Eurozone break-up would pressure rents and capital values

A break-up of the eurozone would lead to more enduring downward pressure on rents in Europe, especially in those countries that exit the monetary union, DTZ claims in its Global Outlook report for 2012.

This downside scenario, which assumes a double-dip recession in Europe, and up to five countries leaving the eurozone, would also lead to significant declines in capital values, not only across the eurozone, but also Asia Pacific markets. By contrast, the US would be more insulated from the impact of the downside scenario, DTZ says, due to its more limited trade linkages with Europe. Indeed, US capital values would actually increase under this scenario due to a projected tightening of US government bond yields which would steer investors towards prime property assets that offered higher income returns.

The downside scenario has become a lot more negative, as well as more probable, according to Tony McGough, Global Head of Forecasting & Strategy Research at DTZ. ´As a result, very few property markets are now isolated from its impact.´

DTZ puts the chances of a downside scenario at about 30% with a worst-case scenario seen as a Greek default triggering its departure from the Eurozone along with Italy, Spain, Portugal and Ireland. The likelihood of this scenario eventuating is put at 10%. This compares to a 45% probability for the base case scenario under which the Eurozone would continue to ‘muddle through’. The base case scenario draws on research from Oxford Economics.

While the outlook for 2012 has worsened and negative sentiment has triggered stronger investor interest in prime property in core markets, DTZ also sees potential upside in secondary markets. The momentum of economic growth in the US has also been building and even in Europe, Irish government bond yields have tightened over the last six months, notes Hans Vrensen, Global Head of Research at DTZ. ‘If the upside scenario occurs, we would expect to see more investor interest in non-prime assets as investors’ risk aversion subsides.’

Vrensen sees potential upside for secondary assets particularly in the UK where average office vacancy rates are less than 5%. ‘And for the past three years the economy has been pretty horrible,’ he pointed out in an interview with PropertyEU. While many investors are nervous about the impact of the debt issue for non-prime properties, Vrensen believe the outlook is better than generally expected. ‘We think it’s healthy to challenge the consensus view. The owners of lower-quality properties have not necessarily been interested in overleveraging in the past, so the situation is really a bit more nuanced as most expect.’

DTZ’s analysis of UK offices shows vacancy rates for Grade C properties are lower than for Grade A and B, McGough added. ‘Typical tenants of Grade C buildings are small and mid size firms forming the backbone of the UK’s economy, which have continued to tick over and have been in the same location for decades. There’s little likelihood of them moving.’

McGough believes an upside scenario where built-up corporate cash gets deployed could shift investors' focus towards non-prime. ‘A lot of non-financial corporates are sitting on loads of money and they don’t know what to do with their cash: give it back to their shareholders or direct it towards investment opportunities. This has become as apparent in real estate investment, development and occupier decisions as in other areas. All it would take is for confidence to return and eurozone debt issues to be successfully resolved for corporations to spring into a more proactive mode. This would push forward occupier demand and economic growth around the world.’