European real estate: five-year forecast ticks up to nine per cent pa. But mid-year view more muted

Europe Real estate September 2015

Yield spread over government bonds drives a 20 per cent hike in investment levels.

September 2015

Key points

  • Five-year 2015-2019 forecast rises to nine per cent pa 
  • Mid-year 2015-2019 forecast a more modest 7.6 per cent pa 
  • European investment levels jump 20 per cent year-on-year 
  • Swedish and German prime assets continue to stand out 
  • Dutch and Spanish office markets also appeal but carry higher risk 

The euro zone saw modest (quarter-on-quarter) economic growth of 0.4 per cent in the second quarter, much in line with the preceding three months1. Like other core markets, Germany’s economy remains subdued, but some peripheral markets such as Spain and Ireland are seeing more rapid growth and we expect to see both outperform their peers over our five-year forecast period.

Although we expect Europe’s fragile recovery to continue, it’s subject to a number of risks including the Greek debt crisis and a China-led slowdown in global growth. Taken as a whole, Europe is poorly positioned to deal with another economic downturn. Unemployment remains stubbornly high while growth is being driven more by consumption than by industrial production. With annual inflation reported at just 0.2 per cent last month, most observers now expect European Central Bank (ECB) President Mario Draghi to have to make good on his recent promise to adjust the size, composition and duration of Europe’s quantitative easing (QE) programme if required.

Our latest macro risk-rating shows that Germany, Sweden and Poland have the strongest macroeconomic fundamentals and are therefore best positioned to handle another dip in growth. Unsurprisingly, the risk is more elevated in the southern European economies of Spain, Portugal, Italy, and, of course, Greece (see Chart 1).

Chart 1: Macro risk-rating map


Country Macro Risk Rating
Sweden 0.51
Germany 0.40
Poland 0.38
Czech Republic 0.32
Ireland 0.24
United Kingdom 0.23
Austria 0.23
Denmark 0.18
Belgium 0.16
Hungary 0.07
European Average 0.03
France -0.05
Netherlands -0.08
Spain -0.48
Portugal -0.50
Italy -0.66
Greece -0.95

Source: Aviva Investors Macro Risk Ratings, June 2015

Although European government bond yields have increased since the start of the year, they remain at historic lows and are not expected to start rising for at least two years (see Chart 2). Indeed, the forward yield curve for five-year German bunds doesn’t anticipate yields rising above one per cent until late 2016. This means the current high spread between European prime property and bond yields will be maintained, underpinning demand for some time to come.

According to CBRE data, turnover in the European investment market jumped almost 20 per cent (year-on-year) in the second quarter to €37 billion, driven mainly by strong growth in Germany and the Nordic markets.

Chart 2: Europe (ex UK) All-Property v 10-year German bunds

Source: PMA, Aviva Investors, Bloomberg. Bund yield projections as at 3 August 2015

Rise in forecast returns

Thanks to continued strong investment into prime European assets, we have raised our forecast for annual returns between 2015 and 2019 to nine per cent from 8.7 per cent previously. However, these projected returns are front-loaded to the first half of the forecast period. Our five-year outlook from mid-2015 is significantly weaker at just 7.6 per cent.

On a risk-adjusted basis, our ‘under/over’ pricing analysis for mid-2015-mid-2020 highlights Belgian and German industrial and Swedish retail as the most attractive markets. Pockets such as the Spanish and Dutch office markets also look relatively attractive on this basis.

However, when we superimpose the macroeconomic risks to which these countries are currently subject, they rank quite poorly. An investor with a downbeat view of European prospects may prefer Swedish industrial and retail sectors along with German retail assets.