Despite the weak economic recovery and a threat of deflation, the confidence of investors has improved.

August 2014

Key points

  • Eurozone growth stalled in Q2.
  • Deflation and a prolonged economic stagnation is a significant risk.
  • Prime real estate retains defensive appeal.
  • We prefer good quality secondary assets in Germany and the Nordics.

Confidence building in financial markets

Euro zone growth stalled in the second quarter as the lacklustre recovery experienced since 2013 finally ran out of steam. Meanwhile, the threat of deflation has increased as inflation levels continue to fall. But financial markets are confident the ECB will prevent a prolonged economic slump and avert deflation. 

ECB action

The ECB has already cut its benchmark interest rate to a record low of 0.15% in June, introduced negative deposit rates and launched ultra-cheap four-year loans to banks to boost lending. Furthermore, according to ECB President Mario Draghi, the bank will “act swiftly” by easing policy further if required. With euro zone inflation falling to 0.4% year-on-year in July and still in the ECB’s “danger zone”, action could come sooner rather than later.

Chris Urwin
With euro zone inflation falling to 0.4% year-on-year in July and still in the ECB’s “danger zone”, action could come sooner rather than later.

Chris Urwin

Head of Global Research – Real Estate

Commercial recovery continues

The recovery in the European commercial real estate investment market continues apace. The value of transactions in mainland Europe rose 38% to €30.7 billion in the second quarter from the same period a year earlier. The office sector accounted for around 40% of this total.

Falling yields

According to CBRE, prime yields for all sectors have been falling since the end of 2012. In the second quarter, prime yields in the main 15 European markets fell by an average of eight basis points in the industrial and office sectors, and by 14 in retail. Yields across all three sectors are now between 55 and 85 basis points beneath their Q2 2009 peak.

Attractive prices – but careful selection required

Prices for prime European real estate continue to look relatively attractive, but careful selection is required: prices have risen a long way and properties are changing hands at prices well above fair value in some markets.

 

Prime real estate is still highly valued for its defensive qualities. We believe this will keep downward pressure on yields in the more liquid markets of Germany and the Nordic countries over the near term.

Strong medium-term prospects

Indeed, this near-term drop in yields together with capital growth explains why our forecast is significantly stronger for the next three years than for the next five. Over the next three years we expect European (ex UK) property will return 8.2% per annum* supported by a nascent recovery in peripheral markets. Over the next five years, however, we expect the annual rate of return to be a more modest 7.4% as yields rise in the medium term.

Prime assets retain appeal

Given the economic uncertainties, investors should take diversified risk exposures. Our preference is for good quality secondary assets in Germany and the Nordic region. But given the risk of a further weakening of European economies, prime assets retain some appeal. While today’s prices may be high by historical standards, they will continue to offer an attractive premium for as long as interest rates remain at extreme lows.

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