March 2018 Europe Real Estate Market Outlook For Investment Professionals only
Executive summary 2.2% Economic upturn is broadening across Europe Monetary policy remains accommodative, with consensus expectations for a rate rise in 2019 The office sector saw 4% rental growth on average across 23 cities in 2017 2018 Eurozone GDP growth 213 billion 2017 European investment volumes Over 4% rental growth in Nordic industrials markets over next three years
Economic recovery broadens Economic growth in the Eurozone consistently beat expectations throughout 2017. Following growth of 0.6% in Q3 and 0.7% in Q4, Eurozone GDP reached 2.5% for 2017, well above the ECB s forecast of 1.7% at the start of the year. This marks the fastest pace of growth since 2007. Strength in the Eurozone economy was underscored by several leading indicators. The manufacturing and composite PMI s, which measure domestic demand, and export and services growth, both registered new peaks in December, with the former at the highest level since the series began in 1997. The European Commission s (EC) sentiment indicator also reached 116 in 2017, the strongest result since 2000 when the Euro was first introduced. Figure 1: Economic sentiment indicator (December 2007 = 100) European Commisiion ES Index 125 105 85 65 Dec 07 Jun 08 Dec 08 Jun 09 Source: Bloomberg. Dec 09 Jun 10 Dec 10 Jun 11 Dec 11 Jun 12 Despite the uncertain political backdrop created by political instability in Spain and various national elections, the recovery continued to broaden during 2017. In Germany, a deal was reached to form a new grand coalition government between Angela Merkel s CDU party and the centre-left Social Democrats (SPD) in February following the inconclusive federal election result last year. Equally significant is the pick-up in French activity indicators including services PMI, inspired by Emmanuel Macron s reform programme and reflected in the improving economic sentiment indicator. In Spain, Catalonia is likely to demand greater autonomy, similar to the system in the Basque country; nevertheless the Spanish economy looks set to continue to perform well. While the European political agenda for 2018 also includes a general election in Sweden in September, the result is unlikely to reverse the current strength of the economic leading indicators and therefore GDP growth. Italy s recent election resulted in a hung parliament. However, 10-year government bond yields remained stable at around 2%, while the stock market largely recovered its modest loss the day following Dec 12 Eurozone France Germany Italy Spain Poland Portugal Jun 13 Dec 13 Jun 14 Dec 14 Jun 15 Dec 15 Jun 16 Dec 16 Jun 17 Dec 17 the election, suggesting investors had already priced in the political outcome. It may be weeks before a government is formed. On a more positive note, Banca Monte dei Paschi di Siena, a struggling Italian bank, took another recuperative step in January, as it sold 95% of a tranche of bad loans, equating to 25 billion, to Quaestio, a boutique fund. The bank s troubles were exacerbated when it failed a stress test in 2016 and the subsequent bailout by the Italian government in 2017. Elsewhere, as a sign of how far the Eurozone has come since the 2011 debt crisis, it was announced that Greece could exit its bailout programme by the end of 2018. Eurozone unemployment hit a nine-year low in December 2017 at 8.7%. Whilst still above the previous cycle s low of 7.2%, this marks a 1.1% y-o-y decline. Southern European markets have shown significant improvement, as the economic recovery spreads across Europe. Portugal s unemployment rate of 7.8% (down from 17.5% in 2013), alongside a host of positive data, was enough for both S&P and Fitch Ratings to upgrade its credit rating from junk status to investment grade. Recent falls in unemployment indicate a potential pick-up in wage growth. Furthermore, both the EC survey of households inflation expectations and the output price index of the Composite PMI suggest that core inflation will rise, but so far wage growth has remained subdued. Monetary policy remains accommodative to growth Headline inflation still lags in Europe, having fallen back from 2% in February to 1.4% in December last year. Further declines are expected during the first half of 2018, dragged down by volatile energy, alcohol and tobacco prices. Weak inflationary pressures continue to impact the ECB s decision to lift interest rates and Mario Draghi has stressed his patience to wait for price growth to return. Figure 2: Eurozone headline and core inflation Inflation % 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0-0.5-1.0 Dec 10 Mar 11 Jun 11 Sep 11 Dec 11 Headline Source: Bloomberg. Mar 12 Jun 12 Sep 12 Dec 12 Mar 13 Jun 13 Sep 13 Dec 13 Mar 14 Jun 14 Sep 14 Dec 14 Mar 15 Jun 15 Sep 15 Dec 15 Mar 16 Jun 16 Core (Excl. Food, Alcohol, Tobacco & Energy) Sep 16 Dec 16 Mar 17 Jun 17 Sep 17 Dec 17 ECB Target 02
