Q: What are the main foreign investment trends in Europe’s real estate market?
A: Although the start of this year was marked by a decline in European transaction volumes, demand for European real estate remains strong by historic standards, with institutional investors’ relative allocation to real estate continuously increasing and new Asian market participants entering the European market.
The current low-yield environment is pushing investors further up the risk curve in search for yield. European investors looking outside Europe face high foreign exchange hedging costs, with the reverse being true for investors from the US and Asia looking into Europe.
Q: What is the greatest opportunity and challenge for FDI in Europe’s real estate market?
A: The European economy is still in expansion mode and seemingly behind the Americas in its economic and property cycles. Interest rates are ultra-low and although property initial yields compressed considerably in recent years, the current yield spread to government bond yields remains attractive by historical standards. The outcome of the political uncertainty in today’s market might have an impact on this, so investors are still cautious in committing capital.
In general terms the rental market benefits from the economic climate, so supply constraints continue to drive rents upwards in select pockets of the real estate market. Competition from office, retail, logistics and residential occupiers push capital values per square metre to unprecedented heights in the city centres of the ‘winning cities’. Those cities that attract the three Ts: tourism, talent and technology innovators, through culture, entertainment and career prospects will continue to be regarded as Europe’s outperformers and continue to attract significant investment.
Q: What is your forecast for the real estate market?
A: Over the next five years, the forecast average return from property is lower in Europe and globally than over the past five. Drivers are moderating rental growth and a forecast increase in interest rates, which will likely affect initial yields on property, albeit not one for one, as well as leveraged returns.
By sector, logistic assets in prime locations are expected to continue to outperform other asset classes in the near term, supported by continued strong occupier fundamentals (growth in ecommerce, including the convenience market) and investor appetite for the sector, which will maintain pressure on yields.
Prime high street pitches in the winning cities are also expected to be resilient and will be supported by an increase in tourism and the consolidating demand of retailers for space in locations with high targeted footfall, to be used as a branding tool, while opportunities in the office sector will remain present in select European cities benefiting from tech demand and the advent of modern ways of working.
Q: What are the most exciting or up-and-coming cities in Europe for real estate?
We would no longer describe Berlin as up-and-coming but we consider it to be exciting as an upscaling market that continues to catch up with other European peer capitals in terms of capital value growth potential. Although pricing has increased considerably over the past five years, we can still find pockets of the market that are going through a substantial uplift.
In Southern Europe we look at Madrid and to some extend Lisbon, as the recovery scenario is solid and is promising upside potential to investors given the yield spread to core Western Europe. Despite the current political uncertainty in Italy, regarding the impact of potential policies on economic growth and interaction with Europe, we still consider Milan as an up-and coming city as the regional economic fundamentals are sound and there is limited supply risk.
Q: What other trends have you identified?
A: We consider urban intensification as a key trend and a structural demand driver. The combination of strong population growth in prosperous urban areas across Europe combined with often limited potential for expansion at the city fringes will increasingly create a shortage of supply for Grade A space, whether for retail, office or affordable residential use.