Invesco Real Estate House View European summary H1 2018 This document is for Professional Clients only in Dubai, Continental Europe, Ireland and the UK, for Qualified Investors only in Switzerland, for Institutional Investors only in the United States, Australia and Singapore, and for Professional Investors only in Hong Kong and in Japan as defined under the Financial Instruments and Exchange Law of Japan. In Canada, the document is intended only for accredited investors as defined under National Instrument 45 106. It is not intended for and should not be distributed to, or relied upon by, the public or retail investors. Please do not redistribute this document. With stronger than anticipated economic growth in Continental Europe in 2017, investor interest has followed and demand has been strong for core assets. With little scope for further yield compression anticipated, net operating income (NOI) growth will become the key component for driving total returns. A synchronised global upswing in economic growth is providing further momentum for the economic recovery across Europe. GDP forecasts continue to be revised upwards and unemployment is falling, generating strong positive sentiment for businesses and consumers and pointing to increased spending. This, in turn, should boost occupier demand for real estate across most sectors. Furthermore, there are also signs that inflation is gradually picking up as a result of improving economic conditions, and this will provide an additional boost to the income earned from real estate through indexation of leases. Improving economic conditions also point to the start of a slow normalisation of interest rates. We believe that 2017 will prove to have been a turning point: The US Federal Reserve raised interest rates twice in 2017, and the expectation is for three-to-four more quarter point increases in 2018; the UK Monetary Policy Committee also increased rates, although Brexit-related concerns are likely to result in current levels being maintained this year; and the European Central Bank (ECB) signalled a reduction in bond purchases. We do not see this as creating a challenge for the pricing of European real estate in the short term, but given the competitive pricing of core assets, there is a need to ensure that asset level fundamentals are able to deliver income growth over the hold period. Overall, we expect prime yields to be broadly stable over the next three years.
Investor demand Overall, we expect prime yields to be broadly stable over the next three years. Demand for European real estate remains robust, with total investment volumes in 2017 estimated to be up 13% on 2016 levels. Sources of capital remain diverse, with c.30% of investment volumes from non-european sources, in particular US, China and Hong Kong. Domestic institutions were slightly less active, but remained net purchasers in 2017 (Source: Real Capital Analytics, March 2018). We expect the diversity of capital sources to remain a feature of the European real estate market in 2018. According to Preqin, as at April 2018, unlisted vehicles raised slightly less capital in 2017 than they did in 2016, but the slowdown was modest, suggesting that unlisted funds will continue to be active in 2018. Furthermore, the latest investor intentions survey from INREV, as at April 2018, indicated that institutions are intending to allocate more capital to real estate in the current year. The latest capital raising survey, as at April 2018, demonstrated an increase of c.25% raised for non-listed real estate globally. Europe remained the top target for capital raised during 2017 with 67.2bn or 44% of the global total, at growth of c.19% on the previous year. Over the next few years, we believe real estate performance is likely to be driven by the ability to achieve income growth. It is therefore important to consider lease structures and opportunities to deliver market-led rental growth at an asset level, and also to seek sub-market and asset opportunities that should outperform the general market through active asset management. Figure 1 European commercial transaction volumes by sector, four-quarter rolling average Logistics benefits from falling retail volumes Office Industrial Retail-centres Retail-shops Retail-average % 100 90 80 70 60 50 40 30 20 10 0 Q1 2008 Q3 2008 Q1 2009 Q3 2009 Q1 2010 Q3 2010 Source: Real Capital Analytics, March 2018 Q1 2011 Q3 2011 Q1 2012 Q3 2012 Q1 2013 Q3 2013 Q1 2014 Q3 2014 Q1 2015 Q3 2015 Q1 2016 Q3 2016 Q1 2017 Q3 2017
Real Estate strategy considerations The combination of an expected cycle duration of at least three years and the low yields investors now have to pay to acquire prime assets is leading investors to favour value add strategies, with a particular focus on manage to core. Creating core assets in good locations should, in our view, deliver attractive returns and provide much needed quality stock given the modest levels of development occurring in many markets. In general, we favour this type of strategy, and taking some development risk, but competition for suitable assets is likely to result in aggressive pricing, so risks should be carefully assessed. Identifying the best opportunities will require a good understanding of key asset characteristics and greater granularity in understanding sub-market characteristics. We believe that structural changes in retailing and a general evolution of supply chains will favour rental growth in the logistics sector. This is a significant change to outcomes in previous cycles where retail was a key beneficiary of rising consumer incomes. There are number of factors driving outlook for logistics rents: Ongoing strong demand from retailers from both the pure online sector and