London City, Prague offices remain 'warm' in double-dip scenario: DTZ

Nearly all European office markets would be unattractive for investors in a double-dip economic recession scenario, according to an analysis by DTZ due to be launched on Tuesday. Non-eurozone office markets would in general be more resilient but the only two exceptions to the general downturn would be London City and Prague.

Dublin, Madrid, Frankfurt and Paris La Defense are among the eurozone markets that could be hardest hit, the property adviser said.

DTZ claims office markets in London City and the Czech capital would remain 'warm' under its Fair Value index and that the two markets appear to offer reasonable value even in a recession triggered by eurozone sovereign debt defaults. The analysis, which looks at 45 office markets in Europe, is based on a double-dip recession scenario supplied by forecasting consultancy Oxford Economics. The scenario - which assumes a 'disorderly' sovereign default in Greece, Ireland and Portugal, though they stay in the eurozone - has been accorded a 20% probability of occurrence by Oxford Economics.

'This is the nearest to a worse-case scenario where we can still work out what might happen,' Tony McGough, global head of forecasting and strategy research at DTZ told PropertyEU. The base case supplied by Oxford Economics shows marginal growth of 1.8% in the next few years has a probability weighing of just 45%, reflecting the uncertainty in the market.

Banks, particularly those in France and Germany, would be hit hard by such sovereign defaults. Global equity markets would ‘collapse’, borrowing costs would rise and business and consumer confidence would plummet, the survey found.

The resulting recession, under the scenario, would see eurozone GDP dropping 1.1% in 2012 and 1.4% in 2012. This compares to growth of 1.1% in 2012 under the October base case and 1.9% in 2013.

The recession would trigger a decline in office demand and push rental forecasts downward. Eurozone markets would be the hardest hit, with the Nordic, Central and Eastern European and UK markets proving more resilient, McGough said.

Yields are forecast to rise in eurozone markets, with the greatest pressure in peripheral markets. Yields are lower in some non-eurozone markets as this reflects reduced sovereign bond yields.

The combined effect of rent declines and yield changes, DTZ said, would lead to lower total returns across nearly all markets over the next five years, with the exception of London (City) and Prague that remain attractive on current pricing.

Under the scenario, capital values would fall in many core eurozone markets but increase by 7% in Prague, not too far below the 11% rise under the base case. 'In London City the more modest hit to rents combines with slightly lower yields to leave capital values little changed in 2016 relative to the base case,' McGough said.

This illustrates that investors need to reconsider their perceptions of market risk in the current environment, DTZ said. 'We consider that in the event of a further escalation of the sovereign debt crisis, investors would be better off in markets outside of the eurozone, and that core German and French markets traditionally regarded as safe havens may actually present a higher risk of value falls.'

DTZ said it expected that it would take another three years before the majority of markets return to an attractive classification under the scenario.