European Real Estate Quarterly Q4 2014

Transcription

1 European Real Estate Quarterly Q4 2014

2 Economy and Capital Markets Late Q3 and early Q4 saw policy decisions rather than economic data drive news flow. The release of the ECB's Comprehensive Review of Eurozone banks and start of its program to buy private sector assets during this period are two larger examples. Positive as these events are, they are improbable catalysts for significantly stronger economic fortunes. Despite the recent deteriorating economic data flow across much of the Eurozone, the outlook is weak rather than recessionary; Figure 1. Eurozone 5/5 year inflation swap implied inflation rate The German IFO headline index fell sharply in October (its sixth consecutive monthly fall), but improved somewhat in November. In contrast, the German manufacturing and services PMIs deteriorated during November. Such a declining trend in surveys taken in isolation would usually point towards German recession. However, given these contradictory survey results and that the European Commission headline Economic Sentiment index (of which Germany constitutes a considerable weighting) recorded a rise in October for the first time in three months and then again in November, an imminent German recession is far from a certainty; Indeed, on balance it's more likely that the Eurozone is experiencing a negative external shock and Germany is proving particularly vulnerable to the current cyclical pressures. What remains unclear is whether the disappointing growth dynamics in the Eurozone are predominantly due to slowing growth globally or the slowdown in China and localised negative flow-on effects from sanctions against Russia; In contrast to the overall fortunes of the Eurozone, the UK economy continues to grow above its trend rate. Despite this outperformance, the UK has not been immune from the slowing growth dynamic both globally and in continental Europe, with Q3 GDP growth registering 0.7% q-o-q, down from 0.9% q-o-q for Q2. This slight loss of momentum is not particularly surprising, given that a number of leading indicators have been suggesting softer growth for some time. Recent weakness in the manufacturing sector and a rise in Sterling in particular are likely causes of this drop in growth; Source: Macrobond Figure 2. Citi Eurozone and UK inflation surprise index This moderation in UK economic growth will have somewhat diminished the BoE MPC's 1 urgency to tighten Source: Macrobond policy. This, when coupled with a dearth of rising price pressures, means the likelihood of a base rate rise has probably been delayed until mid-2015 if not later. Indeed, recent downward revisions to the MPC's inflation forecast add further weight to the view that a rate rise is not imminent. CPI inflation reached only 1.2% y-o-y in September, an outsized 0.5 ppts lower than the MPC was forecasting just three months ago and also a five year low; Similarly, in the Eurozone, this is an environment in which the ECB is likely to continue missing its inflation target by a wide margin. Eurozone CPI for October remained close to zero, at a mere 0.4% y-o-y. With oil prices continuing to suffer weakness following recent price slides, the risk of negative CPI continues to increase, worsening fears of deflation and putting further pressure on the ECB to act with more powerful policy measures; Whilst disinflation is occurring in many of the global economies, the UK and Eurozone countries are being particularly affected. Figure 2. showing the Citi inflation surprise index illustrates that professional forecasters have continuously underestimated the strength of disinflationary pressures in the UK and Eurozone economies for almost two years now; Similarly, Figure 1. shows that inflation expectations for the much longer-term have been declining over the same period, particularly in the Eurozone, where long-term inflation expectations have slipped well below the ECB s target rate; During early November and only weeks into its ABS and covered bond purchasing scheme, there was already considerable conjecture of the ECB soon announcing a plan to buy a wider range of corporate bonds. Whilst this is possible, it's unlikely to materially change the outlook for inflation on its own. Only a large program of government bond purchases is likely to provide the scale needed to properly counter Eurozone deflation; balance 1 Bank of England Monetary Policy Committee