traditional bricks and mortar retailers who are investing heavily in their online capabilities; Retailers are willing to sign longer leases (often in excess of 10 years) than Third Party Logistics operators (3PLs), and are therefore focused on acquiring locations of long-term strategic importance to their business; Demand from retailers is focused on irreplaceable locations around major urban areas and on key transport nodes. Rental growth is expected to be strongest in these locations. Greater differentiation is therefore expected between the best locations and the rest. Land prices are likely to be an important consideration in ensuring value is underpinned by fundamentals. Southern European logistics markets are forecast to outperform as they continue to recover strongly and as e-commerce matures (following the Northern European markets), we expect strong demand from retailers for good quality, flexible space. Scarcity of available stock should provide opportunities for investors to undertake forward funding or forward purchases within the sector. In contrast, due to the rise of e-commerce, bricks and mortar retail real estate is likely to lag during this cycle, especially in smaller, mass-market retail segments vulnerable to store closures as retailers continue to rationalise their store portfolios. As retailers adapt to the new business environment, they have become increasingly cautious about expanding their store networks. Many are closing or disposing of their non-performing stores, while also optimising the productivity of existing outlets. Some retailers are looking to transfer some risk to landlords, e.g., with shorter lease terms or turnover rents. These are global trends that are resulting in increasing polarisation in the retail sector. Our current retail forecasts suggest that performance going forward is likely to be weaker than in the past and it is essential to be mindful of the key factors driving sales and turnover growth of retail assets. Identifying attractive opportunities is more dependent than ever on local expertise. While we remain cautious about the retail sector generally, in retail we favour: Dominant, flexible shopping centres that offer experience, providing a wide range of shops and a relatively high proportion of leisure space; High street locations in thriving cities that benefit from tourism as well as strong domestic demand. Drivers are different from city to city. Whereas luxury retail sector is expected to continue performing well in cities such as London, Paris, Madrid and Milan, we are also seeing strong growth prospects in cities such Lisbon where mass market retail sector is forecast to grow strongly along with luxury retail, driven by both domestic and tourism spending. We had also favoured grocery anchored local retail schemes in strong catchment areas. However, there is growing evidence that online grocery retailing is beginning to gain traction in Europe beyond the UK, particularly amongst millennials. This is likely to have an impact on grocery anchored schemes, and therefore we are now more cautious about the prospects for grocery anchored retail warehouse parks. Effort ratios are likely to be a key indicator of the sustainability of such schemes, with properties in high density urban areas likely to be most resilient.
Figure 2 Strongest three-year rental growth 2018f-20f Best performers office and logistics, plus selected luxury high streets Annual average nominal rental growth 2018f-20f Retail Office Logistics % 7 6 5 4 3 2 1 0 Lisbon Madrid Lisbon SSU (Chiado) Madrid London SSU (Bond Street) Lisbon RW Gothenburg Paris (Northern River Bend) Lisbon Helsinki SSU (City Centre) Milan Milan Frankfurt Brussels SHC Berlin Rome SSU (Via Condotti) Munich Milan SSU (Via Montenapoleone) Copenhagen SSU (Stroget) Brussels SSU Stockholm Lille SSU (Rue Neuve) Paris (Peri Defense) Barcelona Rome Source: Invesco Real Estate, H1 2018; SSU = High street; SHC = Shopping centre; RW = Retail warehouse. f = forecast. In the office sector, the positive economic environment should support steady rental growth in the near term. However, the sector faces headwinds as Europe s working age population starts to decline and the service sector faces disruption from increased automation. Therefore, office based employment growth, which has been a key driver of demand in previous cyclical upswings, is forecast to be more modest in this cycle. Figure 3 Select office employment growth forecast vs history Muted growth forecast for most markets Office employment growth 2013-17 Average annual growth (%) 7 Office employment growth 2018f-22f 6 5 4 3 2 1 0 London (Mid) Paris (LD) Manchester Milan Lyon Warsaw Glasgow Munich Barcelona Madrid Bristol Vienna Rotterdam Amsterdam Helsinki Cologne Cardiff Dublin Stockholm Budapest Marseille Birmingham Rome Zurich London (City) Düsseldorf Hamburg Berlin Leeds Prague Copenhagen Frankfurt Edinburgh Lisbon Brussels Paris (CBD) Gothenburg London (WE) Stuttgart Source: Oxford Economics, January 2018; f = forecast We are also seeing changes in the way people and companies work together. The co-working phenomenon has spread from freelancers, contractors and entrepreneurs, particularly in the tech sector, to the main stream, with corporate occupiers either taking advantage of co-working facilities for their staff, or even looking to create working environments in their own offices that create synergies and build communities. While investors are not yet fully convinced of the longterm viability of the co-working model, the occupier market is signaling that the growing start up segment of the economy is being joined by more established occupiers who are attracted by improved employee satisfaction and flexibility.
