While Europe has not experienced a real estate frenzy on a similar level to that of the US (London, perhaps, being the exception), economists say brisk mergers and acquisitions (M&A) activity is boosting real estate markets and cross-border investment. A big driver for the Baltic and central and eastern European nations is the race to attract foreign direct investment. Scores of companies are locating there to take advantage of lower costs and close proximity to major European markets.
“Although property prices in places such as Prague, Budapest and Warsaw have risen over the past few years, there are still bargains to be had in secondary cities,” says inward investment consultant Adam Breeze. “Even with cost advantages being eroded year on year and new competition from further east, the new EU states represent excellent value, given their overall cost-quality balance.
“According to figures published in January, investment in real estate in central and eastern Europe exceeded E5bn in 2005. While 90% of this was in the new EU member states, other emerging markets are also receiving interest,” he adds.
High yield markets
Frustrated by stock shortages, many real estate investors continue to diversify into higher yielding markets such as central and eastern Europe, particularly in the logistics and manufacturing markets, where demand is high and will remain so.
“For manufacturers it is all about offshoring [to Asia] or nearshoring [to central and eastern Europe],” says Nigel Rowe, head of European industrial and logistics at Cushman & Wakefield/Healey & Baker (C&W/H&B). “The only new manufacturing operations in western Europe are those that are small, specialised and technology or expertise-based.”
The site selection preferences of car manufacturers prove Mr Rowe’s point. Most of them have moved assembly operations to countries such as Slovakia, Hungary and Russia, while their suppliers now flood locations in places such as Romania, Bulgaria and Ukraine.
But Mr Rowe believes this trend will not be sustained. “Already the grants and labour availability have run out in Slovakia, hence the push to the new locations,” he says. “Portugal was the ‘go to’ location 15 years ago. Now manufacturing is shutting down wholesale and moving east.”
Meanwhile, demand for industrial space in all western European countries is moving forward positively but cautiously. “Most locations will report demand greater than supply, so there is upward pressure on rents and prices. But demand is very selective,” he says.
With increased manufacturing and industrial activity come greater employment opportunities. Looking back on the third quarter of 2005, a study by IBM-Plant Location International estimates that Poland, Slovakia, Romania and the Czech Republic experienced job growth of 22%, 14%, 10% and 9%, respectively, compared with an average of 6% for the same period in 2004. “Last year, western European countries continued to lose market share,” says the report.
Nevertheless, Marc Lhermitte, a partner in Ernst & Young’s international location advisory team, contends that both western and eastern Europe will remain attractive for FDI, given the continent’s diversity, with competencies ranging from high tech R&D to heavy manufacturing.
As a result, there remains strong demand for industrial space in western Europe, with many developers now preferring to pre-lease projects or even turning to building speculative developments.
C&W/H&B says that from September 2005, the highest rents obtained for industrial projects were in the Netherlands, France, Russia, the UK and Denmark. The best performers experiencing yield compression were Poland, Denmark, France, Slovakia and the Netherlands.
Given the huge influx of goods being imported from Asia via Europe’s major seaports and airports, demand for distribution space in and around locations such as Rotterdam, Hamburg, Paris, Frankfurt, Amsterdam and London also continues to escalate. Investors and developers of distribution space, such as AMB, are attracted to important western European gateway markets.
However, a hurdle for key western European locations is the reluctance of many communities to grant permission for distribution centre construction. Most equate distribution and warehousing with increased traffic and little employment growth. The office market indicates a different picture. While its outlook is improved, recovery here is slow and supply-driven. Eric Peeters, C&W partner based in Brussels, says that vacancy rates are declining and are less than 10% on average, with 11 million square metres of available space throughout Europe. “Take up is improving, particularly in the private corporate sector,” he adds.
In 2005, approximately 9.5 million square metres of office space in Europe was leased or sold, compared with 9 million square metres in 2004.
“Sixty per cent of the deals are transactions of 0-500 square metres and 25% of the deals are transactions between 500-1500 square metres,” Mr Peeters says. “Seven per cent are 1500 to 3000 square metres; 6% more than 3000 square metres.”
Rents are stabilising, but incentives remain high. “For 2006, we expect a further decline in vacancy rates, an increase in demand from corporate occupiers and rental incentives declining,” he predicts. He points to Spain, Poland, Hungary, Romania, Switzerland, Russia and Italy as ‘hot’ centres.
In Poland, distinct sub-markets are emerging as Warsaw matures. Demand is up in the central business district fringes and non-central locations (NCL), and rents are stable, but net effective rents are still falling as landlords compete for tenants. NCL supply is starting to respond to demand with new development.
Meanwhile, in Russia average lease lengths are getting longer for modern space as the office market grows and matures, with many landlords now offering seven-year terms.
According to C&W/H&B, rents overall are firm or rising, averaging growth of 1.6% between January and September 2005, with increases in cities such as Madrid, Barcelona, Oslo, Geneva, Milan and Turin in the West and Moscow, Sofia, Budapest and Brno to the East. With overall business confidence up, the group sees better potential performers such as London, Paris, Barcelona, Madrid, Helsinki, Milan and Stockholm. According to global real estate service provider NAI, minimal new development in London, coupled with a strong financial services sector, has resulted in higher absorption and lower vacancies hovering around 10.5%.
Paris is also experiencing improved absorption, with much of the demand derived from companies undertaking cost reduction and rationalisation activity. Development activity in Paris has remained relatively subdued, pushing the vacancy rate down to about 6%.
So where are the real estate markets in Europe heading? C&W/H&B specialists in London predict in the company’s Market Beat Europe 2005-2006 that given the level property demand and higher confidence regarding Europe’s economy, yields will fall further in 2006. Even as European real estate prices soared to record levels in 2005, trading volumes in 2006 are expected to exceed those of last year by 14%, with about 115bn eurodollars’ worth of assets changing hands by the end of the year.
“The outlook for trading volumes in 2006 is positive,” says Michael Rhydderch, partner in C&W/H&B’s cross-border European capital markets team. Although further yield compression is expected but not projected to be sustained at the current pace – yields hit a 25-year low last year – Mr Rhydderch maintains “this will only take the froth out of the market and demand will remain ahead of supply for all sectors”.
According to C&W/H&B, total returns in western Europe averaged approximately 15% in 2005; returns are projected to average around 12% this year. Still, while experts maintain that interest rates will remain low in the first half of 2006, they might rise in the second half and, therefore, put a damper on real estate markets.
So who is the overall market leader? Ernst & Young points to the UK, where very attractive fiscal policies and quality services and infrastructure has attracted significant FDI in recent years, benefiting companies involved in everything from manufacturing to high technology.