3 If the deflationary threat in the Eurozone persists, we maintain the view that the longer the ECB Governing Council resists implementing meaningful QE/ QE-like policy, the more likely it becomes that they will be forced to implement it on a much larger scale in the future. Investment Markets Strong investor sentiment combined with increasing interest from cross-border investors continued to drive growth in the European commercial real estate investment market. Q3 investment volumes reached EUR50.6 billion, representing an increase of 9% q-o-q and 33% y-o-y. Investment volumes for the year to end- Q3 were EUR135 billion, representing a 29% increase y-o-y; Assets in the core markets of Western Europe remain strongly in demand, with Germany, France and the UK showing solid y-o-y investment volume growth during the first three quarters of the year. This increase in investment activity has been partly driven by growing appetite in non-prime locations, with the level of investment activity across the UK regional markets particularly increasing; Investor interest has further expanded to the Crisis Countries 2, led by Ireland and Spain, where investment volumes increased by 177% and 140% y-o-y respectively this year to end-q3. The stronger relative economic outlook, coupled with higher rental growth projections, are expected to further motivate investors to look for opportunities in Spain and Ireland over the coming quarters; The office sector retained its position as having the largest share of overall European investment (43%) volumes during the year to end-q3, with office volumes growing 22% compared with the same period a year earlier. The industrial and retail sectors saw activity increase by 37% and 28% y-o-y respectively during the same period. Shopping centre investment activity made a big contribution to overall retail investment volumes in the UK, reflecting the relatively positive economic outlook and improving consumer confidence the UK is experiencing; As Figure 3. shows, the share of non-european sourced cross-border investment continued to increase Source: CBRE, Macrobond throughout Q3, accounting for 28% of overall investment volumes during the quarter (up from 22% two years ago). Asian capital inflows (particularly Chinese money targeting the Europe) have increased significantly over the last 12 months and this trend is expected to continue during Q4 and into 2015; The weight of capital continues to put downward pressure on yields across all sectors in Europe, with the industrial sector experiencing the biggest yield compression during Q3, reflecting the relatively attractive pricing and higher income returns that industrial and logistics properties often offer. Dublin (-75bps q-o-q) and Prague (-50bps q-o-q) saw the largest downward yield movements while yields contracted in all major German and French (-25bps q-o-q); Outlook Figure 3. Sources of capital into Europe 100% 80% 60% 40% 20% Source: RCA Figure 4. Eurozone all property prime yield vs. French and German 10 year government bond yields % The trend of investors being comfortable taking greater levels of risk that began most obviously towards the end of 2013, is set to continue. Investor appetite for value-added investments such as development and refurbishment projects continues to grow, particularly in fringe-of-core and non-core locations; Although prime property yields have continued to compress across Europe, they have been falling less than government bond yields, as illustrated in Figure 4. With Eurozone perceived safe haven government bond yields likely to remain low for at least the foreseeable future, real estate s attractive yield gap is expected to continue to drive investor demand, and increasingly interest for higher yielding secondary properties; Expected returns in the Crisis Countries and central Europe are forecast to outperform the lower income yielding core markets over the next five years, primarily due to favourable economic conditions and improving occupier market 0% Domestic Continental Global German 10 year government bond yield French 10 year government bond yield Eurozone all property prime yield 2 Greece, Italy, Spain, Portugal & Ireland

4 fundamentals. Spain (offices), Ireland (retail and logistics) and central Europe (retail and logistics) are expected to be the top performing locations and sectors in terms of total returns during the period. Office Market Q3 saw occupier demand in the office sector slow across Europe, with aggregate take-up falling 20% q-o-q and sit 9% below the five year quarterly average. Despite a weak Q3, overall take-up for the first three quarters was in line with that of the same period last year; Q3 take-up slowed down particularly in central Paris, down 55% q-o-q to only reach 183,000 sq m. The decline was mainly due to the weak letting activity in La Defense and Western Business District. However, due to a strong H1, overall take-up during the year to end-q3 was up 24% y-o-y; Take-up in the top seven German office markets totalled 2.1m sq m during the first three quarters of the year, a decrease of 4% y-o-y. Among the individual markets, Cologne and Dusseldorf registered the biggest falls, being 31% and 30% y-o-y respectively; The aggregate vacancy rate across Europe remained largely unchanged despite an increase in development completions, due to Q1-Q3 take-up being fairly resilient. However, there were clear differences between markets. Warsaw and Milan recorded significant increases in vacancies, while Dublin and central London continued to see strong declines. The vacancy rate in central London has fallen in five consecutive quarters, with the level of available space now down to pre-gfc 3 levels, due to strong occupier demand and modest completion levels; Aggregate prime rental values across Europe rose marginally by 0.4% during Q The most notable increases during Q3 were Dublin (12%), London West End (5.0%) and London City (4.8%). Prime rental values in most of the German markets remained stable, except Dusseldorf where rental values fell by 2% during the quarter; Office investment volumes across Europe increased by 22% y-o-y to reach ceur59 billion during the year to end-q3. Germany, France and the UK continued to attract the bulk of office investment activity, while investor demand picked up significantly in the Crisis Countries, most notably in Spain and Ireland, where investment volumes rose by 295% and 129% y-o-y respectively during the first three quarters of the year; Figure 5. shows the main European office markets continued to see further yield compression during Q3, with prime net initial yields in Germany s top five markets now at pre-gfc levels; Figure 5. Selected European markets prime net initial yields London City Central Paris German top 5 Milan CE3 % Outlook Source: PMA A fall in economic sentiment in some European countries suggests 2014 is likely to see a slowing recovery in the office occupier market during the closing stage of the year, with full year take-up likely to only be broadly in line with 2013 levels; Low levels of development completions and a lack of prime stock are expected to drive strong prime rental value growth in Spain over the eight quarters. Rental value growth is expected to remain weak in Warsaw, Prague, Lisbon and Rome, with meaningful positive growth not expected to return until 2016; The majority of European office centres are expected to experience positive capital value growth during 2015, with the largest prime capital value increases anticipated in Dublin (22.8%), Madrid (14.5%), Barcelona (12.4%), London City (11.2%) and Manchester (11.2%). By contrast, a number of southern European and CEE markets are likely to see capital value declines, including Warsaw (-1.6%) and Lisbon (-1.0%). 3 Global Financial Crisis

