Key points

  • Occupier demand is rising in Europe’s office markets. Annual investment volumes were up by 30 per cent in the third quarter
  • Rents are rising fastest in the retail sector and investment activity has increased 45 per cent on last year
  • Rents are also now rising modestly in the industrial sector after 13 consecutive flat or falling quarters
  • Yield compression has accelerated over the course of 2015 but the spread offered by real-estate assets over government bonds remains attractive
  • Industrial assets are set to outperform at the sector level with those in Benelux looking especially attractive

Rents are rising across all sectors while investment volumes are up significantly from a year ago

The euro zone economy saw modest growth of 0.3 per cent in the third quarter with the European Commission’s economic sentiment index, which hit a four-year high in September, indicating that improvements continue, albeit at a slow pace.

Meanwhile, Mario Draghi, President of the European Central Bank, has signalled that more monetary stimulus is on the cards when the bank next meets in December. European inflation returned to negative territory in September which means that we now expect to see annual inflation of zero for 2015. Elsewhere, Europe’s anaemic employment gains and the ongoing slowdown in emerging markets suggest that further stimulus is necessary if Europe is to see improved employment growth and investment spending.

Occupier demand continues to rise

Even so, Europe’s office markets continue to see significant improvements in occupier demand. In many cases, the strong occupier demand coupled with a lack of development has resulted in declining vacancy rates and rising rents. Investment demand is also strong as illustrated by aggregate third quarter investment volumes that were up by 30 per cent on last year (see Chart 1) with Portugal, Belgium and Norway recording the largest single year-on-year increases.

Chart 1: European investment market turnover (€ billion)

Meanwhile, Europe’s consumers are becoming more upbeat about their personal finances. Consequently, confidence in the retail sector continues to grow across the region with rental growth for retail properties continuing to outperform that of office and industrial premises. According to CBRE, retail rents posted year-on-year growth of 6.1 per cent in the third quarter with markets such as Dublin, Madrid and Barcelona all delivering rental growth north of eight per cent. Meanwhile, investment activity in the sector jumped by 45 per cent year-on-year to a brisk €12.9bn.

Rents are also now progressing in Europe’s previously moribund industrial sectors. After 13 consecutive quarters of falling or static rents, industrial rents finally ticked up in the second quarter of this year with a modest year-on-year improvement of 1.1 per cent. Investment demand for industrial and logistics property remained robust in the third quarter as was demonstrated by a 32 basis point compression in prime yields.

However, total investment volumes for Europe’s industrial sector dropped away dramatically in the third quarter to be some 20 per cent down on their levels of a year ago. Our view is that this is more a reflection of the continuing shortage of supply rather than a lack of demand.

Pockets of value still on offer

Since the start of 2015, the rate of decline in property yields has accelerated. This reflects the attractiveness of European real estate when compared to other income-producing assets, as well as its relatively robust income security and growth prospects. With government bond yields set to remain low, the substantial spread offered by real-estate assets is likely to continue for some time.

Although projected European (ex UK) total returns for the next few years are trending down, we believe that good value opportunities are still on offer in some markets. Our forecast for prime all-property total returns in Europe (ex UK) is now six per cent per annum over the 2016-20 period.

We currently expect Spain’s property markets to deliver the best total returns over the next few years with a forecast 7.7 per cent p.a. all-property return for the next five years thanks to strong rental growth (see Chart 2). At the sector level, we expect industrial assets to outperform office and retail properties during our 2016-2020 forecast period, especially in Belgium and the Netherlands. Swedish retail and German industrial assets also appear to offer deep value.

Chart 2: Europe (ex UK) total return forecasts, 2016-20 (% p.a.)

Important Information

Unless stated otherwise, any sources of information, views and opinions expressed are those of Aviva Investors Global Services Limited (Aviva Investors) as at 25 November 2015. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. 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. Some of the information within this document is based upon Aviva Investors estimates. These have been calculated by Aviva Investors Real Estate Strategy and Research Team based on data sourced from recent market transactions and should not be relied on by anyone else for the purpose of making investment decisions. 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 in the UK by the Financial Conduct Authority and a member of the Investment Management Association. Contact us at Aviva Investors Global Services Limited, St. Helen’s, 1 Undershaft, London EC3P 3DQ.