New record level in CRE investment activity
1st February 2015
Simon Townsend, head of DTZ’s Middle East Capital Markets teams gives an insight into current European commercial real estate investment trends. Based in the UAE, Simon’s team advises investors on local, regional and global acquisitions and disposals within DTZ.
Despite economic growth in key European markets being slower than expected, investor demand for European commercial real estate remains strong. Driven by strong relative pricing and the availability of new capital, peripheral markets are showing the largest growth in investment volumes while the UK and Germany lead the major markets.
Commercial real estate investment activity reached EUR 39.2 billion [USD 48.1 billion] in Q3 2014. Although marginally lower on Q2, volumes continue to grow on a rolling annual basis. Over the last twelve months volumes reached EUR 168 billion [USD 206.4 billion], a 24% increase on the same period a year ago taking volumes back to early 2006 levels.
SHARP UPTURN IN PERIPHERAL MARKETS
However, there remain variations at a country level. The strongest growth in activity has been led by the peripheral markets – Ireland, Italy and Spain. Combined volumes reached EUR 4.6 billion [USD 5.6 billion] in Q3, a 255% increase on the EUR 1.3 billion recorded a year ago. In Spain growth was a staggering 315% over the same period, highlighting the change in fortunes for these markets – of course, growth is coming from historically low levels.
Of the major markets Germany posted the strongest growth with volumes up 29% to EUR 7.7 billion [USD 9.4 billion]. Meanwhile, growth in the UK was more muted at 4%. Following a strong Q2, French volumes posted a 17% decline with quarterly volumes of just EUR 3.6 billion [USD 4.4 billion] in Q3.
Rise in volume was also recorded in the Nordics, with volumes reaching EUR 3.6 billion in Q3 2014, marking a 17% y-o-y increase. Growth was led by activity in Norway and Finland while volumes were trending lower in Sweden.
Compared to recent quarters, trading of assets above EUR 500 million was low, with just a couple of deals closing over the quarter. However, there was a noticeable uptick in activity for deals between EUR 100m and EUR 500m. These totalled nearly EUR 17 billion [USD 21 billion] in Q3, nearly 40% higher than a year ago. As a result, the growth in deals across this size band helped drive average lot size up from EUR 35m last quarter to EUR 36m in Q3.
A further increase in smaller lots was also observed with the volume of sub EUR 100m deals representing nearly 60% of total volumes.
SOURCE OF CAPITAL
Compared to a year ago, we have seen growth in all sources of capital on a rolling annual basis. Domestic investors continue to dominate, with EUR 95bn invested over the past year, representing 56% of total volumes. The volume of activity has reached a plateau following recent growth.
In contrast, non-European investment continues to grow at a rapid rate. EUR 49bn of capital has been invested in Europe from outside the region in the past year, a 64% increase on the same period a year ago. In absolute terms the volume of non-European investment is close to the record EUR 50bn seen at the peak of the market in 2007. As a share of total activity is has now reached a record level on an annualised basis at 29%, with a broader range of investors now active in the market.
Domestic players continue to divest as we continue to see net sales by domestic capital. Domestic players divested EUR 1.8bn in Q3, compared to EUR 1.5bn in Q2. European cross border investors also continued to divest though the level narrowed this quarter. Non-European investors continued to increase their European holdings with a net EUR 2bn invested in the third quarter, taking annualised net investment to EUR17bn.
Non-European investment is driven by Asian capital. On an absolute basis, capital from globally sourced funds remains dominant. Nearly EUR 5bn was invested in Q3 taking the annualised total to nearly EUR 20bn. They have equally been strong traders, with net sales over the past year of just EUR 2bn.
The big story continues to be the strength of capital from Asian sources. Over the past year they have pumped a net EUR 7bn into Europe including over EUR 2bn in the third quarter. Besides Asian capital we continue to see strong net flows from North America and the Middle East.
The main focus of investment remains the UK; it attracted 50% (EUR 6bn) of all non-European investment in Q3, with just over half of this investment made in London. Germany attracted a further EUR 1.6 bn.
Relative to total investment, Central and Eastern European markets attract a high share of cross border investment, in line with historic trends. Despite strong interest from global opportunity funds, we do see strong domestic interest in some Southern European markets, for example Spain.
Prime yields continue to compress across Europe and are now at or below pre-crisis levels in a number of markets. Only six out of 21 office markets we track have yields reached their previous low. In 60% of markets there is still scope for further compression. In six of these markets yields are still more than 100bps above the previous low, including Budapest, Dublin and Madrid.
Based on our transaction data, average yields remain at relatively higher levels. Retail yields currently stand at 6.9%, well above their historic low of 5.3%. Over the past year, retail yields have edged in just over 20bps. A 50bps inward shift in office yields to 7.1% has led to a narrowing of the gap. Industrial yields have seen the biggest inward shift of over 100bps to 8%.
With average yields well over 100bps above their previous historic lows, we see the potential for growth in investment activity outside of prime markets.
Recent economic data has been disappointing; economic recovery has stalled in a number of markets and the outlook remains relatively subdued. Growth in recent years has also been weak and the general outlook has been far below trend growth across the region.
As a result we expect bond yields to remain low for longer and the expected rise in interest rates in the core euro area is likely to be delayed until 2016/17. Whilst weak economic figures may impact occupational markets it means real estate remains relatively attractive. Our Q2 Fair Value Index showed many markets remain attractive, even with low prime headline yields.
However, investment activity continues to grow on the back of strong relative pricing and availability of new capital. Since the beginning of the year new capital targeting EMEA has grown 11% to a record USD 142 billion. Growth in Europe has been driven not only by unlisted funds, but also a strong increase in capital rising by the listed sector (up 52%).
Since the onset of the fourth quarter 2014 we have already seen a flurry of major deals over EUR 100m exchange in the UK and Germany. With investors now focussed on deploying their raised capital we see investment volumes reaching EUR 175bn for 2014 as a whole, which is a 22% increase on 2013.
Looking forward, we see the growth momentum being maintained with volumes reaching EUR 210 billion [USD 258 billion] in 2015, a 20% increase on 2014. This would take volumes above 2006 levels. Given the weight of capital and strong relative value, we see upside potential to these figures as sentiment overrules fundamentals.