5 Logistics Market Resilience in France and the UK, thriving in Germany Occupiers have been active over the first nine months of 2014, with take-up levels rising across most logistics markets; In Germany, in spite of slowing economy, nationwide take-up in 2014 is expected to reach between 4.5 and 5.0 million sq m. Q1-Q3 logistics market take-up totalled just over 3.8m sq m. This is the fifth consecutive year that take-up for this period exceeded 3m sq m, which illustrates how active the occupier markets in Germany have become; In France, occupiers have favoured modern warehouse space close to large metropolitan areas in the north-south axis, in particular in the Greater Paris region and around Lyon; Third Party Logistics service providers (3PLs) are currently the most active occupiers across France and account for over 40% of take-up, marking a decisive return after several years of decline. Take-up in France for the full year is likely to exceed 2.2m sq m; In the UK, built-to-suit activity accounted for 81% of all take-up on new buildings. Supply levels continue to decline with logistics space available in ready to occupy units down 16% during the year to end-h1, and down 7% end-2013 and end-h1; Figure 6. Logistics take-up in 24 markets across Europe (sq m) 9,000,000 8,000,000 7,000,000 6,000,000 5,000,000 Forecast 4,000,000 3,000,000 2,000,000 1,000, H1 Source: PMA, AEW Europe Strong investment activity Transaction volumes in the logistics and industrial sector totalled EUR8.7 billion during H1, the strongest level for the period since Indeed, this H1 figure approximately equals the average full year figure between ; This was a 25% increase on volumes for H and saw industrial and logistics investment activity as a proportion of all real estate investment activity rise; The UK attracted the bulk of the sector s investment during H1, with a 40% share of the European total; Germany, France and the Netherlands also saw considerable investment activity during the first half of the year. However, despite moderate activity in the CEE markets during the period, investment volumes were lower than recorded for H2 2013, owing to the extremely high volumes achieved during Q4 last year; Investor interest in the southern European countries was focused predominantly on Italy and Spain, with the latter in particular seeing growing interest from investors keen to take advantage of the substantial re-pricing in that market; Our Opinion In the more mature markets of the UK and France, investors tend to target established locations around large cities, with sites offering land availability for potential extension of existing space, and in proximity to multimodal transport (road, rail, water); In Germany, the logistics market continues to develop and expand. Pre-let and even speculative development activity is occurring in areas where occupier demand is strong and liquid. For standing assets, an increasing number of investors are willing to accept shorter weighted average lease lengths, as a perceived resilient German economy offers sufficient support to occupier demand to mitigate reletting risk.

