Real Estate Research
Continental European real estate market commentary - Q3 2018
Growth in the Eurozone remains above trend which is filtering through to active leasing and investment markets. However, Schroders forecasts that Eurozone economic growth will slow through 2018 - 2019.
Growth in the Eurozone remains above trend which is filtering through to active leasing- and investment markets. Going forward however, Schroders forecasts that Eurozone economic growth will slow albeit slightly to 1.75-2.0% p.a. through 2018-2019. Consumer spending should be supported by an increase in employment and rising real wages and most Eurozone governments can afford to loosen their fiscal policy. However, there are signs that the decline in unemployment is starting to put upward pressure on wages, particularly in Germany, and while ECB has announced to halt QE at the end of the year, Schroders expects the ECB to raise interest rates gradually from the second half of next year. In addition, while the EU has so far avoided a trade war with the USA, the slowdown in China and other emerging markets is likely to damp growth in Eurozone exports. We expect the Netherlands, Spain and Sweden to see the fastest economic growth over the next few years, followed by France and Germany. There is an outside risk of a new sovereign debt crisis, if the coalition between far right and far left parties in Italy unravels.
Office take-up was strong across continental Europe in the first half of 2018. While the main driver is the growth in employment, demand is also being propelled by two other trends. First, the expansion of serviced office providers, although that is to some extent cannibalising lettings to smaller occupiers. Second, many larger companies are upgrading their offices, not to impress clients, but to attract and retain skilled staff and improve their wellbeing and productivity. As a result, we are now seeing a simultaneous increase in prime and average grade office rents, not only in the big German cities and Stockholm which initially led the upswing, but also in Amsterdam, Brussels, Madrid and Paris. While there is a risk that this increase in rents will trigger a building boom, in most cities the upturn in development has so far been in step with demand, adding less than 1% p.a. to total floorspace. Also, many markets continue to see very low levels of vacancy, particularly for quality space.
The logistics market in continental Europe is also enjoying strong demand, thanks to the upturn in manufacturing, the growth of online retail and a structural increase in contracting-out to third-party providers. 3PLs and online retailers accounted for 45% and 15% of take-up respectively, in the first half of 2018 (source: JLL). However, on the supply side, developers have been quick to respond with build-to-suit projects, with the result that prime logistics rents in most locations have been flat this year. The exceptions are Paris, Lyon, Hamburg and southern Germany where development land is scarcer and rents have started to increase. Looking ahead, we expect more cities to see an increase in the prime logistics rents, with growth typically running around 2% p.a.
By contrast, retail real estate markets are polarising, as consumers buy more online and prioritise experiences over goods. The trend is clearest in northern Europe where online sales now account for over 10% of total sales and the number of people visiting stores in France and Germany is falling. In most countries shopping centres are suffering higher vacancy than retail parks because: internet penetration in clothing is higher than in bulky goods; shopping centre rents are higher relative to sales than retail park rents and retail parks tend to be more accessible by car. In general food anchored schemes are also relatively defensive, although the success of individual formats varies from country to country, with hypermarkets struggling in France and Spain, but gaining market share in Sweden.
The total value of investment transactions in continental Europe fell by 20% in the first half of 2018 compared with the same period in 2017. Although superficially this decline can be attributed to one-off factors such as a shortage of big portfolio deals, or concerns about potential tax changes in Germany and Sweden, the bigger picture is that investors are starting to factor in an increase in bond yields over the medium term. Schroders expects that the yield on German 10 year bonds will rise to 2.5% by 2022. While that will put upward pressure on eurozone real estate yields, we think that the increase in office and logistics yields between end-2019 and end-2022 will be limited to 0.25-0.4%, assuming that the eurozone economy continues to grow and prospects for rental growth remain favourable. The exception could be the retail sector where investors’ concerns about on-line diversion and future rental growth could lead to an earlier and sharper increase in yields.
Our strategy is to focus on office and logistics in major European cities which have diverse economies, a large pool of skilled labour, good infrastructure and are attractive places to live. Examples include Amsterdam, Berlin, Hamburg, Frankfurt, Luxembourg, Madrid, Munich, Oslo, Paris, Stockholm and Stuttgart. We also see opportunities in certain alternative sectors benefiting from long-term structural forces, such as data centres, hotels with management contracts and primary and secondary healthcare.
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