For real estate owners, this suggests that office assets should be flexible enough to provide occupiers with a wider range of working environments and amenities for their staff to ensure that they can recruit and retain the best talent. Increasingly property managers may find themselves moving to a more operational model of building leasing and management. Southern European office markets continue to recover and are expected to show some of the strongest rental growth over the next three years. The main German cities, Milan and Paris continue to offer stable performance supported by low supply, modest pipelines and strong occupancy growth. However, rental growth has been anticipated by the market and is generally priced into yields. Following pressure in CBD locations, stronger rent growth prospects can be expected in selective locations and sub-markets outside central locations benefiting from infrastructure development and where demand growth is being shifted as a result of low vacancy in the CBD. The European hotel market continues to perform strongly as increasing travel and limited supply growth boost operational performance In a global context, European hotels remain at the top of the list of developed markets. As of February 2018, average occupancy rates were up to 61.8%, average daily rates (ADR) was up to 98.90 and revenue per available room (RevPAR) grew by 5.1%. According to STR, as of March 2018, Europe is now entering the eighth consecutive year of positive RevPAR growth. Recent growth is being driven by strong demand. While there are pockets of increasing supply, demand growth is more than compensating for the increase. Intra-regional travel is the dominant factor driving growth as the European economic recovery becomes broad based. Strong domestic demand growth is being further supplemented by smaller, but ever growing, numbers of interregional visitors. There are growing levels of investor interest in European hotels as many are becoming aware of the yield premium and structural benefits of leased hotels from a portfolio construction perspective. We continue to favour seven-day trading markets where supply is constrained unless there are opportunities to benefit from exceptional lease terms, market miss-pricing or infrastructure developments. Current favoured markets, in our view, for outperformance are; Edinburgh and Paris. We also see continued value in the stability in the German markets, like Munich, that are recovering from terrorist attacks, and the similarly recovering Brussels market. The residential market outlook should benefit from strong demand growth in urban areas in most European markets. Quality supply remains relatively tight in most European cities and this generation s aim to live in urban areas, close to work and public transport and the need to have amenities in their neighbourhood, should support strong prospects in the well-connected suburban areas in the most attractive European cities that provide the best live-work-play environment: We favour mass market product in sustainable locations such as London and South East commuter areas, and best in class in the UK regions. Frankfurt has recently seen strong growth in recent months and Madrid Private Rented Sector (PRS) is also growing in prominence after a recovery in the build-to-sell market.
Investment Risks The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested. Property and land can be difficult to sell, so investors may not be able to sell such investments when they want to. The value of the property is generally a matter of an independent valuer's opinion. Important information This document is for Professional Clients only in Dubai, Continental Europe, Ireland and the UK, for Qualified Investors in Switzerland, for Institutional Investors only in the United States, Australia and Singapore, and for Professional Investors only in Hong Kong and in Japan as defined under the Financial Instruments and Exchange Law of Japan. In Canada, the document is intended only for accredited investors as defined under National Instrument 45-106. It is not intended for and should not be distributed to, or relied upon by, the public or retail investors. Please do not redistribute this document. By accepting this document, you consent to communicate with us in English, unless you inform us otherwise. For distribution of this document, Continental Europe is defined as Austria, Belgium, Czech Republic, Denmark, Finland, France, Germany, Ireland, Italy, Luxembourg, Netherlands, Norway, Spain and Sweden. The views expressed herein are those of Invesco Real Estate professionals based on current market conditions and other factors and are not necessarily those of other Invesco professionals. The views expressed herein do not refer to any specific Invesco product. Target figures, where mentioned, are not the actual allocations of a specific Invesco product. Opinions and forecasts are subject to change without notice. Past performance is not a guide to future returns. This document contains general information only and does not form part of any prospectus. It is not an invitation to subscribe for shares in a fund nor is it to be construed as an offer to buy or sell any financial instruments. As with all investments, there are associated inherent risks. The information contained in this document may not have been prepared or tailored for any audience. It does not take into account individual objectives, taxation position or financial needs. Nor does this constitute a recommendation