Fidelity International has warned that higher prices and yield depression are pushing European prime real estate into 'bubble' territory, exacerbated still further by the behaviour of new investors.
'We are concerned by conditions at the prime end of the real estate market which could presage trouble ahead. For years, prime commercial real estate in the Eurozone was seen as more stable than other major centres in the US and UK,' commented Adrian Benedict, real estate investment director at Fidelity International.
According to Fidelity, notable institutions such as life assurance companies and retail funds are shifting their allocations to real estate in the hunt for yields, as a result of the depressed return on bonds.
'With a significantly lower cost of capital than those already in the market, they are therefore able to pay higher prices and accept considerably lower yields. However, having only experienced decades of relatively safe products with attractive, tax-free, guaranteed yields from liquid investments, this group is less aware of the risks of real estate investments,' the Fidelity report notes.
This 'distinct' group of new investors, with a tendency to hold prime assets, is likely to place further pressure on prices and could ultimately depress yields to 'unsustainable levels that no longer compensate for the capital risk involved'.
Forced sales
'We currently find ourselves in a situation with new investors who are not entirely familiar with how this asset class works and believe it can be exited flexibly when required. Their demands for liquidity could easily collide with a reality of forced sales and collapsing returns, or even investor lock-ins, when the market turns,' explained Benedict.
'We do not think the market has reached this level yet, and, unlike previous cycles, this new investment is not leveraged, which is encouraging. But we are increasingly cautious; it has all the hallmarks of a bubble which buyers enter at their own risk.'
Despite this, Fidelity said that not all segments of the property market were 'red hot'. The current spread in pricing between prime real estate and the rest of the institutional grade market - standing at around 200 basis points (bps) - was 'almost double the long-term average'.
Benedict concluded: 'We would urge investors to ensure they are not over-exposed to prime property, and to seek out non-prime investment within the Eurozone or elsewhere which can still command a sustainable yield.'
See also an analysis by CapitalWatch editor Robin Marriott in the latest edition of EuroProperty: Fidelity sounds the alarm on prime European real estate'
