2017 Real Estate Market Outlook September …...1.7% in 2016.3 Despite the political stabilisation...
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Part of the M&G Group Real Estate Market Outlook Continental Europe September 2017
Transcript of 2017 Real Estate Market Outlook September …...1.7% in 2016.3 Despite the political stabilisation...
Part of the M&G Group
Real Estate Market OutlookContinental Europe
Sept
embe
r 201
7
3
Meanwhile in August, French factories reported they
were hiring at their fastest rate since 2000 and factories
in Spain at a rate not seen since before the start of
monetary union in 1999, according to IHS Markit’s
purchasing managers’ index (PMI).
On the region’s periphery, Greece made its first sale of
government bonds since 2014 in July. The bond issue
was an important indicator as to how Greece will cope
when the bailout payments stop and the country has to
meet its financial needs from taxation and borrowing
from the markets. The hope must be that a return to
the sovereign debt market represents a milestone on
the road to recovery.
The first half of the year also marked five years
since Mario Draghi’s now famous ‘whatever it takes’
remarks. At the time, funding costs for the periphery
had climbed to unsustainable levels. Spanish 10-year
government bonds traded at 7.5%, Italy at 7%, Portugal
at 11% and Greece at 27%. By finally acting as the
lender of last resort, the European Central Bank (ECB)
significantly decreased this risk. Its financial stimulus
alongside structural reforms and improved growth has
seen funding costs fall, offering the prospect of debt
sustainability for these economies. With 10-year bonds
at 5.3%, Greece’s return to market is clear evidence that
the peripheral recovery is well underway.
Loose monetary policy and reduced debt costs,
through the ECB cutting interest rates to penalise
saving, has encouraged investors to take on more
risk. This has served as a supportive backdrop for
improved consumer sentiment, higher asset prices and
a pick-up in consumption. This helps explain why the
performance of the retail property sector was the first
to recover in Europe followed closely by the office and
industrial sectors.
Executive summary• Eurozone growth continues to gather momentum
with recent actual data surprising on the upside
• Loose monetary policy and reduced debt costs
has encouraged investors to take on more risk
• Record low yields in CBDs are likely to persuade
investors to look further afield to find value
• A spread of up to 400bps of prime office yields
over government bonds offers a healthy cushion
and remains attractive
The populism movement appeared to be gaining
momentum across the developed world earlier this year,
but the Dutch and French election outcomes suggest
that the Eurozone has taken a different turn. Even in
Italy, where a lagging economic performance and
general election next year offer the potential for an
upheaval, sentiment is slowly improving.
Eurozone employment levels continued to recover over
Q2, with the unemployment rate in May downwardly
revised to 9.2%, stabilising at 9.1% a month later. In
the core countries, the unemployment rate declined in
June to a record low of 3.8% in Germany, but remained
unchanged in France at 9.6%. However, Macron’s
immediate priorities are centred on domestic policies
including labour market reforms and therefore the trend
is likely to improve. In the periphery, the unemployment
rate in Spain fell to an 8-year low of 17.7% while in Italy
it picked up modestly from 11.2% to 11.3%.1
Political risks recede as fundamentals improve
47%share of foreign capital
targeting Europe in Q2Source: CBRE
9.1%1
European unemployment in June
2.0%consensus forecast for
Eurozone 2017 GDP growthSource: Consensus Economics
Source: Bloomberg.
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Fig 1: European Commission economic sentiment indicator
1 Source: Capital Economics, Bloomberg.
4
Eurozone growth continues to gather momentum with
recent actual data surprising on the upside. Q1 real gross
domestic product (GDP) growth was revised up from
0.5% to 0.6% q-o-q, marking the sharpest expansion
since Q1 2015.2 Eurozone Q2 GDP grew in line with Q1,
as suggested by the composite PMI indicator despite
falling in June. The performance helped to drive y-o-y
expansion from 1.9% to 2.1% — the highest rate since
the second quarter of 2011 and now higher than the 2%
UK equivalent.
In terms of the year as a whole, Belgium, France,
Germany, Spain and Sweden received GDP consensus
forecast upgrades in August, resulting in an overall
Eurozone forecast growth of 2.0% for 2017, up from
1.7% in 2016.3
Despite the political stabilisation seen in the Eurozone,
lower borrowing costs and a generally improved
economic outlook, the ECB continues to avoid breaching
its inflation target ceiling of 2%. Indeed the headline rate
fell from 1.9% in April to 1.3% in June while core inflation
rose from 0.9% to 1.1%, mainly driven by the German
economy already working at full capacity. Elsewhere,
Spain, France and Italy all have large output gaps and
so inflation there should stay lower for longer. Overall,
oil prices have been ebbing, which suggests inflation will
remain contained.