Indeed the ECB has pledged to keep buying bonds at a rate of 30 billion a month until at least September 2018. However, the booming Eurozone economy has led to speculation that the stimulus will end then and be followed by rising interest rates hence the surge in the Euro. According to the Morgan Stanley next-interest-rate-hike survey, interest rates are likely to edge up in 13 months time (2019), but the spreads above property yields should still remain attractive in 2018 with potential for further yield compression in select markets. Figure 3: Morgan Stanley survey: 13 months to first rate rise Months 80 70 60 50 40 30 20 10 0 Jan 11 Jul 11 Jan 12 UK Source: Bloomberg. Jul 12 EU Jan 13 Jul 13 US The Eurozone outlook for 2018 is one of rude health, with consensus estimates expecting 2.2% growth for the year. The countries forecast to lead the recovery include Poland (3.8%), Luxembourg (3.5%), Sweden (2.6%), Spain (2.5%) as well as the Netherlands and Germany, both expected to achieve growth of 2.2%. 1 With actual growth figures continuing to beat analyst expectations, we could see economic growth in 2018 reach a similar level to that achieved in 2017. However, as the ECB s monetary policy support tapers, growth is likely to slow in 2019, forecasted at 1.8%, and therefore still attractive. Occupier markets remain buoyant The recovery in economic sentiment across Europe continues to filter through to the occupier markets. The office sector saw rental growth of 4% on average across 23 cities in 2017. Both Stockholm (13% p.a.) and Berlin (11% p.a.) outperformed once again, followed closely by Brussels, Helsinki, Amsterdam and Southern European cities (8% p.a.). 2 Across Europe, the supply response remains modest. Even in markets where pipelines (measured as a % existing stock) are largest, namely in Luxembourg, Madrid, Brussels and Barcelona, strong job creation is 1 Source: Bloomberg 2 Source: JLL 3 Source: Capital Economics 4 Source: PMA Autumn 2017 5 Source: CBRE IDF Q417 report 6 Source: Immostat Q4 2017 Jan 14 Jul 14 Jan 15 Jul 15 Jan 16 Jul 16 Jan 17 Jul 17 Jan 18 generating demand to absorb it. Occupier data also suggests that the Barcelona office market has not paused as a result of recent political events, with JLL reporting positive rental growth in all four quarters of 2017, delivering an impressive 8.1% y-o-y growth by year-end. Nevertheless, demand could weaken if firms become more cautious, but there is little evidence of a significant weakening of the regional labour market, according to Capital Economics. In 2018, employment growth in the five largest Eurozone economies is expected to be led by the Netherlands (1.4%), Spain (1.3%) and France (1.2%). The relative underperformance of Germany partly reflects its already high employment rate. In Italy, the labour market is set to slow markedly in 2019 (0.6%), but will still be slightly above the long-term average. 3 Office employment growth of 2% is expected over 2018, 4 which should support the ongoing recovery in rents. Figure 4: Office net additions and vacancy rates (% stock) Net additions (% stock) 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 2.0 0.0 0.0 Rome Copenhagen Stockholm Milan Paris Munich Berlin Vienna Helsinki Cologne Hamburg Amsterdam Frankfurt Dusseldorf Lyon Lisbon Stuttgart barcelona Brussels Madrid Luxembourg Historic average '96-'17 (LHS) Forecast average '18-'22 (LHS) Vacancy % 2017 Vacancy % 2020 16.0 14.0 12.0 Source: PMA Autumn 2017. Technology will continue to be a key driver of office occupier demand across Europe. In some tech-dominated cities such as Berlin and Amsterdam, the submarkets where these companies reside are showing stronger rental growth than in the corresponding prime submarket. Similarly in Paris, the key driver of demand is consolidation and the search for higher quality, flexible working space above 5,000 sq m. Occupiers are prepared to compromise on location in order to secure space at a more reasonable price relative to the CBD. 5 Thus, with the 26 billion Grand Paris infrastructure project set to deliver a further 200km to the capital s transport network, including 68 metro and RER stations over the 2019 to 2030 period, Paris is likely to see a number of edge of CBD submarkets including Saint Denis, Saint Ouen and Suresnes benefit from an increase in office occupier demand. At 850,000 sq m, these Inner Rim submarkets, as defined by Immostat, recorded the highest level of take-up in 2017 since records began in 2000. 6 10.0 8.0 6.0 4.0 Vacancy rate (%) 03
Over the next three years, we forecast the next leg of the property cycle to be driven by Stockholm, Berlin, Helsinki, Amsterdam and Madrid with average rental growth exceeding 4% p.a. While Milan, Rome, Madrid and Barcelona have relatively high vacancy rates, this masks a tighter prime CBD market. Rental growth is now coming through in the industrials sector quite strongly, but only within select markets. Of the six cities to see improvement in 2017, all saw 6% p.a. or more, ranging from 13% in Prague to 6% each for Stockholm, Milan and Rome. We expect a further pick-up in growth in 2018, supported by Europe s lag compared to the UK and US logistics markets, which were early adopters of e-commerce trends. Although still high, rental growth expectations in the UK and US are moderating. In contrast, continental European markets are likely to see an acceleration in growth, as vacancy rates reach record lows (sub 5%), confidence in the manufacturing sector picks up and e-commerce adoption becomes more widespread. Figure 5: Select European industrial market fundamentals in a global context Current Vacancy Take-up Outlook Source: M&G Real Estate, Q4 17 JLL, PPR, Transwestern. 