European markets starting to normalise, Investment Briefing hears

The spreads between property and bond yields in the core markets of Europe are still sufficiently attractive for real estate investors, according to Guy-Young Lamé, associate director of research at Invesco Real Estate.

‘The average yield for prime is around 6%, which still marks an attractive premium above bond yields. However, bond yields are starting to normalise so they remain a key warning signal for us to monitor,’ she said during a presentation on the 2014 outlook for European real estate at the PropertyEU Investment Briefing in Paris yesterday. The Outlook Briefing was held at the Paris office of law firm Taylor Wessing.

With weak growth expected to remain a key feature of the European macro-economic picture in 2014, Germany continues to be the most robust economy in the Eurozone, Lamé said. But Southern Europe is set to converge with the core European GDP growth trend from 2015 onwards while CEE continues to outperform, she noted. The best opportunities in terms of attractive yields are in these regions, she added. ‘Poland and Russia are growing the most.’

Several markets in Europe have already re-priced, but others offer stronger potential of growth, Lamé said. ‘Core markets are stable, but security comes at a price. IRRs for core markets are around 6% compared to 8-9% in Southern Europe. In CEE, there’s also more room for higher yields. Investors will continue to focus on core in 2014, but with weak growth, prime yields and returns will remain low.’

Real estate transaction activity is already starting to normalize in the major European markets like France where Lamé predicted that investment volume would reach €15 bn this year. It is also starting to pick up in Spain and Italy, with both markets booking growth in excess of 100% in the first half of this year. ‘Liquidity is improving in Italy and Spain, we’re seeing improving appetite.’

CEE is likewise booking significant recovery, albeit at a less spectacular pace than in Southern Europe, with growth of 23%. By contrast, investment activity in France contracted over the six-month period, by 16%.

Capital values are still historically low in some markets, Lamé pointed out, adding that this was a good barometer to measure potential growth. This applies in particular to countries in Southern Europe - Lamé is predicting a turning point for Spain next year - but also to some market segments in the Netherlands, Ireland and Poland.

Lamé expects market-led rental growth in the office sector to remain weak in the short term, but stronger rental growth is expected from 2015, reflecting rebounding GDP growth. Rents also remain under pressure in the retail sector due to weak spending and this is not expected to change in the next 12 months given the outlook for sluggish consumption growth. At the same time, retail yields have hardened significantly. Lamé: ‘Retail is still a focus for Invesco, but it is not as dominant as last year.’

By contrast, prospects for the logistics sector in Western Europe look relatively bright on the back of rising e-commerce sales which are forecast to grow by 11% per annum over the next five years to €191 bn. ‘This growth should continue to support a steady increase in demand for logistics units across Europe,’ Lamé said. ‘We are still a buyer of long-let logistics.

While the macro-economic outlook remains anemic or even fragile, one bright spot is that concerns about the eurocrisis have subsided in the past 12 months. ‘The eurocrisis is less of a story thanks to the ECB,’ agreed Martin Vest, managing director Western Europe at Aareal Bank. ‘But,’ he added, ‘that is not due to the politicians. The issue is still there and so is the public indebtedness. I can’t see how we can reduce public debt with low growth rates and low inflation. I don’t see a way out either. At the moment, nobody seems to care all that much if you look at the capital markets, and that is definitely thanks to the ECB. But that could change very quickly.’

Nevertheless, the financing markets are starting to normalise, he noted. ‘Core debt is available. Maybe not at the best conditions, but it’s less of an issue than it was 12 months ago.’ LTV ratios are starting to creep up again, but in general Aareal aims to limit leverage to 50-60% across Europe, Vest said. ‘Finance is less of a story for those seeking loans, it’s more of a story now for the banks. We’re seeing more competitors, with new players like debt funds and insurance companies and there is a deal flow now for non-debt providers. There are definitely areas and products that we wouldn’t finance, but in the segments where we are active like offices, logistics, retail and hotels, prices have gone down for finance.’

While investors are finding it increasingly easy to obtain finance for their investment products, the banks still have some issues to deal with which is curbing their appetite to finance product outside core markets, Vest said. ‘We have to hold higher liquidity ratios than before the crisis. As a result, we will confine our activity to Ile de France region for the time being. That’s one of the lessons we’ve learned from the financial crisis.’

Since the outbreak of the financial crisis, debt finance has been very restricted in Spain and Italy, but Aareal is now looking again at Spain, Vest said. ‘We have initiated internal discussions about Spain. A good sign for Spain is that we’re not just seeing opportunistic investors and hedge funds investing in the country, but also long-term institutional investors.’

Nevertheless, not all opportunities can be financed, Lamé pointed out. ‘There’s a clear divide. You can’t get finance for a secondary office in Strasbourg, for example. Spain is improving, but there’s still a lack of financing.’