Economic recovery gathers pace
While central banks globally dither over interest rate
changes, the Czech central bank became the first
European central bank since the global financial crisis to
raise rates (to 0.25%) in August. The ECB, on the other
hand, has shown no signs as of yet of following Prague’s
lead. The Bank will most likely wait for further firm
evidence of a sustained rise in inflation before raising
interest rates. According to the August Morgan Stanley
first-interest-rate-hike survey, the consensus estimates
that the ECB won’t increase rates during the next 20
months (until 2019).
Real estate fundamentals are responding well to the
improved economic environment with the office sector
seeing the strongest rental growth in the year to Q2
(up to 9.7% in Stockholm followed by 9.1% in Brussels).4
Across Europe, the supply response remains modest.
Even where the largest available stock and pipelines
can be found in Northern cities such as Amsterdam,
Stockholm and Luxembourg, strong job creation is
generating demand to absorb it. The major exception
is Helsinki, where employment growth has remained
tepid for the last four years, reflecting declining or flat
GDP. However, the pick-up in growth to 2.3% in 2017
could mark a turnaround in the Finnish market.5 Indeed,
supported by a lack of modern space, rents grew by
4.7% in the year to June, the third highest rate in Europe.
A lack of office development, coupled with a strong
labour market, means that German cities, such as Berlin
and Munich, have some of the tightest office markets
in Europe. According to Cushman and Wakefield, these
cities will have the second and third lowest vacancy
rates in the world by 2019 of 3.1% and 3.3% respectively,
just behind Sydney.6
Occupier markets buoyant
Source: Bloomberg.
Infl
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Core (Excl. Food, Alcohol, Tobacco & Energy)Headline ECB Target
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Fig 3: Eurozone headline and core inflation
2017 real GDP forecast % y-o-y
Italy
France
Belgium
Germany
Eurozone
Sweden
Spain
June July AugustMay
0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5
Source: Consensus Forecasts, August 2017.
Fig 2: 2017 GDP forecasts
2 Source: Bloomberg.3 Source: Consensus Forecasts, July 2017.4 JLL Q2 2017.5 JLL Q2 2017.6 Source: Global Forecast: Are we Overbuilding? Cushman & Wakefield,
July 2017.
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In the industrial sector, positive economic growth and
structural changes related to e-commerce continue
to support healthy demand. Logistics completions are
rising, but the risk of oversupply remains concentrated in
a few markets. Industrial rents across Europe remained
broadly stable in the year to Q2, save in Helsinki (6.7%),
Dublin (6.2%) and Italy (5.8% in both Rome and Milan).7
With the fundamentals for this sector significantly
improving, we expect a pick-up in rental growth going
forward. Our view is supported by the lag compared
to UK and US logistics markets, which have already
benefitted from e-commerce trends.
We expect the European industrial cycle to be led
by Dublin with an average rental growth per annum
exceeding 4% over the next three years, followed by the
Nordic markets of Copenhagen, Helsinki and Stockholm.
Southern markets follow closely with Barcelona, Madrid
and Milan expected to deliver an average rental growth
of up to 3% pa over the same period.
Fewer retail markets are recording increased rental
growth compared to the start of the European property
cycle. Notable exceptions include markets in the fast
growing economy of Sweden and recovering southern
markets. The strongest year to June rental growth of
8.3% was recorded in Lisbon, Portugal, while rental
growth in the core retail shop markets of France and
Germany remained stable over the same period.7
Driven by private consumption underpinned by
monetary policy, retail was the first sector to recover
and therefore is most likely to stabilise ahead of other
sectors. Nonetheless, we expect supply-constrained
high streets located in established tourist destinations,
such as Madrid and Milan, to continue to outperform
throughout the cycle. Overall, we expect an average
rental growth of 2% pa over the next three years for
the combined shop, retail warehouse and shopping
centre sectors.
Over the next three years, we forecast the next leg of
the property cycle to be driven by Stockholm, Berlin,
and Brussels with average rental growth in select
submarkets exceeding 4% pa. Outside Northern cities,
development pipelines are significantly smaller, with the
exception of Dublin, reflecting higher existing vacancy.
At c.3% pa, we expect Barcelona and Madrid to deliver
the strongest rental growth over the next three years
among southern markets.
On the Brexit debate, Frankfurt appears to be the
biggest beneficiary of financial services jobs moving
out of London. In July, three Japanese banks, Nomura,
Daiwa, and Sumitomo Mitsui all announced new EU
headquarters in the German financial capital. In the
same month, Citigroup, Morgan Stanley and Deutsche
Bank also confirmed they would send staff to Frankfurt.