3 YR Rental Growth Outlook Los Angeles 1.20% UP 4.40% New Jersey 5.10% UP 4.10% Seattle 3.10% UP 4.40% Miami 4.40% UP 3.10% London 5.00% STABLE 4.30% Bristol 3.80% STABLE 3.40% Birmingham 7.00% STABLE 3.70% Manchester 3.00% STABLE 3.70% Stockholm 3.00% UP 4.60% Helsinki 6.00% UP 4.40% Madrid 4.30% UP 3.50% Berlin 3.00% UP 2.30% We have also identified two drivers that will impact the growth trajectory of the European logistics market. The first is the 700 billion TEN-T transport infrastructure programme to improve railway and road links and better connect 94 ports and 38 airports along nine cross-border network corridors by 2030. The second is the launch of the Digital Single Market (DSM), another EC funded initiative, set to improve digital competitiveness across Europe by allowing consumers to more easily purchase goods from international-based retailers, thus driving online sales. Urban (last-mile) and regional logistics assets tend to carry out very different, albeit complementary operations. The former is run by locally sourced skilled labour and tends to hold stock for less than 24 hours, while the latter is often far more automated, due to the greater quantity of goods stored and the lower availability of trained labour in more rural locations. Notwithstanding these operational differences, the TEN-T and DSM projects are set to benefit both property types by lowering transport and delivery costs by increasing the speed at which goods will move along the nine cross-border corridors spanning all EU28 members. We expect the European industrial cycle to be led by Nordic markets, including Stockholm and Helsinki, with an average rental growth exceeding 4% p.a. over the next three years. Madrid, Milan, Copenhagen and Brussels are anticipated to follow, all projected to deliver growth of between 3% and 4% over the same period. In the retail sector, rents continued to grow in 2017, albeit at a much slower rate than the previous year, driven by Southern European markets. Milan was the only retail shop market in Europe to see positive rental growth every quarter, driven by the strength of domestic demand coupled with rising tourism. As in other markets, tourism, especially high spending visitors from emerging markets, appears to be an increasingly important driver of retail rents with prime high street locations in key cities set to benefit the most. Figure 6: Tourism flows and retail shops rental growth % Tourist arrivals (000s) 20,000 18,000 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 Rome Paris Milan Stockholm Barcelona Madrid Prague Berlin 2017 tourist arrivals 2025 tourist arrivals Rental growth pa (av '15-'17) Rental growth pa (% av '18-'20) Source: Eurostat, M&G Real Estate Q4 2017, Euromonitor International 2017 Consumer confidence in continental Europe is also high and the health of the global economy should sustain healthy tourism flows, creating the conditions for healthy retail growth this year, and possibly into 2019 where we expect continued retail shop rental growth, albeit at a slower rate. Overall, we expect an average rental growth of 2% p.a. over the next three years for the combined retail shop, retail warehouse and shopping centre sectors. 9.0 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 3-year average rental growth %pa 04
Investment Market On an annual basis, European investment volumes reached a record high in 2017 ( 213 billion), up 8% on 2016. 7 On a rolling y-o-y basis, however, this represents a 3% drop from the peak in Q3 2017. On an annual basis, the Nordic markets of Denmark (+44%) and Finland (+31%) saw some of the largest volume increases, alongside the Netherlands (+43%) and Portugal (+37%). Capital flows across the region featured several major M&A deals including China Investment Corporation s (CIC) 12.2 billion acquisition of Logicor, a pan-european logistics and warehouse owner; Gecina s takeover of French listed peer Eurosic; and Areim and Blackstone s takeover of Finland s Sponda. 2017 also saw three deals exceed 1 billion. The largest was Coeur Défense in Paris Western Business District (WBD). Investor interest in Europe remains strong, with INREV s Investment Intentions Survey suggesting 41% of global capital will be deployed in the region in 2018. However, a lack of core real estate and lower levels of global capital raising could see volumes start to taper off from previous highs. Figure 7: Rolling annual investment volumes billion Transaction volumes ( bn) 250,000 200,000 150,000 100,000 50,000 0 Q4 2006 Q2 2007 Q4 2007 Q2 2008 Q4 2008 Q2 2009 Q4 2009 Q2 2010 Q4 2010 Q2 2011 Q4 2011 Q2 2012 Q4 2012 Q2 2013 Q4 2013 Q2 2014 Q4 2014 Q2 2015 Q4 2015 Q2 2016 Q4 2016 Q2 2017 Q4 2017 Other CEE Benelux Nordics Peripherals Germany France Source: M&G Real Estate, CBRE Q4 2017 High levels of liquidity continued to pressure prime yields over Q4, with the logistics sector compressing by -15bps on average, driven by Spain, Italy, France and Germany. The largest move over the quarter was seen in Amsterdam retail warehouses (-35bps), while both Madrid and Barcelona saw retail warehouse yields harden by 7 CBRE Q4 2017 05
