European real estate prospects remain encouraging, despite heightened political risk and more uncertainty, says Monika Sujkowska.

 

The UK is now expected to enter a shallow economic recession by the end of 2016, though this is unlikely to trigger a recession in the rest of the European Union (EU). The 'Brexit'-induced uncertainty and its effect on financial markets and business investment may nevertheless shave 0.2-0.4 per cent off overall euro-zone growth over the next 12 months. The impact of a slowdown would vary across the market with Ireland and Benelux countries likely to take more of a hit than others.

Increased uncertainty to breed more volatility

The main change in our thinking on prospects for European real estate is a greater focus on potential geopolitical shocks. Populist parties in the Netherlands, Italy and France may gain more parliamentary seats in upcoming elections by mid 2017. We nevertheless assume no further disintegration of the EU and maintain our forecast property returns for most markets in the region. Irish real estate is an exception due to the country’s close trade and financial links with the UK. Benelux real estate is also expected to be affected, albeit to a lesser extent.

Uncertainty over the outcome of the UK-EU negotiations will breed further volatility, as will votes across Europe this year and next. We anticipate lower for longer interest rates and possibly an extension of the European Central Bank’s asset-purchase programme, both of which will be supportive for high-quality continental European real estate. Relative pricing for property is likely to improve further in ‘core’ markets, especially Germany, Switzerland and the Nordics where government bond yields may break fresh record lows in the coming weeks.

On balance, we expect continental European transaction volumes to fall modestly in the second half of 2016. Many investors will delay acquisitions as they adjust their risk premiums following recent corrections in more liquid asset classes. Nevertheless, sentiment will be supported by favourable underlying fundamentals, with subdued development activity and steadily rising occupier demand resulting in shortages of space in a number of markets. So the outlook for rental growth is broadly positive. In addition, very accommodative monetary policy in the area will underpin property pricing, with yields expected to be unchanged in most parts of market and likely to compress for the best quality assets.

Mass exodus from London unlikely

There is much speculation about companies based in London relocating their staff to continental Europe. We believe this is premature and the capital may defend its position as a global financial hub due to its unique strengths such as a low corporate tax rate, a diverse talent pool and relatively low regulation. Companies are more likely to favour continuity and maintain headquarters in London, although some functions such as euro-denominated trading may be moved. So there may be a modest uptick in demand for office space in smaller EU financial centres. However, this is unlikely to be focused on two or three cities in the bloc as argued by some, but rather spread across more locations where City institutions operate.

Activity levels to be more affected than asset values

The UK’s shock decision to leave the EU is clearly a source of uncertainty. This will affect activity more than asset values, with the latter aided by a more entrenched economic recovery and even looser monetary policy. Indeed, top-quality assets in core markets are likely to prosper from the increasingly uncertain environment. While we maintain our forecasts of 5.6 per cent average annual total returns for European real estate between 2016 and 2020, we assign a higher probability to future geopolitical risks, be it further EU disintegration, political impasse or otherwise.

Key polling dates

·         Autumn 2016: Hungarian referendum on rejecting EU mandatory refugee quotas

·         October 2016: Italian constitutional referendum

·         March 2017: Dutch general election

·         April-May 2017: French presidential election

·         June 2017: French parliamentary election

·         September 2017: German parliamentary election

Important Information

Unless stated otherwise, any sources and opinions expressed are those of Aviva Investors Global Services Limited (Aviva Investors) as at 1 July 2016. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Past performance is not a guide to future returns. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested.

Issued by Aviva Investors Global Services Limited, registered in England No. 1151805. Registered Office: St. Helen’s, 1 Undershaft, London EC3P 3DQ. Authorised and regulated by the Financial Conduct Authority and a member of the Investment Association. Contact us at Aviva Investors Global Services Limited, St. Helen’s, 1 Undershaft, London EC3P 3DQ.

Approved for Austria, Belgium, Denmark, Finland, France, Germany, Ireland, Italy, Luxembourg, Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the UK.
RA16/0455