EMERGING TRENDS AND INVESTMENT IMPLICATIONS
Although many investors welcomed the new year with fairly high hopes, the markets have been on a stomach-churning ride since the start of the year, wrenched up – but mostly down – because of alarm over a slowdown in China and the plunging price of oil to $29.70 a barrel last week, its lowest level in 12 years. European shares ended on Friday at their lowest since mid-December 2014, hit by losses in commodity-related stocks as BHP Billiton announced a major write-down. The Dow Jones was also down almost 10% since the start of 2016 with S&P 500, Nasdaq and Dow Jones down by 2.17%, 3.34% and 2.19% respectively for the week ending January 15, 2016.
Investors are becoming increasingly nervous, having already pulled $12.4bn from US equity funds since the start of this year, FT reports. Similarly, European investment funds counted net withdrawals for the first time since the start of October 2015. Investors have favoured the relatively low-risk money-market funds, which attracted $10.4 billion last week while treasury funds attracted $1.9 billion. Nevertheless, persistently low interest rates mean commercial paper and government bonds do not provide investors with compelling risk-adjusted returns. Thus, global institutional investors display continued appetite for real estate because it offers returns that they cannot currently reasonably achieve with a similar risk level in bonds.
According to the Investment Intentions Survey 2016 published on Wednesday, January 13, 2015 by INREV, ANREV and PREA, investors will commit a minimum of €48 billion to real estate in 2016 globally – an increase of almost 13% compared with last year’s €42.5 billion – with the average target allocation to real estate being 10.3% compared with an average current allocation of 9.4%. European investors lead the pack in terms of building up their real estate portfolios with 64.8% of them expecting to increase their real estate allocation over the next two years. Next in terms of optimism are the North American investors, 42.3% of whom expect to increase their allocation. In third place come Asia Pacific investors, with 39.4% indicating they expect to increase their allocation over the next two years.
As Timbercreek Asset Management reports, ‘the European real estate market delivered the strongest performance of any developed market in 2015, driven by additional monetary stimulus, falling cap rates and strong property fundamentals in London.’ Commercial real estate investment in Europe reached €77.9 billion in the last quarter of 2015, boosting the 2015 commercial real estate investment volume to a record €263 billion, an 18% increase from 2014. The transaction volume is likely to increase further in 2016, as investors have plenty of capital to deploy and occupier fundamentals are improving significantly. Increased take-up was recorded in the majority of key office markets in 2015, and, according to Knight Frank forecasts, aggregate European office take-up will increase by around a further 10% in 2016. Nevertheless, we should expect growth from 2015 to be more measured.
Although several analysts highlight the fact that some gateway cities such as London and Paris seem to be approaching lower bounds, very low yields in UK prime markets have not put off investors, according to a new survey by Colliers International (Global Investor Outlook 2016). The UK remains a primary target for 65% of all investors with an EMEA focus with London remaining the primary target of their investments. This is followed by Germany (37%), France (22%) and Spain (16%). The Netherlands and the Nordics captured the same amount of preferences (14%), while Italy and Poland were singled out more often as secondary markets.
Moreover, the EURIBOR rate – the closest proxy we have for a European risk free rate – is still well below historic averages and thus the spread between income yields on European property and government bonds remains high, despite property yields being so low. European property yields are at record lows in many markets, breaking through an apparent psychological barrier. Yet, most research analysts expect the trend to persist with further potential for yield compression on the back of raising investment volume, which creates ongoing pricing pressure. However, we note that real estate investment companies are wary of the unsustainability of these price levels and ultimately expect the yields to widen once the Bank of England and the European Central Bank start the long-expected interest rates lift off. Most economists now predict another year of ultra-low interest rates, expecting a maximum 1% increase by the end of 2016 and therefore short-term interest rates will likely remain the same in the medium term.
According to Colliers’ survey, 64% of EMEA investors are looking for leveraged IRRs of between 6% and 15%, with 25% looking for leveraged IRRs in excess of 16%. Compared to previous surveys this looks relatively aggressive, although EMEA return expectations remain more modest than American and Asia-Pacific investors. High expected returns undoubtedly reflect the widespread availability of debt in most European markets.
So will 2016 be the year of Continental Europe’s Real Estate? Despite ‘full pricing’ in several European markets, both domestic and international investors remain undeterred and most except investment volumes to further accelerate in 2016. With an expected steady economic growth of around 1.5% through 2016-2017, strengthening occupier fundamentals and rising rental growth across the region’s major markets, average investment grade European real estate, according to Schroders, should average 6-8% total return per year between end-2015 and end-2016 and the majority of performance is likely to come from the income return of around 5%.
- Agate Freimane, BrickVest Investment Team, Senior Investment Director
- Ondrej Hlozek, BrickVest Investment Team, Real Estate Investment Analyst