25bps each despite the independence referendum in Catalonia. On a y-o-y basis, the logistics sector remained the largest driver of compression (-47bps on average), with investors attracted by comparatively higher yields and the ongoing structural shift towards e-commerce. Retail shops and retail warehouses each saw yield compression of -35bps over the year. Prime yields for the former are now at or below 3% in Paris, Amsterdam, Copenhagen and the majority of German markets. Conclusion With the economic recovery accelerating across Europe, we expect the occupier markets to follow suit. Ultra-low interest rates look set to continue in the short term, helped by weak inflation expectations, meaning European real estate will continue to offer value compared to other asset classes. Whilst investment volumes may start to taper off, further yield compression is likely over 2018, albeit at a slower pace. Coupled with strong occupational fundamentals, healthy rental growth should continue to support strong total returns in the medium term. 06
Contact Vanessa Muscarà Associate Director +44 (0)20 7548 6714 vanessa.muscara@mandg.com Richard Gwilliam Head of Property Research +44 (0)20 7548 6863 richard.gwilliam@mandg.com Christopher Andrews, CFA Head of Client Relationships and Marketing, Real Estate +65 6436 5331 chris.j.andrews@mandg.com Lucy Williams Director, Institutional Business UK and Europe, Real Estate +44 (0)20 7548 6585 lucy.williams@mandg.com Stefan Cornelissen Director of Institutional Business Benelux, Nordics and Switzerland +31 (0)20 799 7680 stefan.cornelissen@mandg.co.uk Costanza Morea Italy +39 (0)2 3206 5577 costanza.morea@mandg.com Florent Delorme France +33 (0)1 71 703088 florent.delorme@mandg.fr Alicia Garcia Spain +34 915 615 257 alicia.garcia@mandg.com www.mandgrealestate.com For Investment Professionals only. This document is for investment professionals only and should not be passed to anyone else as further distribution might be restricted or illegal in certain jurisdictions. The distribution of this document does not constitute an offer or solicitation. Past performance is not a guide to future performance. The value of investments can fall as well as rise. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and you should ensure you understand the risk profile of the products or services you plan to purchase. This document is issued by M&G Investment Management Limited (except if noted otherwise below). The services and products provided by M&G Investment Management Limited are available only to investors who come within the category of the Professional Client as defined in the Financial Conduct Authority s Handbook. They are not available to individual investors, who should not rely on this communication. Information given in this document has been obtained from, or based upon, sources believed by us to be reliable and accurate although M&G does not accept liability for the accuracy of the contents. M&G does not offer investment advice or make recommendations regarding investments. Opinions are subject to change without notice. Notice to recipients in Australia: M&G Investment Management Limited does not hold an Australian financial services licence and is exempt from the requirement to hold one for the financial services it provides. M&G Investment Management Limited is regulated by the Financial Conduct Authority under the laws of the UK which differ from Australian laws. Notice to recipients in Hong Kong: The contents of this document have not been reviewed by any regulatory authority in Hong Kong. If you are in any doubt about any of the contents of this document, you should obtain independent professional advice. Notice to recipients in Singapore: This document is issued by M&G Real Estate Asia Pte Ltd. This document may not be circulated or distributed, whether directly or indirectly, to persons in Singapore other than (i) an institutional investor pursuant to Section 304 of the Securities and Futures Act, Chapter 289 of Singapore (the SFA ) or (ii) otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA. M&G Investments and M&G Real Estate are business names of M&G Investment Management Limited and are used by other companies within the Prudential Group. M&G Investment Management Limited is registered in England and Wales under numbers 936683 with its registered office at Laurence Pountney Hill, London EC4R 0HH. M&G Investment Management Limited is authorised and regulated by the Financial Conduct Authority. M&G Real Estate Limited is registered in England and Wales under number 3852763 with its registered office at Laurence Pountney Hill, London EC4R 0HH. M&G Real Estate Limited forms part of the M&G Group of companies. M&G Investment Management Limited and M&G Real Estate Limited are indirect subsidiaries of Prudential plc of the United Kingdom. Prudential plc and its affiliated companies constitute one of the world s leading financial services groups and is not affiliated in any manner with Prudential Financial, Inc, a company whose principal place of business is in the United States of America. FEB 18 / 267506