Poor transparency has prevented Italy from realising its potential as a destination for foreign investment in real estate but a recent initiative offers new hope, as Anne Koeman and Raffaella Pinto report
In recent months, the euro has come under great scrutiny and some have even called for abolition of the common currency altogether. However, as European property investors will recognise, the introduction of the euro has been of great importance in opening up many markets that were previously exclusively driven by domestic investors. Italy is an example; abolishing the currency risk associated with the weak lira significantly improved the attractiveness of the country for real estate investors, and foreign investment has been in excess of 40% of the total volume following the inception of the new currency. That said, experiences of international property investors in the Italian market have been mixed and complaints concerning the opaqueness of the Italian investment market are widespread.
The limited transparency of the Italian market is confirmed by the Real Estate Transparency Index published by Jones Lang LaSalle, which groups Italy in Tier 2 of ‘transparent' markets. While this might not sound very problematic, the latest edition points out how the country lags behind other core European markets such as France and Germany and, in terms of market transparency, is closer to Poland - a country that joined the EU in 2004 and falls outside the euro-zone. This article reveals how the lack of transparency relates to the market structure and how efforts, already underway, may improve the situation for foreign institutional investors over time.
Italy has a strong culture of wealth preservation through buying property. The country experienced long periods of double-digit inflation in excess of the European average well into the 1980s. Real estate investments were considered an attractive hedge against inflation, which led to one of the highest home ownership ratios in Europe. Although the situation has changed with regards to inflation, a culture that favours property investment remains. Some of this demand is accommodated through investment in commercial real estate; typically, deals are relatively small and undertaken by private investors or domestic funds. Over the past decade approximately three-quarters of the total number of transactions in Italian real estate were for deals under €50m. This trend is amplified in the central districts: looking at offices in the central districts of Milan only, excluding portfolio transactions, this ratio rises to almost 80%, with domestic investors clearly dominating this segment of the market .
Domestic investors determine the pricing of assets in central locations by reference to the price per m2 in comparison to residential or owner-occupier purchases. Their focus is on capital values rather than income or total return, which means that transaction yields can be keener than a cash-flow approach would suggest. Even if domestic investors were to normally adopt more sophisticated valuation techniques to evaluate investment decision on assets in non-core locations, they are unlikely to use such methods for centrally located properties. Hence, prime office yields in Milan have ranged from 4.25% in 2007 to 5.15% in 2009, despite headline rents for a representative prime building remaining at €500 per m2 since 2002. As such, yields on prime property (by definition located in the city centre) are almost always too low for foreign institutional investors to justify investment given the market's weak rental growth characteristics.
An associated issue with the market structure is the poor availability of data. Prime ‘hypothetical' yields are a common recorded investment indicator, but underpinning these with evidence from market transactions is much more problematic. Over the decade analysed, yields were only disclosed on 41% of the total number of transactions. Interestingly, this ratio increases from a mere 25% on all deals in the city centre to 55% for deals in the hinterland of Milan.
This pattern bears a strong relationship with the prominence of certain types of investors across parts of the market. A higher proportion of institutional investments lead to greater data availability. Of all Milan office investments made by institutional investors over the past decade, approximately 65% were for buildings outside the city centre. The yields achieved here also reflect the investment principles of institutional investors, as they ranged from 5.6% in 2006 to 6.75% in 2009. However, as many researchers use prime yield data to analyse the overall market, this could mean that their advice might forgo investment opportunities that exist outside the central areas.
Italy remains the fifth-largest real estate market in Europe. However, as DTZ's Money into Property points out, it constitutes only 8% of the total invested stock in Europe, whereas almost 10% of the total investible stock in Europe is located in Italy. This implies a higher than average owner-occupier ratio and larger investment potential. Improving the market transparency in Italy could help investors to capitalise on this potential.
Over time, the market structure might be slow to change. The prominence of small, private deals in some parts of the market is unlikely to disappear, given its cultural character. However, the nature of the investible stock also plays an important role here, with institutional investment-grade properties making up only a small part of the total size of the invested stock.
Indeed, one could argue that it is not the dominance of domestic investors that is holding back the Italian investment market, but the lack of modern investment stock suitable to the institutional investor. Development has been limited in the past decade, depriving the occupier as well as the investment market of good-quality stock. The situation seems to be changing now. Milan, in particular, is seeing a substantial amount of new developments completing in the near term, bringing a new generation of welcomed investment products to the market.
In a market context where many deals are done behind closed doors, information is rarely made public or shared between real estate advisers. However, an encouraging development in this area is now under way with the establishment of the Italian Research Forum. This association between researchers of the five largest real estate advisory firms aims to publish annual ‘consensus' data on the Italian commercial property market to help clear the mist of obscurity.
Improvements in the quality and comprehensiveness of data have the potential to make
a profound impact on the decision-making processes, as poor data ultimately compromises the quality of advice given on market opportunities, making a lack of transparency a concern to the property investment and research community alike.
Anne Koeman (left) is a senior research analyst at PRUPIM (London) and Raffaella Pinto is a senior research analyst at Jones Lang LaSalle (Milan) and a member of the Italian Research Forum