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Panos Danos: Global Real Estate Trends 2019-2020

Panos Danos: Global Real Estate  Trends 2019-2020

Will the current property cycles in Europe continue?

The   positive   momentum   for   commercial   real-estate   investments   in   Europe continued in 2018, with an investment volume of EUR 264bn in 2018 for all commercial property segments combined, only 2% below 2017, which was a record year.

“On the back of a stable occupier market, European commercial real estate entered 2019 with some of the strongest fundamentals ever seen on the continent.” (source: BNP Paribas Real Estate, At a glance: European Property Prospects – 2019). According to BNP Paribas Real Estate, gross initial prime yields (GIYs) in some core markets  stand  at  a  historically  low  level,  so  there  is  little  room  for  further compression, bar the logistics sector.

Let’s  take  the  European  office  market  as  an  example.  “For  70%  of  the  office markets prime yields will remain stable in 2020. We do see potential for property yields to start unwinding from mid-2020 coinciding with resurgence in core inflation and thus monetary policy tightening. Even so we think the increase will be gradual, with the cumulative average rise in yields over the 5-year forecast period expected to be +50bps for offices and +35bps for logistics.” (source: At a glance: European Prospects –2019/2020).

Forecasts for office rental growth in Europe range from virtually non-existent, to around 8% this year. Berlin is expected to enjoy the strongest growth in office rents of 8%.

Even though Spanish cities have already experienced sharp growth, they still have some potential with expected average annual growth exceeding 2% over 5 years. French office markets are projected to generate stable or slightly higher rents, while London’s could decline initially due to Brexit.

Capital appreciation returns are set to slow further. Values of tier-1 offices cannot go up much higher, because GIYs would be ridiculously tight. As a result, total returns booked by first-grade offices—after adding net rental income—are expected to be in the single digits for most office markets in 2020. One exception is Berlin (+11%), a market supported by an expected growth in rents, despite carrying the lowest real-estate yield in Europe (2.7%).

Prime total returns across the 36 European markets that BNP Paribas Real Estate covers may average +4% in 2020. The best returns are expected in Madrid (+8%), Amsterdam (+9%) and the German cities of Cologne (+9%), Dusseldorf (+8%) and Frankfurt (+7.5%). “In contrast to the prime segment, the broader market (including secondary assets) will have a higher level of return. The total return here will average +6.75% in 2020. There are only three markets: Berlin (+16%), Marseille (+11%) and Amsterdam (+10%) with double-digit returns."A large part of this is due to the higher yield, providing a higher income return relative to the prime segment. In the case of Berlin, again the expected strong rental upswing is supporting higher capital growth.” (source: BNP Paribas Real Estate,  2019).


How did European debt pricing look at the end of 2019?

Senior debt contracted in first-class European offices and the loan-to-value ratio (LTV) was below 65% in many markets.

Borrowing costs for commercial real estate generally decreased in 2019, due to lower swap rates and margins. "From the lenders' point of view, risk undoubtedly increased in 2019; yields decreased, underlying values increased and key risk measures appear to be tight in some markets, with costs generally below 2.5% and very often below 1.5% all-inclusive."
(source: European Outlook for 2019-2020).

For borrowers, lower debt costs mean that there are many markets which offer them the required IRRs.

Retail under pressure but not catastrophic

The retail segment is still under pressure. However, the newly-coined term, 'disruption', may not be appropriate to describe in detail what is happening in Europe (and indeed in other parts of the world).

Online sales do not necessarily pose a threat to the existence of physical stores. In fact, they can support them when retailers adopt a so-called ‘omni-channel’ approach. Retailers in Europe have developed a unified supply chain, where physical and online stores use the same distribution systems (with 'click and collect').

E-commerce and logistics companies will continue to play a leading role in the industrial real-estate industry, with 'last mile delivery' becoming increasingly important.

‘Last mile’ is a term used in supply chain management and transportation planning to describe the movement of people and goods from a transportation hub to a final destination in the home.


Conclusion

We favour offices and logistics over retail investments—for the time being—regardless of geography. It is clear that we are in the ‘late’ property cycle in many markets, though we believe that investors will not get stuck at the losing end of cyclical swings in the property market.

Capital markets remain very supportive indeed. However, investors should take out moderate levels of debt to avoid a ‘fire’ (i.e. forced) sale at the end of a market downturn.

Caution  is  needed  for  lower-tiered  markets. It  is  better  to  invest  in  properties  that  can  be repositioned in prime locations. Investors cannot afford to ignore lower capital appreciation returns in the coming months.
 

 

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