Real estate to enjoy longer low interest rate regime

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1 FORESIGHT Real estate to enjoy longer low interest rate regime European Fair Value Index Q 015 9//016 Contents Overview Drivers of Fair Value Index 3 Market in Focus: Warsaw Retail 3 Cushman & Wakefield Fair Value Methodology Cushman & Wakefield's European Fair Value Index was 55 in Q, down from the Q3 published figure of 6 (Figure 1). The number of attractive investment opportunities in European commercial property has receded as yields have fallen and more have become fully priced. Just 38 of the 117 included in our index were classified as underpriced for Q, with industrial continuing to be the most attractive sector. Of the larger, Paris industrial, Madrid office and Frankfurt industrial show as underpriced. On the basis of pricing alone, the five most attractive are Riga industrial, Vilnius industrial, Riga retail, Antwerp industrial and Vilnius retail. With Eurozone interest rates unlikely to rise until 018 at the earliest we do not expect any rises in prime property yields in core Eurozone until 017/18. Rather, we think yields will continue to edge lower in the near term in some and that attractive investment opportunities will diminish further. We expect the fair value index to level off around 50 and not to show the precipitous decline that it did during the financial crisis. This is because we expect reasonable growth in most economies to filter through to rent rises, rather than the falls in rents brought about by the recession in the financial crisis. This report reflects the position as at Q 015. Since then, though, the oil price has hit decade lows, stock have fallen sharply, and worries about the global economy abound. Mario Draghi has signalled more monetary easing to come in the Eurozone in March, which would be supportive of real estate investment. However, although not our base case, the danger for property is that financial market turmoil is followed by weaker growth in the economy and rental and income growth are hit. Author Matteo Vaglio Gralin Associate Director, Research + (0) matteo.vagliogralin@cushwake.com Contacts Fergus Hicks Global Head of Forecasting + (0) fergus.hicks@cushwake.com Magali Marton Head of EMEA Research +33 (0) magali.marton@cushwake.com Figure 1 Cushman & Wakefield European Fair Value Index, Q More underpriced More fully priced Q 016 Q cushmanwakefield.com FORESIGHT 1

2 European Fair Value Index Q 015 Overview The all-property European Fair Value Index score for Europe was 55 in Q, down from Q3's published figure of 6. The index measures the attractiveness of European property on a relative pricing basis compared to government bonds. It assumes a five-year hold period (a score of 100 indicates that all are underpriced for investors and zero that all are fully priced, Table 1). Industrial remained the most attractive sector in Q, with an index score of 77 and 57% of classified as underpriced (Figure ). Retail was the second most attractive sector, with a score of 55, and 3 of classified as underpriced. The office index score fell further to 0, well below the 50 mark, and with only 16% of classified as underpriced. We expect the European Fair Value Index to decrease in the short term as investor demand continues to push property yields lower and attractive investment opportunities diminish. The office and retail indices are both expected to bottom out this year, while we expect industrial to reach its low only at the end of the forecasting period. In several European we expect yields to start to move out from 017/18. Of the 117 included in our European Fair Value Index, 38 were classified as underpriced for Q, 53 as fairly priced and 6 as fully priced. Compared to Q3, 19 have been downgraded, just two upgraded, while the majority of (95) saw no change in their Fair Value categories. Baltics, CEE and Eurozone Periphery regions have the highest share of underpriced (Figure 3). Germany has the majority of its classified as fairly priced, while the UK still has 19 fairly priced, and is further ahead in the cycle. The two classified as fairly priced in the other category are Moscow and Kyiv offices, both of which have high return forecasts due to double-digit yields. However, downside risks for these two are clearly high, particularly given the drop in the oil price, and our fair value model may be overly flattering them. Swiss continue to look unattractive due to their very low property yields (between %) and weak rental growth prospects. Of the larger, Paris industrial, Madrid office and Frankfurt industrial show as underpriced. In terms of pricing alone, three of the top five most attractive for Q are industrial; Riga, Vilnius and Antwerp. The other two are the retail of Riga and Vilnius. According to our fair value analysis, the top three are underpriced by 19% and more, with Riga industrial the most attractive, being 3% below fair value. However, the size of these would limit the deployment of large amounts of capital to them. Table 1 Fair Value Index TM scores GEOGRAPHY/SECTOR Q3 015 Q 015 Europe all-property 6 55 Europe offices 6 0 Europe retail 6 55 Europe industrial 8 77 Note: Q3 scores refer to those published in the Q3 report; charts show revised index scores, which may differ due to changes in property forecasts. Figure Cushman & Wakefield European Fair Value Index More fully priced Figure 3 Number of in each category by region/country Office Retail Industrial More underpriced Fully priced Fairly priced Underpriced *Other includes six from Turkey, Ukraine, Russia and Switzerland. Kyiv office has been added to the index this quarter, while Moscow retail has been removed cushmanwakefield.com FORESIGHT

