Assessing the European investment market

Following a record year for European investment in 2015, how has the market fared so far this year in comparison? Where are the opportunities in European property?

7th October 2016

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2015 was a record year for European investment, how has the market fared so far in 2016?
European transaction volumes reached €317 billion in 2015 (according to Real Capital Analytics) , reflecting an exceptionally strong year. This is unlikely to be repeated in 2016, as total investment for the first six months of the year declined by 30% from the corresponding period in 2015. The UK, which typically accounts for nearly a third of European investment, saw the largest fall at -45%, as investors’ anxiety over Brexit weighed heavily on a market that was already at a mature stage in the cycle. Yet, even with the UK stripped from the total, investment in Continental Europe fell by 22% y-o-y. Interestingly, of the top 25 most liquid cities, only seven saw an increase in investment during this period, indicating that the slowdown was widespread across the region.
What was the cause of slowdown in investment?
We attribute the decline to a number of factors. One is that the y-o-y comparison was made against a high base in 2015, which might underestimate the true strength of the market. However, there is also a strong possibility that investor sentiment has shifted due to economic and geo-political uncertainty, causing investors’ appetite for risk to diminish. Further, the drop off in transaction numbers, particularly ‘mega deals’ potentially points to a change in attitude among investors in response to historically low property yields. Average prime yields in Continental Europe have fallen to around 3.50% and 4.00% for high street retail and office respectively, tightening by around 50 bps in the past year. Gateway cities, such a Paris, with strong financial and creative sectors, as well as a global reputation as world class retail destinations, have seen yields fall below 3.5%. More risky markets, such as Southern Europe, have also seen significant yield compression in recent years as investors have moved up the risk curve.
What is the outlook for yields from this point onward?
Despite being at a mature stage in the cycle, property yields are likely to remain around current levels for the remainder of the year and into 2017, despite the slowdown in demand, as low interest rates and bond yields provide a short-term buffer. External factors such as Brexit and ongoing structural issues in the European economy mean that rates are likely to remain lower for longer. It will be interesting to see if investor perceptions of pricing evolve to reflect the new environment, either triggering a rebound in investment or a continuation of the current slowdown in activity.
If real estate markets are reaching a mature point in the cycle, where are the opportunities?
Market timing plays an important role in identifying opportunities. Yields are at historic lows across most markets and sectors, indicating that many real estate markets are at a mature point in the cycle. In our view, the best opportunities will continue to be found in wealthy, dynamic, vibrant and growing cities, with global profiles. However, pricing is likely to prohibit acquisitions in prime locations. Outperformance is likely to be found in emerging urban areas that benefit from spill-over in demand from established locations and structural change, driven by growing populations, particularly young, highly skilled inhabitants.

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