European real estate activity dips from record levels

June 2016

Continental European commercial real estate returns are set to be buoyant in 2016 before moderating, says Chris Urwin.


Favourable relative pricing, healthy occupier sentiment and low yields in other asset classes mean the outlook for continental European real estate remains positive, notwithstanding fears of a global slowdown, deflation and political risk in the area.

Transaction activity on the continent eased in the first quarter after the record €170 billion worth of business seen in 20151, but was still the third strongest start to a year on record2. After average all-property prime yield for continental Europe compressed by around 60 basis points to 4.4 per cent last year, generating very strong capital growth, we expect the pace of yield compression to ease further in 2016.

Weak supply drives rental growth

Strong rental growth persists as the economy picks up, labour markets heal – the euro-zone unemployment rate fell to the lowest since August 2011 in March – and supply remains low. The development pipeline is modest with anticipated net additions to stock in key European office markets like Munich, Milan and Paris low by historical standards. High levels of development are expected in some central and eastern European office markets, such as Warsaw, and Dublin where a surge in supply is likely to weigh on rental growth in the years ahead.

In addition to offering good income growth prospects, property can offer an attractive yield relative to other low risk income-producing asset classes. Indeed, with yields on five year government bonds in France, Germany and Sweden all trading in negative territory, the spread relative to real estate yields is unusually wide by historical standards.

Logistics seems to offer particular value

On a risk-adjusted basis, many logistics markets appear attractive. The distribution sector tends to be higher-yielding and has displayed lower volatility than many retail and office markets in the past. The French, Swedish and Benelux markets look particularly attractive in our view.

On a selective basis, deep value can be found in some prime retail markets, including Italy, Sweden and the Netherlands.

The cycle is most advanced in offices and so value in the sector may be limited. Nevertheless, some office assets in countries like the Netherlands, Germany and Finland appeal. Generally, we favour office locations that serve a highly educated workforce in cities where there are agglomerations of knowledge intensive economic activity. We are cautious about the long-term prospects for locations that accommodate activities that add little value and compete primarily on cost.

Preferred regional market

The recovery in real estate prices has lasted many years. From a global perspective, we view continental Europe as attractive as late cycle risks are less prevalent than in the US and, to a lesser extent, the UK. However, prospects vary by market. To deliver outperformance we continue to target assets with low income risk and see value in good quality secondary assets in the Nordics and Germany.

We expect continental European property to average annual returns of 5.6 per cent between 2016 and 2020, driven primarily by income rather than capital growth. While returns are expected to moderate over the period, we view prospective returns as attractive for relatively low risk investors.

1 Source: CBRE, January 2016
2 Source: CBRE, April 2016

Important Information

Unless stated otherwise, any sources and opinions expressed are those of Aviva Investors Global Services Limited (Aviva Investors) as at 23 May 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. Some of the information within this document is based upon Aviva Investors estimates. It is not to be relied upon by anyone else for the purpose of making investment decisions.

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In Summary

  • Transaction activity eased in the first quarter, but was still the third strongest start to a year on record2
  • The development pipeline is modest with anticipated net additions to stock in key European office markets like Munich, Milan and Paris low by historical standards
  • We expect continental European property to average annual returns of 5.6 per cent between 2016 and 2020, driven primarily by income rather than capital growth
  • On a risk-adjusted basis, many logistics markets appear attractive