In June, however, Colliers recorded less than 10,000
Brexit-related financial services job relocations across
European financial centres including Paris, Dublin, and
Luxembourg. With a current vacancy rate above 10%,
we forecast a more modest average rental growth
of less than 2% pa for Frankfurt offices over the next
three years.
Source: JLL.
Pri
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EuropeUK US
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Fig 6: Prime industrial rental growth
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Availability Index (2009 = 100)
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Source: PMA Spring 2017 (excludes Nordic markets).
Fig 5: Modern logistics stock estimated take up and availability index
% o
ffice
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End 2016 vacancy (LHS) Total net additions 2017-19 (LHS)
Employment growth % 2017-19 (RHS)
4.5
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Source: PMA Spring 2017.
Fig 4: Prime available office space (% stock) and forecast employment growth (2017-19)
7 Source: JLL Q2 2017.
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sector. In the office sector, yields in Amsterdam, Milan,
Brussels and Stockholm fell by 25bps. Prime office
yields in Paris and Berlin stand at around 3.0%, with
an increasing number of markets now approaching
historical lows. For shops, only Brussels, Prague and
Stockholm yields fell by 25bps, all to 3.5%. Yields also fell
by 10bps in Milan and Rome to 3.4%.8
Record low yields in CBDs are likely to persuade
investors to look further afield to find value. Edge of
CBD submarkets, for example, continue to offer more
attractive pricing, and also benefit from limited supply
and strong prospects for rental growth. With transport
links improving across European cities, as governments
invest more into both digital and physical infrastructure,
submarkets deemed to be core are expanding. Given
the discounts on offer, non-CBD submarkets with strong
occupier fundamentals and greater urban connectivity
can provide opportunities to higher returns. For example,
in Stockholm, the development of a subway extension
from the city centre will boost the prospects for the
Solna/Sundbyberg district. Equally, the Grand Paris
project, with phased scheduled completions from 2019
to 2027, will see a number of edge of CBD submarkets,
including Saint Denis, benefitting from improved
transport infrastructure, such as new metro lines 14, 15,
16 and 17 as well as the extension of RER C.
Looking ahead, only one in four real estate investors in
Europe believes that the current market cycle will peak
soon, according to the findings of the latest property
investment climate study by Union Investment. Three
quarters of respondents do not expect it to peak until
after 2018. Of that figure, 43% expect the peak in 2020
or later.
In summary, the European property market continues
to be characterised by ongoing economic growth,
limited available supply, and attractive relative pricing.
Moreover, business confidence remains undented by
various political elections in the first half of the year,
with the Eurozone GDP projection for 2017 (2.0%) now
higher than the actual 2016 figure of 1.7%. Monetary
policy is likely to remain ultra-loose for a long while. Given
the weight of capital targeting European real estate,
coupled with an expected lag between government
bond movements and prime property yields of between
18 to 24 months (according to Capital Economics), we
expect further inward compression to continue albeit at
a slower pace in the short to medium-term. Underpinned
by improving demand fundamentals, we expect the
European property market to continue delivering strong
investment returns going forward.
Conclusion
Real estate investment markets have so far not been
deterred by upward movements in government bonds
(up to 24bps in German 10-year government bonds over
Q2), with the share of foreign capital targeting Europe
increasing over the last year from 33% to 47% in Q2
2017. A spread of up to 400bps of prime office yields
over government bonds offers a healthy cushion and
remains attractive.
Overall, Europe has had a positive start to the year
with Q2 investment volumes (€50.7bn) rising by 26%
q-o-q and 15% y-o-y. On a 12-month rolling basis,
Germany remains the main driver of investment activity
in the region at €61.2bn. Other markets, such as Finland
(+66% in Q2 y-o-y) and Spain (+76% in Q2 y-o-y), were
also more active as more stock came to the market.
Competition for the best assets remains widespread
with further yield tightening of up to 25bps in Q2. The
greatest yield compression took place in the logistics
Investors targeting European property
Yie
ld %
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Spread Government Bond YieldPrime Office Yield
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Source: PMA Spring 2017, Bloomberg.
Fig 7: Prime office spreads vs 10-year government bonds
8 Source: JLL Q2 2017.
0
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Q4 2006
Q2 2007
Q4 2007
Q4 2008
Q2 2008
Q2 2009
Q2 2010
Q4 2009
Q4 2010
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Q2 2012
Q4 2013
Q2 2013
Q4 2014
Q2 2014
Q4 2015
Q2 2015
Q4 2016
Q2 2016
Q2 2017
Germany Peripherals Nordics France Benelux CEE Other
Source: CBRE Q2 2017.
Fig 8: Rolling annual investment volumes €billion
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+44 (0)20 7548 6714
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