By Kim Politzer, director – European research, Invesco Real Estate
We expect prime European real estate to continue to attract institutional capital looking for stability and income while secondary markets show the strain of little investor and occupier interest.
Investor caution has increased during 2012 and a focus on secure income rather than total returns remains a common feature of the market. Shorter income streams are being penalised both from a valuation perspective and also with regard to availability of finance. Consequently, while prime yields have been stable in most core markets, risk aversion has driven yields out in secondary locations and in some Southern European markets. Given that many institutional investors are targeting income returns of c.4.5%- 5.0%, we believe that there is little scope for further yield compression for the current narrow definition of prime real estate. However, accessing prime real estate product will continue to be difficult as investors continue to pay more for long, secure and stable “income” while sacrificing total return. For those targeting core strategies, although prime properties in gateway cities may look expensive relative to normal metrics, they may be considered to be fairly priced when compared with other asset classes. Over a five-year hold period we expect income and rental value growth to drive performance rather than significant yield movement and therefore market and asset selection in order to deliver this growth remains key. There has been little change to our view that the path of economic recovery in Europe will continue to be long and ‘bumpy’. We do not expect to see any significant economic improvement until H2 2013 and the growth forecast for in 2014- 17 is modest. Although the country level outlooks are relatively weak, we expect a number of local markets to perform better than their macro economies. These ‘gateway’ cities benefit from strong regional and global connectivity that helps to generate new business and jobs, and political structures often allow effective city level policy action to enhance this further. The major gateway cities are therefore expected to experience a return to rental growth first, as it is these cities that have the strongest GDP and employment growth prospects in the short-to-medium term. Real rental growth in these markets is forecast to return during 2014. Smaller cities and those in austerity hit economies may see further rental declines in the short term, and recovery is further away, especially in cities highly dependent on public sector jobs. Given on-going concerns about the resolution of the eurozone crisis, our analysis suggests a focus on markets outside the immediate, short-term volatility of the eurozone. While no European market is protected from the volatility we would expect the UK, Sweden and Poland (outside the eurozone) and Germany to show stronger relative performance. Supply constrained gateway office markets are expected to deliver the best short-term returns. These markets are likely to see the earliest recovery in occupier demand driving rental growth. Retail is expected to be strongest in dominant parks and shopping centres and on destination high streets where luxury brands continue to need a presence and will set higher rental levels. Weaker locations should be avoided as retailers continue to rationalise their store portfolios. Logistics is expected to continue to offer solid income returns and the growth of internet shopping is expected to benefit the logistic sector. Given the continued high level of uncertainty within the eurozone, investors continue to need to proceed with caution irrespective of their strategies as some markets lack pricing transparency while others look expensive but remain liquid, emphasizing the importance of having a strong local platform to fully understand and access the available opportunities.
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