Tenant default poses threat to property income returns: Invista

European property markets have delivered attractive income returns over the past two years despite the economic crisis, but the risk from tenant default for future returns should not be underestimated, Invista Real Estate Investment Management warns in its latest research report.

With interest rates expected to remain low in the short term, Invista predicts an increasing weight of investor capital will seek income-producing property investments. The company's forecasts suggest income returns will range from 5% in Austria, Belgium and Germany to more than 7% in Finland, Ireland, Portugal and Spain. However, the risk to property income returns from tenant default is considered to be above ‘normal’ levels, primarily as a result of the worst global economic conditions of modern times. Pricing trends in the Eurozone CDS (credit default swap) market suggest that default risks are highest in the telecommunications, utilities, banking and insurance sectors, in contrast to the retail, technology, food & beverage and industrial sectors.

Rental growth is expected to depend on the level and sustainability of economic and employment growth over the next few years, both of which have become more uncertain in the short term due to initiatives to reduce government budget deficits. This suggests that 2010 will be the worst year for rent declines in the current cycle. Over the longer term, Invista sees modern office properties located in supply-constrained city centres such as Paris, Munich and Vienna, as potential growth winners within the European market.

The retail sector is expected to remain under pressure due to weak consumer spending, however, 'hotspots' for rental growth could emerge as retailers consolidate within the best units and centres in a 'flight to quality' to protect their profits. This could generate some competition and a degree of rental growth in prime city-centre locations and dominant regional shopping centres. The same can be said for logistics/distribution market rents, where a 'flight to quality' is also expected to emerge amongst distribution occupiers, which could support prime rents in hub locations.

Tim Francis, Director of Continental European Strategy & Research at Invista, commented: 'Over the longer term in Continental Europe, income returns have typically made a greater contribution to overall property performance than capital growth, both in cyclical and non-cyclical markets. Taking into account the subdued outlook for rental growth across Continental Europe, we therefore expect investors to remain focused on preserving and enhancing income returns at their currently attractive levels, and thus are unlikely to be attracted to higher risk, capital growth investments.'