ANALYSIS: Falling euro makes European real estate more attractive for US investors

Demand for European real estate from global investors, especially dollar denominated investors, is set to increase due to the recent decline in the value of the euro.

Indeed, a further decline in the euro may be on the cards, according to Joe Valente, European head of research for real estate at JP Morgan Asset Management. ‘Europe already attracted substantial investment prior to the recent decline in the euro. It is likely to offer yet more value to US investors after the sudden depreciation of the currency,’ he said in a commentary.

The main European markets continue to be regarded as a safe haven for many international investors, Valente said. ‘Property yields are still substantially higher than in most real estate markets around the world. Interest rates are also lower in the Eurozone which allows high cash-on-cash returns. The trend going forward is thus for more investment in Europe. This should support capital values, both at the prime end of the market as well further up the risk curve.’

Valente claims that the decline of the euro against the US dollar means it is now much more in line with market expectations of future interest rate movements. ‘While this wasn't the case just six months ago, the euro seems to have caught up with market fundamentals.’

Euro set to decline further
The trend is likely to continue, he said, as any sign of a decline in quantitative easing by the European Central Bank (ECB) is likely to be seen as a negative signal by the market and could trigger a sudden increase in government bond yields and appreciation of the euro. ‘The ECB, as well as most of the other large central banks around the world, is thus bound to maintain an extremely accommodative monetary policy in order to maintain low interest rates and an attractive exchange rate.

‘The market is likely to pause for breath going forward given the decline in euro and the fact that the Fed is less likely to raise rates if it creates an unwarranted appreciation in the dollar, which penalises net exports and GDP growth in the US.’

Valente noted that the European economy has been stagnating for most of the past five years. ‘It did bounce back in 2010, but economic growth failed to take hold in the years that followed. Germany's GDP growth was a meagre 1.5% from 2011 to 2014.

Meanwhile, Southern Europe came close to bankrupting the whole euro area with Portugal, Greece, Ireland and Spain all requiring substantial bailouts. There is still substantial downside risk going forward and the Eurozone might yet disappoint, which would inevitably lead to a further depreciation of the euro.

‘Moreover, with the official unemployment rate in the Eurozone at 11.1% , and much higher in some countries - 25.6% in Greece, 23.0% in Spain - it is clear that the eurozone badly needs a period of currency undervaluation, a fact that the ECB appears to have taken on board.’

Self-fulfilling prophecy
Although the euro seems to have finally caught up with current market expectations, Valente claims there is a risk that the market revises its expectations for US interest rates again. ‘Indeed, the Fed might take advantage of any respite in the current market rally to tighten its monetary policy. This, again, would trigger another decline in the euro. Furthermore as the global economy, and in particularly economic growth in China decelerates, the US dollar is likely, once again, to appreciate as investors rally towards a "safe haven".’

Most importantly perhaps, the growing focus on euro parity against the dollar could become a self-fulfilling prophecy, Valente said. ‘Such a scenario would not be particularly surprising. In 1999, when the euro started trading, it was valued at $1.17. The capital markets quickly realized that this value was too high, and, by October of 2000, the euro had fallen back to just $0.83. The subsequent rebound saw the euro appreciate well past its equilibrium rate to reach $1.60 in 2008.’

It is highly likely that the sort of scenario played out in 1999 will be mirrored over the next few years, Valente predicted. ‘In the short to medium term the euro is likely to experience a period of undervaluation, perhaps falling to $0.80-0.90 before recovering to at least its equilibrium rate of $1.20.’

A weaker euro is inherently good news for the European economy, Valente continued. ‘The Eurozone can afford to attract some import-led inflation given the low level of inflation in Europe. A lower exchange rate should also support net exports and drive foreign direct investment in Europe. However, the euro's decline to date is unlikely to provide a real boost to economies in Southern Europe which arguably need a much bigger currency depreciation to become competitive again.’

On the other hand, a lower euro would ‘undoubtedly’ help Germany's economy which is much more reliant on exports outside the Eurozone, and therefore, more sensitive to changes in foreign exchange rates, he added. ‘It should also provide assistance to French and Italian exports which have fared rather poorly over the past 10 years in part because of the strength of the euro.’

On the whole, however, property fundamentals are unlikely to be affected by the recent decline in the euro, Valente said. ‘Stronger economic growth, if it materialises, will take time to feed through to the property market. Over the medium term, however, it could have a substantial effect on occupier demand and thus rental growth across all sectors particularly in Germany.’