Prices for prime property have continued to rise as investor demand outstrips supply, and the weight of investor capital looking for prime assets is expected to continue through 2011 to 2013, until bond rate rises begin to put downward pressure on prices from 2014.
With bond rates forecast to rise, we do not expect significant yield movement to drive performance over the next five years, and instead expect value growth to be driven by rental growth. Therefore the sectors where we forecast the strongest performance are those with a compelling story to support rental growth.
We believe the office sector should deliver the best short-term returns in supply-constrained city centres such as London, Paris and Stockholm. Growth is sufficiently well established that we believe there is enough occupier demand to support a more ‘value add' strategy in these markets, taking on vacancy and delivering good-quality refurbished space before new speculative development is completed. However, returns in these markets are highly cyclical so timing is crucial.
The outlook for the City of London, in our opinion, is particularly strong as its position as a global financial centre means that it should benefit from healthy growth in emerging markets. With evidence that development activity is increasing, our forecasts indicate that office investment in 2011 should deliver strong returns prior to the delivery of a significant tranche of new speculative space in 2014. Investment now should deliver attractive capital driven returns in the near term, in our view, with solid income returns in the long term. However, beyond 2014, increasing supply is expected to dampen rental value growth prospects and further capital growth might be limited.
In the medium term we expect retail to be the strongest-performing asset class. We forecast that the strongest rental growth will be in Central Europe, supported by a burgeoning and wealthier middle class. However, we caution that investing in the retail sector across much of Europe requires considerable care. In the short term retail performance is likely to be weak as austerity measures weigh on consumer confidence. In the medium term the definition of prime pitch is likely to be narrower than ever before as the retail industry evolves.
Given the strong economic outlook for Poland, we believe retail rental growth should be particularly robust, as a lack of development activity over the past two years means that new floorspace has been unable to keep pace with demand. A lack of clearly defined city centres in some of Poland's major cities will mean that both investor and occupier focus is likely to be on shopping centres.
While the story for Poland is already compelling, we also expect a good recovery in Hungary in the medium term as austerity programmes wind down and consumer spending starts to grow, albeit from a very low base. Yields in Hungary are well above those in Poland and the Czech Republic, and therefore investors could also benefit from inward yield shift as well as rental growth.
We believe logistics will continue to play an important role within portfolio strategies as a provider of stable income returns, even though logistics yields across Europe are beginning to look expensive and rental growth is projected to be weak because of the cost-sensitive nature of logistics operators. Our analysis indicates that some of the best prospects for rental growth in the logistics sector are to be found in the Nordics, especially Sweden. Here the economic recovery has been particularly robust as a result of the strong performance of both exports and domestic demand. Logistics properties in the Stockholm-Jönköping-Gothenburg corridor are best placed to serve these domestic and export markets, and we expect some further inward yield shift as well as real rental growth over the next five years. This should, in our view, generate attractive total returns as well as income returns. The main risk is of further development, financed by investors seeking ways to gain access to the Swedish logistics market, which could dampen rental growth in the medium term.
As we expect to underwrite real estate investments based on an expectation of rental value growth rather than yield movement, a "buy-the-market" approach remains inappropriate.
Local factors will be important in underwriting the rental growth prospects of an individual investment and care should be taken to ensure the lease profile allows any expected rental growth to feed through to returns during the hold period.
Kim Politzer is director of European research at Invesco Real Estate