European Quarterly Outlook JULY 2011

Transcription

1 European Quarterly Outlook JULY 2011

2 EUROPE Executive Summary Key Themes Economic growth is improving steadily and interest rates are rising, although concerns about the outlook persist. Forecasts could get revised down if the sovereign debt crisis escalates. Real estate transaction volume continues to be dominated by large office and retail deals, mainly at the prime end of the market. Reflecting mixed news on the economy, corporate occupiers remain very cost conscious and competition for space is minimal. Rental growth is limited to supply-constrained office CBDs and a handful of prime retail markets. Bank lending continues to focus on core. Except for properties that are substantially pre-let, development finance is still largely off the table, which could leave Europe s major markets short of stock in the coming years. Implications and Outlook for Commercial Real Estate The interaction between weak economic forecasts and a lack of supply are key to the rental market recovery. Prime retail assets should record the strongest rental growth once the consumer recovery gains traction. With about 520 billion of real estate debt maturing over the next three years, a significant funding gap is expected as banks reduce their real estate exposure. Prime markets look expensive and yields are set to drift outwards. Secondary yields remain elevated and have room to fall, but this can only occur once occupier activity strengthens and banks rediscover their appetite to lend in this space. Increasingly, low returns on prime assets will put pressure on investors to explore higher-yielding value-added strategies, including providing debt finance. 1

3 MACROECONOMIC ENVIRONMENT Sovereign Crisis Threatens to Spread The sovereign debt crisis has spread beyond Greece, Ireland and Portugal and is threatening to engulf Italy, the world s 8 th largest economy. Eurozone policymakers initially employed measures to ease liquidity, which have so far failed to calm market nerves. But there are positive signs that the focus is now turning to address the insolvency problem at the heart of the crisis. Despite the ongoing debt crisis turmoil, core European GDP growth has been robust so far in 2011 and consensus forecasts have been edging upwards. A number of challenges remain, even if the debt crisis is successfully resolved. Interest rates are now rising and disposable incomes are under pressure from austerity measures; the consumer outlook remains mixed. Weaker growth news being reported by the US is a source of further discomfort. Sentiment among Europe s corporate occupiers is still shaky, highlighted by the drop in the forward-looking Purchasing Managers Index in 2Q11. Annual GDP Growth and Economic Sentiment Indicator for the EU27 6% 125 Forecast 4% 115 2% GDP Growth Forecast -2% 85 GDP Growth -4% 75 Econ. Sentiment Indicator (Right Axis) -6% Month Euribor and Euro Area 5-year Swap Rate 6% 5% Forecast 4% 3% 2% 3M Euribor 1% 5-year Swap Rate SOURCES: EUROSTAT, BLOOMBERG, RBS, CONSENSUS ECONOMICS, PRUDENTIAL REAL ESTATE INVESTORS 2

4 TRANSACTION VOLUME Investor Sentiment Mixed Overall investment volume has disappointed relative to expectations so far this year. Sentiment is undoubtedly being weighed down by concerns about the strength of the recovery and the escalating sovereign debt crisis in the eurozone periphery. Another factor holding back activity is that debt is still hard to secure on non-prime assets. Transaction volume continues to be dominated by large office and retail deals, mainly at the prime end of the market. 2Q11 sales volume in the European private markets was 25.4 billion (US$35.6 billion), up 14% on a lacklustre first quarter, according to DTZ Research. There is a risk that total investment volume could fall short of its long-term average in Private Investment Transaction Volume, Bil Rest of Europe United Kingdom Germany France 10-Year Average FORECAST FORECAST 2Q07 4Q07 2Q08 4Q08 2Q09 4Q09 2Q10 4Q10 2Q11 4Q11 Share of Total Private Investment: Office & Retail 6 One bright spot is the rebound in cross-border investing, which has risen by 34% over the past 12 months. Overseas investors have been targeting prime office and retail deals, with a focus on the deep, liquid UK market and relatively healthy economies such as Sweden and Germany. Investors are increasingly attracted to retail, which commanded a robust 37% share of investment during the first half of SOURCES: DTZ RESEARCH, PRUDENTIAL REAL ESTATE INVESTORS Office Retail

5 INVESTMENT PERFORMANCE Yield Shift Easing in Prime Markets According to flash estimates from CBRE, prime office yields fell by just 5 bps in Western Europe in 2Q11 and have dropped by a total of just 10 bps since the start of the year. The lack of yield impact on values in 2011 reflects the subdued nature of investment market activity. Part of the story may simply be that prime markets look expensive. Prime property yields remain below long-term averages and rental growth has yet to validate the repricing that occurred in In search of better returns, investors are increasingly shifting their focus to good secondary as well as retail, although a lack of debt for acquisitions is holding activity back. Secondary yields remain elevated. Nonetheless, the spread between prime real estate yields and risk-free rates remains high particularly when compared to German bond yields. This should continue to provide incentive for core real estate investing % 6% 5% 4% 3% 2% 1% Estimated Annual All Property Prime Total Returns Yield Impact Income Return Rental Growth Total Return Year Government Bonds and Europe ex UK All Property Prime Yields Euro Area 10-Year Govt Bond Yield Germany 10-Year Govt Bond Yield 10-Year Average Europe ex UK All Property Prime Yield SOURCES: CUSHMAN & WAKEFIELD, CBRE, OECD, PRUDENTIAL REAL ESTATE INVESTORS 4

