European real estate prospects

EUROPEAN PROPERTY MARKETS ELONGATED EUROPEAN REAL ESTATE CYCLE

Sukhdeep Dhillon, Senior Economist & Associate Director, BNP Paribas Real Estate

Since 2012, Newsec has been a BNP Paribas Real Estate Alliance Partner, which gives Newsec access to an international network of potential clients and relevant connections. The alliance allows for both Newsec and BNP Paribas to expand coverage, and help to advise you and drive your real estate strategy internationally.

The European economy remained on the brink of a recession throughout last year. Towards the end of the year we saw tentative signs of stabilisation with the latest quarter GDP growth coming in better than expected. Final year figures are likely to show the economy slowing more than expected overall in 2019, to a real GDP growth of only +1.1 per cent, compared to +1.9 per cent in 2018. To everyone’s surprise Germany avoided a recession, although this does not mean the country is completely out of the woods. Looking ahead, growth across Europe is not expected to gain much traction through 2020. Employment growth is expected to remain at a similar pace while unemployment rates are expected to remain low. Our central scenario is that the European growth will be slow but positive, with a sub-par forecast of 0.8 per cent growth in 2020. We also expect European nations will consider introducing growth-enhancing fiscal measures this year to move out of this low growth trap.

The sub-par forecast for economic growth and inflation will place downward pressure on the government bond yield outlook. The total amount of negative yielding debt peaked in the summer of 2019 at $17 trillion. A number of factors will continue to push government bond yields lower. Unless something drastically changes, underlying structural factors suggest bond yields will remain lower for longer.

Real estate as an asset is typically the main beneficiary of low bond yields. The spread between bond and property yields will remain favourable. European government bond yields continue to trend lower. This has been and will be supportive for real estate pricing. The European real estate market is also at a mature stage of the cycle. Our forecasts therefore indicate this stage of the cycle will be elongated. We have revised our view positively with yields across most European markets expected to decrease further this year for both logistics and offices. The retail sector depicts a much more mixed picture.

It is important to note that investment volumes in certain markets are limited due to the lack of good quality prime assets, as well as other country specific factors. This was the case for the UK, where a lack of good quality prime assets available to the market has held back investment, coupled with caution from investors (overseas especially) about the direction of the UK economy with Brexit. No doubt the uncertainty and the stage of the cycle also means sellers are reluctant to bring their assets to the market and are waiting for the right moment.

Overall average total returns for the markets we cover will reach 9.2 per cent this year, largely driven by both income (+4.3 per cent) and capital growth (+4.9 per cent).

Core versus secondary markets Last year, across a number of European countries, investors became frustrated by the lack of prime assets available in core locations. As a result, investors widened their risk profile by looking further afield into secondary assets, or outside the typical CBD areas. Regions such as the ‘Non-Capital’ Cities therefore came onto investor radars. In the case of the UK, 39 per cent of total investment volumes were allocated to property outside of London in 2019. A similar pattern was seen in France where investment outside the capital reached approximately 30 per cent, up from 25 per cent the year before. Areas such as Marseille, Bordeaux and Lille featured highly. Similarly, investors turned to cities outside of Madrid, with Seville, Valencia and Bilbao experiencing great investor interest.

Looking ahead, this year the focus and deployment of investment is likely to be on core locations over secondary. Cities that remain popular for investors will be the cities that are most supportive of occupiers, specifically those able to attract the talent needed such as London, Paris and Berlin. Having said that, lack of supply remains an issue, whereby investors may in certain cases wait for opportunities in those core locations or consider similar products in regional cities.

Alternative sector no longer an alternative: it is mainstream Demand for alternative assets is likely to increase. Typically, the composition of a property portfolio has consisted of offices, retail and industrial assets, but this is changing.

The alternative sector continues to enjoy remarkable growth year on year. The alternatives sector is a composite

»Last year, across a number of European countries, investors became frustrated by the lack of prime assets available in core locations. As a result, investors widened their risk profile by looking further afield into secondary assets, or outside the typical CBD areas«

of tenant activities including student housing, hotels, build-to-rent, coliving, senior housing and healthcare.

Last year across Europe the sector grew by an impressive 37 per cent – now accounting for 25 per cent of total investment, up from 16 per cent the year before. Looking ahead, demand from investors into the alternative sector is likely to continue,

pushing this sector closer to becoming an established asset class alongside offices, retail and logistics.

The alternative sector has benefitted from investors who were not interested in venturing outside of their usual locations, but instead diversified their holdings in their core locations. Of course the attractive yields only solidified their decisions to take the plunge and commit to the sector.

Fundamentals across Europe such as an ageing population and the increasing demand for education mean there is huge potential for growth in this sector. What we are likely to see going forward is investors now venturing out to other core locations, pursuing further investments in the alternative, or the ‘not so alternative’ sector.