3 Swiss Spain France Germany Finland Romania Netherl UK Belgium Sweden Italy Norway Denmark CZ Rep Russia Hungary Ireland Poland Turkey European Fair Value Index Q 015 Drivers of Fair Value Index Fair total returns Fair/required total returns rose for some European this quarter, driven by a higher illiquidity and risk premium component that offset the fall in bond yields. The illiquidity and risk premium in part depends on the spread between corporate and 5-year bond yields, and is a proxy for tenant risk. European 5-year bond yields remain at very low levels, supported by solid demand, boosted in the Eurozone by the ECB s QE programme (Figure ). The length of the programme was extended in December as inflation remains way below target. Bond yields dropped in Q in several, with Russia, Turkey, Italy and Spain seeing the biggest falls. The other two components of the fair total return in the model (transaction and depreciation costs) are stable throughout time. Forecast returns 015 was a record year for European commercial real estate activity and volumes surpassed 007 levels. Yields fell in Q in 37 of the 117 covered in our European Fair Value Index. For those in which yields fell, the average decline over the quarter was bps. We expect prime property yields to further compress this year in several European, supported by strong investor demand, a shortage of stock and the low interest rate environment. From , dependent on market, we expect yields to move out gradually due to less favourable investment conditions. Reasonable growth in most European economies is forecast to filter through to modest rent rises. For all the European we cover in our Fair Value analysis, we expect rents to rise by 1.5% p.a. over the next five years. Growth is pretty similar across all three sectors (Figure 5). Figure 5-year government bond yield cycle 5% min max Q % 1 5% -5% Source: Bloomberg Min-Max refers to Q Q 015 period Figure 5 Prime rental growth (five years from Q 015, p.a.) Simple Average Min-Max 8% Madrid Dublin Dublin % Edinburgh Berlin, Rome The Hague -% Office Retail Industrial Market in Focus: Warsaw Retail Ranked 31 st overall in our Fair Value Index TM for Q, Warsaw retail shows as underpriced by 7%. The Polish economy expanded 3.6% in 015 and is expected to expand by 3.3% p.a. over the next five years. Fair returns remained around 5.5% in Q, in line with previous quarter. A fall in the 5-year bond yield was almost offset by a higher illiquidity & risk premium component. Figure 6 Warsaw retail: fair and forecast returns 15% Fair return 1 5% Forecast return Expectations for further yield falls this year and moderate rental growth lead us to forecast prime total returns of around 7.% p.a. over the next five years, which outpaces fair returns by a margin (Figure 6). Q3 Q Q1 Q Q3 Q Q1 Q Q3 Q Q1 Q Q3 Q Q1 Q Q3 Q Year bond yield Depreciation cost Transaction costs Illiquidity & risk cushmanwakefield.com FORESIGHT 3

4 Figure 7 European office market Fair Value classifications, Q 015 Cushman & Wakefield Fair Value Methodology The Cushman & Wakefield Fair Value Index was launched in August 010 and covers 8 globally. Fair value is the value at which an investor is indifferent between a risk free return and the forecast return from holding property, taking into account the extra risk of investing in the property asset class. When a property price is at fair value, an investor is being adequately compensated for the risk taken in choosing to purchase real estate; similarly, when the property price is below the fair value price, an investor is being more than compensated for the risk taken in choosing to purchase real estate. When buying at or below fair value, an investor does not necessarily buy at the bottom of the market. Our Fair Value analysis focuses on prime assets and a five-year investment horizon, and hold for the market overall; individual transactions may provide opportunities and risks beyond the average market view. In the report we compare results for the current quarter with those published in the previous quarter s report, though the history of the Fair Value Index does change as our forecasts change. For more information please contact Matteo Vaglio Gralin: matteo.vagliogralin@cushwake.com cushmanwakefield.com FORESIGHT

5 EMEA John Forrester Chief Executive + (0) john.forrester@cushwake.com Disclaimer This report has been produced by DTZ Debenham Tie Leung Limited (C&W) for use by those with an interest in commercial property solely for information purposes and should not be relied upon as a basis for entering into transactions without seeking specific, qualified professional advice. It is not intended to be a complete description of the or developments to which it refers. This report uses information obtained from public sources which C&W has rigorously checked and believes to be reliable, but C&W has not verified such information and cannot guarantee that it is accurate and complete. No warranty or representation, express or implied, is made as to the accuracy or completeness of any of the information contained in this report and C&W shall not be liable to any reader of this report or any third party in any way whatsoever. All expressions of opinion are subject to change. The prior written consent of C&W is required before this report or any information contained in it can be reproduced in whole or in part, and any such reproduction should be credited to C&W. To see a full list of all our publications please go to cushmanwakefield.com or download the Research App Cushman & Wakefield 15 Old Broad Street London ECN 1 AR phone + (0)