of the suitability of any investment strategy for a particular investor. This should not be considered a recommendation to purchase any investment product. This does not constitute a recommendation of any investment strategy for a particular investor. Investors should consult a financial professional before making any investment decisions if they are uncertain whether an investment is suitable for them. You may only reproduce, circulate and use this document (or any part of it) with the consent of Invesco. This material may contain statements that are not purely historical in nature but are forward-looking statements. These include, among other things, projections, forecasts, estimates of income, yield and return. These forward-looking statements can be identified by the use of forward looking terminology such as may, will, should, expect, anticipate, project, estimate, intend, continue, target, believe, the negatives thereof, other variations thereon or comparable terminology. All forward-looking statements included herein are based on information available on the date hereof and Invesco assumes no duty to update any forward-looking statement (except as required by law). They are based upon certain beliefs, assumptions and expectations, some of which are described herein. These beliefs, assumptions and expectations can change as a result of many possible events or factors, not all of which are known to us. Actual events are difficult to predict, are beyond the issuers control, and may substantially differ from those assumed. Accordingly, there can be no assurance that estimated returns or projections can be realized, that forward-looking statements will materialize or that actual returns or results will not be materially lower than those presented. You should not place undue reliance on these forward-looking statements. This document is issued in: Australia by Invesco Australia Limited (ABN 48 001 693 232), Level 26, 333 Collins Street, Melbourne, Victoria, 3000, Australia which holds an Australian Financial Services License number 239916. Austria by Invesco Asset Management Österreich GmbH, Rotenturmstraße 16-18, A-1010 Wien, Austria. Belgium by Invesco Asset Management SA Belgian Branch (France), Avenue Louise 235, B-1050 Brussels, Belgium. Canada by Invesco Canada Ltd., 5140 Yonge Street, Suite 800, Toronto, Ontario, M2N 6X7, Canada. the Czech Republic by Invesco Real Estate s.r.o., Praha City Center, Klimentska 46, 110 02 Prague 1, Czech Republic. Denmark, Finland and Norway by Invesco Asset Management SA, 18, rue de Londres, F-75009, Paris, France. Dubai by Invesco Asset Management Limited, PO Box 506599, DIFC Precinct Building No 4, Level 3, Office 305, Dubai, United Arab Emirates. Regulated by the Dubai Financial Services Authority. France by both Invesco Asset Management SA, 18, rue de Londres, F-75009, Paris, authorised and regulated by the Authorité des marchés financiers in France, and Invesco Asset Management Limited French Branch, 18, rue de Londres, F- 75009,Paris, France. Germany by Invesco Asset Management Deutschland GmbH, An der Welle 5, D - 60322 Frankfurt am Main. Hong Kong by Invesco Hong Kong Limited 景順投資管理有限公司, 41/F, Champion Tower, Three Garden Road, Central, Hong Kong. Italy by Invesco Asset Management SA Sede Secondaria, Via Bocchetto 6, 20123 Milan, Italy. Ireland by Invesco Global Asset Management DAC, Central Quay, Riverside IV, Sir John Rogerson s Quay, Dublin 2, Ireland, regulated by the Central Bank of Ireland. Japan by 1) Invesco Asset Management (Japan) Limited, Roppongi Hills Mori Tower 14F, 6-10-1 Roppongi, Minato-ku, Tokyo 106-6114; Registration Number: The Director-General of Kanto Local Finance Bureau (Kin-sho) 306; Member of the Investment Trusts Association, Japan and the Japan Investment Advisers Association, and/or 2) Invesco Global Real Estate Asia Pacific, Inc., Roppongi Hills Mori Tower 14F, 6-10-1 Roppongi, Minato-ku, Tokyo 106-6114; Registration Number: The Director-General of Kanto Local Finance Bureau (Kin-sho) 583; Member of the Investment Trusts Association, Japan and Type II Financial Instruments Firms Association. Luxembourg by both Invesco Real Estate Management S.a r.l., President Building, Avenue JF Kennedy 37A, L - 1855 Luxembourg and Invesco Asset Management SA, 18, rue de Londres, F-75009, Paris, France. the Netherlands by Invesco Asset Management S.A. Dutch Branch, Vinoly Building, Claude Debussylaan 26, 1082 MD Amsterdam, Netherlands. Singapore by Invesco Asset Management Singapore Ltd, 9 Raffles Place, #18-01 Republic Plaza, Singapore 048619. Spain by Invesco Asset Management Sucursal en España, Calle Recoletos 15 Piso1, E - 28001 Madrid, Spain. Sweden by Invesco Asset Management S.A. Swedish Filial (France), Stureplan 4c, 4th Floor, Stockholm, SE - 114 35 Stockholm, Sweden. Switzerland by Invesco Asset Management (Schweiz) AG, Talacker 34, CH-8001 Zürich, Switzerland. the UK by Invesco Real Estate, a division of Invesco Asset Management Limited, 43-45 Portman Square, London, W1H 6LY, UK. Authorised and regulated by the Financial Conduct Authority. the United States of America by Invesco Advisers, Inc., Two Peachtree Pointe, 1555 Peachtree Street N.E., Atlanta, Georgia 30309, USA. Contact us Timothy Bellman Head of Global Research +1 972 715 7485 tim.bellman@invesco.com Telephone calls may be recorded. Lisa Nell Director Marketing, Europe +44 207 543 3535 lisa.nell@invesco.com Invesco Real Estate Portman Square House 43-45 Portman Square London, W1H 6LY, UK II-REHVE-SUM-1 04/18 GL202