6 Retail Market Retailers adapting to a low retail spending environment With the current weaker retail sales volumes in the Eurozone, international retailers continue to underpin occupier market activity through selected acquisitions, new openings and implementation of cross-channel strategies; By January 2015, Kingfisher may become France s largest DIY retailer ahead of Adeo (Leroy Merlin and Bricoman). The British firm is expected to buy Mr. Bricolage, which operates 81 stores plus a buying centre supplying 728 independent retailers; The French DIY market has been declining for three years, including a 0.1% drop in revenue during 2013 to EUR24.4 billion. To counter this negative trend and encouraged by trends from US multichannel retailers, DIY retailers aim to extract further synergies between their internet and physical store platforms. Since 2013, Kingfisher has been testing an exchange service of DIY jobs between individual customers. In September 2014, Leroy Merlin launched a free rental service in three stores; The Auchan retail group is also testing a collaborative delivery service: customers can pick up an order for a neighbour at Auchan drive pick-up points and receive a EUR3 voucher; In Germany, escalating price pressures have led to consolidation amongst food retailers. One notable and recent example is the family-owned Tengelmann group intending to sell 450 Kaiser supermarkets to rival Edeka. The Austrian investor René Benko, who took over Karstadt department stores for a price of only EUR1, will close 6 stores out of 83, with 10 additional redundant units to follow. About 25% of the Karstadt stores are deemed to be unprofitable; In the eastern part of Germany, many German retailers want to tap new consumer spending power across the border as local consumption remains anaemic. In Frankfurt-an-der-Oder, a town in the east of Germany bordering Poland, 40% of sales at Karstadt department stores are to Polish customers. In the same town, the Mios Edeka cash and carry chain has opened a Polish e-commerce site for its store. In Berlin, located less than 2 hours drive from the border, many stores have signage in Polish; A combination of disposable income per capita having risen considerably off a relatively low base in Poland and the Czech Republic over the last decade, and consumer goods prices rising faster in these countries than in Germany, Germany is becoming an increasingly attractive shopping destination for its eastern neighbours; In Spain, the majority of occupier demand from foreign retailers remains concentrated in Madrid and Barcelona. Forever 21 has a store in Barcelona and plans to expand into Madrid. Uniqlo is currently seeking space in both cities. During the summer, Aldo opened its first store in Madrid. This follows Brooks Brothers, 7 For All Mankind, Stella McCartney, Coach, Fifth & Pacific, and Moncler all having launched their first stores in Spain during 2013; European retail investment up Retail property investment volumes in Europe reached EUR32 billion during the Q1-Q3 period, recording a strong 47% increase compared to the same period last year. The UK and Germany accounted for 38% and 21% of this overall volume respectively. Throughout Europe, the southern European countries saw the biggest jump in investment activity, with volumes up 209% during the three quarters with EUR5 billion of activity; Shopping centres continue to maintain the biggest investment market share, accounting for more than half of all retail volumes. The UK shopping centre market continues to be extremely buoyant, accounting for 36% of the overall European total. Southern European volumes were higher than in Germany or France. Retail investment volumes are expected to reach EUR51 billion for full year 2014 and EUR61 billion in 2015; Our Opinion Figure 7. Europe retail investment volume EUR billions Prime yields for all types of retail continue to fall Source: RCA across Europe. In a significant proportion of cities, prime high street retail yields are at historical lows. This is particularly the case in the largest cities, with London, Paris and Berlin all now at record lows. Shopping centre prime yields are also at historic lows in London and the major German markets; In the UK, the post-gfc cycle of retailer failures has slowed considerably, with retail sales volumes expected to continue to see healthy growth into the medium-term. In this context, many investors continue target prime and dominant assets, but an increasing number are relaxing their risk criteria to also look at secondary locations and non-core assets; Despite the assorted macroeconomic challenges France continues to face, the French shopping centre investment market continues to offer interesting opportunities: the elevated rate of obsolescence is helping to underpin ongoing development activity. New prime areas are also appearing in the high street market of Paris as international retailers expand outside the traditional high-end streets to new locations

