longer as constrained as in the last 20 years, consumer spending is no longer as strong - with euro-zone uncertainty and multi-channel retail becoming a reality. Also, owners of shopping centres are more prepared to trade stock - with a certain knock-on pressure from the euro-zone crisis, one or two minor jewels have become available in both high street and shopping centre markets."

Looking ahead, the divergence between prime and secondary will continue to grow wider partly due to the growing number of large REITs such as Unibail-Rodamco only targeting the higher end. Europe's largest real estate investment trust has been busy selling non-core retail assets and re-investing into super-regional shopping centres, which have weathered the current economic turmoil better than their smaller brethren. UK-based property company Hammerson is following suit, having recently sold off the majority of its London properties for more than £500m to Canadian investor Brookfield to redeploy its funds to new shopping centre developments in the UK and France.

These assets are also attracting attention from investors outside Europe. Simon Property, the largest US REIT by value, recently acquired Klépierre - a Paris-based real estate company that owns, manages and develops shopping centres, retail properties and offices throughout continental Europe. The company is looking to complete €1bn of disposals in 2012-13, with at least €500m of this to be achieved this year, in order to strengthen its financial structure.

Simon's main challenge will be Klépierre's properties in Southern Europe, which are in the front lines of the continent's debt crisis, although the firm is known for boosting the value of its properties through marketing and changing the tenant mix.

David Skinner, chief investment officer for global real estate at Aviva Investors, says: "I think Simon was attracted to the relative cheapness of Klépierre stock, given the wide discount to NAV compared to before the stress in the euro-zone. Debt funding costs were low and with US REITS trading at a premium the group was able to raise new equity. Klépierre stock represented an efficient use of capital relative to buying US shopping centres. The group has wanted to gain exposure to a European shopping centre platform for some time and all these factors came together to create this opportunity."

Andrew Allen, director of global property research at Aberdeen Asset Management, adds: "The recent transactions are pointing in the same direction, and we are seeing consolidation among the very strong operators into the largest, well-anchored shopping centres in quality locations across Europe. The prices have held up because they are perceived as having the strongest prospects for growth. Additionally, they are generally better defended against the structural changes we see, such as the ongoing rise in e-commerce."

Alice Breheny, head of research at Henderson echoes these sentiments. "Investors like shopping centres for their defensive qualities, but even if there is a sustained recovery, e-commerce will determine which the best and worst locations are," she says.

"There will be a need for less retail space in the future and I think it will have the greatest impact on the weakest centres over the long term. The most important criteria investors should look at are a strong tenant mix, pedestrian traffic and shops that attract the higher spending consumers. If you have a mediocre mix with poor leisure and catering facilities then it will push people online."