Sustained investor appetite for Europe’s prime assets has buoyed our near-term return forecast.

June 2014

Key points

  • Slow economic recovery expected with deflation a serious threat.
  • Declining vacancy rates and lack of new supply to spur European rental growth.
  • Investment flows in mainland Europe up 30% on last year with strong performances in periphery countries.
  • We suggest a focus on good quality secondary assets ,value-add and opportunistic strategies.

Euro zone economic growth has been far from spectacular since the region emerged from recession in 2013. And it's likely to continue. We're forecasting GDP growth of 0.9% for 2014 followed by 1.3% in 2015.

The significant fall in peripheral government bond yields partly reflects a decline in perception of near-term risks. However, we're still concerned about deflation. This is because it could undermine occupier demand and deter investors worried about falling rents. With the exception of prime assets, this could blight the property sector. 

Eurozone inflation stood at 0.7% year-on-year in April – well below the European Central Bank’s (ECB) target of “below but close to” 2%. Following its latest policy meeting, ECB president Mario Draghi said the bank was “comfortable with acting next time”. While we expect the ECB to loosen monetary policy further in the form of quantitative easing, the size and timing of this policy stimulus remains uncertain. The house view is for the ECB to cut its benchmark interest rate further from its record low of 0.25%.

Occupier markets

Nonetheless we expect improving occupancy levels and a more sustained economic recovery in Europe to drive rental growth. This should be accentuated during the second half of our forecast period as a lack of new supply also comes into play more across most of Europe. Our current house view is for all-property rental growth for Europe (ex UK) of 2.6% a year during the 2014/16 period, strengthening to 3.7% a year in 2017/18.

Europe’s investment markets

Investment activity in Europe was up 30% during the first quarter of 2014 compared to the same time last year at €26.5 billion reflecting robust investor interest. According to, a leading commercial property adviser, CBRE more than two-thirds of investors plan to raise their real estate spending this year. Not surprisingly, volumes are continuing to rise, with Europe’s office markets still accounting for the majority of transactions.

While the economies of France, Germany and Sweden all saw greater investment volumes in the first quarter, the same was also true of for peripheral markets such as Spain and Ireland.


Meanwhile, the divergence between prime and secondary real estate valuations in Europe shows little sign of abating. According to the CBRE’s valuation indices, values at the average end of the market continue to fall. In the first quarter, a drop in real estate prices in the Netherlands and central Europe helped to deliver a tenth consecutive quarter of capital declines for secondary properties leaving them 21% cheaper than at the end of 2007.

By contrast, prime all-property capital values have risen for the last eight consecutive quarters. According to the CBRE’s Eurozone Prime Capital Value Index, after reaching their nadir in the third quarter of 2009, prime valuations have climbed consistently to gain 22.8%, breaching their pre-crisis peaks in the first quarter of this year.

Office, industrial and retail markets

During the first quarter of 2014, prime rents were up across all sectors, according to the CBRE EU15 indices (which include UK numbers). Even so, prime yields in all sectors have been falling since the end of 2012. In aggregate, the CBRE EU15 prime yield indices all showed further yield compression in the first quarter of the year. Prime industrial and retail yields both fell by five basis points (bps) while prime office yields declined by eight bps. Yields in all three sectors are now between 75bps and 100bps lower than when capital values last peaked in the second quarter of 2009.

CBRE data show that year-on-year rental growth has been strongest in the retail sector at 5.5% compared to 1% in the office sector and just 0.2% in the industrial sector, although the recent outperformance of the former was mainly driven by German cities.

Even so, the retail sector has generally been the most resilient in recent years experiencing positive capital growth of 0.1% in the first quarter of the year. While retail capital values are still circa16% below their peak levels of the fourth quarter of 2007, office and industrial values are 21% and 29% lower respectively. Europe’s retail sector is expected to deliver the strongest capital growth over our 2014-18 forecast period at 2.9% a year against forecast all-property growth averaging 2%.

Euro zone outlook

Prime European real estate continues to look favourable, but market sentiment and pricing momentum have already moved a long way and prices paid are frequently well ahead of valuations in some markets.

With real estate investment volumes strengthening across Europe, prime real estate is still highly sought after for its defensive qualities. We believe this will weigh on yields in core markets in the near term.

Indeed, this near-term yield compression and capital growth accounts for why our forecast is significantly stronger for the next three years than for the next five.

For the 2014-16 period we expect to see all-property total returns in Europe (ex UK) of 8.3% a year, however, we expect this to decline to 7% a year over 2014-18 as yields rise further out.

With the search for yield intensifying and investors showing increased risk appetite, we continue to prefer good quality secondary assets in more liquid core markets. Under our main case we stress a focus on value-add and opportunistic strategies where fundamentals are most compelling, including selective investments in Spain and Italy.