GLOBAL – Investors should expect annual returns of around 5% from commercial real estate debt investments in Europe as the market eventually comes to resemble its US counterpart, according to new research.
A study by Standard Life Investments used data from the Giliberto Levy CRE Debt Index in the US and the De Montfort Lending Survey in the UK to model expected returns on a 10-year annualised basis.
Using data from De Montfort from 1999 to 2012, the research suggests a 5.3% yield per annum when using a margin over five-year swap rates, or a 4.7% yield if using three-month LIBOR as the reference rate.
The returns are based on data for UK offices and only account for income, not capital appreciation.
By using the 10-year US Treasury yield as a proxy for the risk-free rate, the paper identifies that US commercial real estate debt "provides favourable risk-adjusted returns on average throughout the various different cycles from 1983".
It adds: "The risk-adjusted returns using the synthetic UK data … compare favourably to other assets and are in line with the North American experience.
"However, the timeframe is shorter, and the results only examine the income element. The capital element is much more dependent on changes in the underlying interest rate environment and is therefore more problematic to model."
The Giliberto Levy CRE Debt Index, created by Michael Giliberto and John Levy in 1993, was the first index to measure the performance of investments in the US commercial mortgage industry, covering more than 16,000 loans marked to market.
The total annualised return from the index from inception was 8.7% and for the 12 months to the end of June 3.7%.
"Investors should look to the North American CRE debt market for guidance as to how the European sector will develop going forward and the likely return volatility profile," the research says.
"North American markets went through a similar evolutionary process in the early 1990s and currently resemble what is anticipated within European markets five years from now.
"The expected structural change is likely to aid the stability of European debt markets in a similar fashion to the US."