7 Residential Markets The average house price across the EU rose by 1.7% y-o-y during Q2 2014, while the Eurozone saw house prices remain static over the period. However, there are still large variations across Europe, with Ireland and the UK showing double digit y-o-y growth, while Italy and France continue to suffer house price falls. The Spanish residential market experienced the first positive annual growth since 2008, with house prices increasing by 0.8% y-o-y during Q2 2014; United Kingdom The UK housing market has shown signs of slowdown over the past few months, with annual house price growth falling for three consecutive months to 8.5% in November Average house prices in London are now c30% higher than their pre-gfc levels, mainly driven by supply-demand imbalances and strong demand from overseas buyers. Outside of London, southern England continued to lead the recovery, while the northern regions saw the weakest performance; Figure 8. shows that the number of monthly mortgage approvals fell by 15% y-o-y to 37,076 during October, the lowest level since May This fall further indicates a softening in the UK housing market activity; The pace of house price growth is expected to moderate over the coming quarters amid political uncertainty relating to the 2015 General Election and stricter mortgage lending rules. The prospect of rising interest rates in 2015 is likely to have a negative impact on housing demand and affordability; France House prices for existing dwellings in France continued to fall during Q2 2014, albeit at the slower pace of 1.2% y-o-y, compared with a fall of 1.9% y-o-y during Q1. House prices decreased by 2% y-o-y in Ile-de-France during Q2, with prices for houses falling more significantly (-3.3%) than for apartments (-1.4%); Despite falling house prices, the number of existing home sales has improved since March 2013, as Figure 9. below shows. Although this upward trend has slowed slightly during Q3 2014, annual sales volumes increased by 5% y-o-y during September 2014; The ECB s further interest rate cuts have pushed the long-term fixed mortgage rate to a historical low of 2.9% in August. Cheap housing loans combined with a shortage of housing supply are likely to reduce the downward pressure on house prices over the next few quarters; Figure 8. UK monthly mortgage approvals Source: Macrobond Figure 9. Monthly existing home sales in France (rolling 12 months) 000s 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10, Germany Source: INSEE German house prices have increased considerably in some urban areas over the recent years, especially for owner-occupied apartments in Germany s biggest cities, with prices now much more expensive than the national average. The German residential market is likely to continue to benefit from attractive low interest rates, record low unemployment rate and an increase in household income; The rise in housing demand has led to a significant increase in residential building permits over the last five years. This upward trend has continued throughout the last two quarters, with the number of building permits issued reaching 274,134 during the 12 months to end-september (an increase of 6.4% y-o-y); A total of EUR9 billion was transacted in the German residential investment market during Q1-Q3, an increase of 4% y-o-y. Investment volumes are likely to slow gradually over the coming quarters, mainly due to a lack of large residential portfolios being offered for sale.

8 An affiliate of Natixis Global Asset Management AEW Europe is a leading European real estate investment manager with 9 offices throughout Europe. AEW Europe is focused on the creation, execution and management of discretionary commingled investment vehicles, separate account strategies and real estate securities funds to both institutional investors and private clients. The group has over 270 employees who are responsible for over 18 billion of assets under management. The integration of AEW Europe with the resources and capabilities of North American-based AEW Capital Management creates a truly global real estate investment management platform with aggregate gross assets under management of more than 37 billion. Research & Strategy Contacts AEW Europe 8-12 rue des Pirogues de Bercy Paris, France AEW Europe 33 Jermyn Street London SW1Y 6DN, UK AEW Europe Carl-Theodor-Straße Düsseldorf, Germany Sam Martin MSc MRICS Head of Research & Strategy Tel. +44 (0) sam.martin@aeweurope.com Ken Baccam MSc Associate Director Tel. +33 (0) ken.baccam@aeweurope.com Shan Shan Qi MSc Analyst Tel. +44 (0) shanshan.qi@aeweurope.com Holger Zilleken MSc Associate Tel. +33 (0) holger.zilleken@aeweurope.com Investor Relations Contact Abraham Mboyo Mbango MSc Analyst Tel. +33 (0) abraham.mboyombango@aeweurope.com Schalk Visser CFA Head of Investor Relations Tel. +44 (0) schalk.visser@aeweurope.com This publication is intended to provide information to assist investors in making their own investment decisions, not to provide investment advice to any specific investor. Investments discussed and recommendations herein may not be suitable for all investors: readers must exercise their own independent judgment as to the suitability of such investments and recommendations in light of their own investment objectives, experience, taxation status and financial position. This publication is derived from selected sources we believe to be reliable, but no representation or warranty is made regarding the accuracy of completeness of, or otherwise with respect to, the information presented herein. Opinions expressed herein reflect the current judgment of the author : they do not necessarily reflect the opinions of AEW Europe or any subsidiary or affiliate of the AEW Europe s Group and may change without notice. While AEW Europe uses reasonable efforts to include accurate and up-to-date information in this publication, errors or omissions sometimes occur. AEW Europe expressly disclaims any liability, whether in contract, tort, strict liability or otherwise, for any direct, indirect, incidental, consequential, punitive or special damages arising out of or in any way connected with the use of this publication. This report may not be copied, transmitted or distributed to any other party without the express written permission of AEW Europe.