6 OCCUPIER MARKETS Occupier Recovery has Softened Reflecting mixed news on the economy, occupiers remain very costconscious. Competition is limited for anything other than the very best space. Office take-up has dropped back from last year s levels, as fewer large leasing transactions are being completed. However, a lack of new supply means that vacancy rates are edging downwards, putting upward pressure on rents in supply-constrained CBD markets such as London, Stockholm and Paris. In the retail sector, competition for space in prime high streets and large, dominant shopping centres is improving. A number of markets, including London, Paris and Milan, are reporting positive annual rental growth. However, the retail warehouse sector continues to struggle in markets where consumers face weak employment and earnings growth. Logistics, typically viewed as late cyclical, is showing signs of recovery in transport hubs around markets such Frankfurt, Stockholm and Warsaw, where export growth and retail spending have improved. 2 15% 1 5% -5% -1-15% % 1 5% -5% -1-15% -2-25% European Office Take-Up Index (4Q Rolling) Quarterly Change Take-Up Index (2005 = 100, Right Axis) Annual Headline Rental Growth: High Street Retail, Office and Logistics High Street Retail Office Logistics SOURCES: CUSHMAN & WAKEFIELD, CBRE, BNP PARIBAS REAL ESTATE, PRUDENTIAL REAL ESTATE INVESTORS 5

7 DEBT AND DEVELOPMENT Accessing Bank Debt will Remain Difficult The availability of senior debt is still a source of uncertainty for property investors. Banks continue to have a narrow focus and it remains difficult to source funding outside the core space. Development finance is still largely off the table, unless substantial prelets are in place. The lack of new construction threatens to leave Europe s major real estate markets short of new stock in the coming years although this could give rents a welcome boost. With about 520 billion of real estate debt maturing over the next three years, a significant funding gap is still expected as banks continue to reduce their real estate exposure. This means that investors can earn attractive returns by providing debt finance. Bank lending conditions remain tight, with senior debt margins still above pre-crisis levels across Europe. Until banks start to compete for new lending again, margins will likely remain at elevated levels. Concerns are growing that debt rollovers granted since the downturn have fostered an unwelcome concentration of non-performing loans on the books of Europe s banks. SOURCES: CBRE, DTZ RESEARCH, CUSHMAN & WAKEFIELD, PMA, PRUDENTIAL REAL ESTATE INVESTORS 15% 1 5% -5% Net Additions as % of Existing Stock Shopping Centres Offices Logistics European Real Estate Debt Maturity Profile, Bil Estimated European Debt Funding Gap, , Bil 523 Forecast Refinancing Requirement Debt Funding Gap Debt Available

8 PROPERTY MARKET OUTLOOK Weak Rental Recovery a Persistent Theme Recent events have served to heighten the risks to the macroeconomic and financial outlook. The interaction between weak economic forecasts and the prospect of supply shortages owing to the lack of development will determine how the recovery plays out. 8% 6% 4% IPF Prime Office Rental Growth Forecasts, , % p.a. Green bars denote early recovery markets In line with GDP forecasts, the rental outlook for Europe s office market remains sluggish. Some early recovery markets have already recorded a strong rebound in rents and are likely to see growth rates dip later in the forecast period as new supply eventually hits the market. Prime retail assets should record the strongest rental growth once the consumer recovery gains traction. In general, prime markets look expensive and yields are set to drift outwards, although modern logistics facilities have some scope for yield compression in the near term. Secondary yields remain elevated and have room to fall, but this can only occur once occupier activity strengthens and banks rediscover their appetite to lend in this space. Increasingly, low returns on prime assets will put pressure on investors to explore higher-yielding value-added strategies, including providing debt finance. SOURCES: CUSHMAN & WAKEFIELD, IPF, PMA, PRUDENTIAL REAL ESTATE INVESTORS 2% 1 8% 6% 4% London WE Warsaw London City Lyon Paris CBD Stockholm Berlin Frankfurt Munich Brussels Milan Manchester Copenhagen Rome Amsterdam Vienna Madrid Barcelona Dublin Hamburg Average Prime Net Initial Yields by Sector, Actual and Forecast, 1Q01-4Q15 Office Logistics Retail Forecast 1Q01 1Q03 1Q05 1Q07 1Q09 1Q11 1Q13 1Q15 7

9 EUROPE Investment Themes ATTRACTIVE RISK-ADJUSTED OPPORTUNITIES THEME INVESTMENT IMPLICATIONS Late Recovery Office Markets Value recovery to date has been largely limited to Europe s major office markets these markets now look expensive. Re-pricing has been less pronounced in smaller, late-cyclical CBD markets. These late recovery markets are expected to deliver faster rental growth than has been recorded to date. Core Logistics Logistics is typically a late-cyclical recovery play. Best opportunities will be in major logistics hubs in North Europe, where rental growth prospects are strongest. Lack of New Supply Office and retail development has fallen to historic lows. Opportunity for value-add office and retail strategies encompassing new development and refurbishment. Focus on supply-constrained markets in faster-growing North Europe cities. Debt Funding Gap Real estate market needs new debt sources as traditional bank lenders reduce their exposure. Providing mezzanine debt to help deal with the expected funding gap offers attractive riskadjusted returns. Focus on deep, liquid core European markets to minimise exit risk. 8

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