European real estate: prime property retains appeal
Prime property retains its appeals thanks to in-built defensive qualities with concerns over the economic outlook growing.
- Prime property’s defensive characteristics appeal as economic outlook deteriorates.
- Prime property in Germany and the Nordic and Benelux regions looks most attractive.
- Interest rates to stay even lower for even longer.
No grow zone
The euro zone economy is running out of steam, growing just 0.2% in the third quarter of 2014. Germany narrowly avoided a recession. Inflation is low and falling. And lower energy prices brought inflation down to 0.3% in November. As a consequence, we have revised our growth forecast for 2015 down to 0.7% from 0.9%. We expect the European Central Bank to implement full-scale quantitative easing at some point next year, but the risk of a prolonged period of economic weakness is growing.
We have upgraded our forecast for prime property total returns in Europe (excluding UK) to 7.9% per annum for the 2015-19 period*. This stronger forecast reflects the scope for yields to fall even further than anticipated, with interest rates and government bond yields expected to remain lower for longer. With commercial real estate looking cheap relative to fixed income, we are likely to see significant capital inflows into prime real estate. At around €30bn, inflows into European markets were up nearly 30% in the third quarter compared with the same period the year before.
Deteriorating secondary markets
Despite economic weakness, we expect steady rental growth in prime property across Germany, the Nordic and Benelux regions. So far these markets have proved resilient to weaker economic conditions, with a supply shortage supporting prices. At the same time, fears that Europe may be entering a lengthy period of weak growth and very low inflation mean prospects for secondary markets have deteriorated.
We have upgraded our forecast for prime property total returns in Europe (excluding UK) to 7.9% per cent per annum for the 2015-19 period
Income security is key
We therefore have a strong preference for high-quality assets that offer a good degree of income security. Prime assets in core markets currently look attractive. The retail and industrial sectors in both Germany and Benelux, along with the Swedish retail sector, look particularly appealing on a risk-adjusted basis. We expect continued polarisation in retail markets: cities offering exposure to a large, wealthy catchment areas are likely to significantly outperform.
Elsewhere in Europe
The Irish market still offers some value on a risk-adjusted basis, but with less upside potential than six months ago. Occupier markets in Spain and Italy, meanwhile, are expected to recover more slowly. As a consequence, scope to generate high returns in these markets is limited. Several central European markets look unattractive, particularly the Polish office sector where there is excess supply.
Given the deterioration in the economic outlook, we now have a stronger preference for higher quality assets in core markets. The pricing of prime assets may be expensive by historical standards.
But given that we now have greater conviction that rates will remain even lower for even longer, yields still look attractive.
*The Irish market still offers some value on a risk-adjusted basis but there is less upside potential than six months ago. Meanwhile occupier markets in Spain and Italy are expected to recover more slowly. Consequently, we believe the scope to generate high returns in these markets is limited.
Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (“Aviva Investors”) as at 1 December 2014. Unless stated otherwise any opinions expressed are those of Aviva Investors. 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.
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