Investors are looking to Madrid, Paris and Frankfurt as the cities that offer the best potential in the current market
This year’s survey of office performance clearly shows a pattern of rental growth emerging across western Europe’s property markets. A first wave of recovery occurred in London, Amsterdam and Stockholm in 1994 and 1995 as these economies outperformed their neighbours, and the supply and demand equation in property markets shifted back in favour of the supply side.
Then last year, Lisbon, Madrid, Milan and Paris also saw rents start to grow again, after they had fallen by as much as 40% to 50% from their 1991 level. This year, Frankfurt has followed suit, recording the first tentative growth after seven years of decline.
Only Brussels and Berlin fall outside of these two bands: Brussels because it is virtually recession proof, losing only 10% of its 1992 peak rental value before returning to growth again in 1997; and Berlin because rents are still falling, down from DM 85 per m2 a month in 1991, to DM 43 per m2 this year, although the rate of decline has slowed dramatically.
But there are some concerns that the recovery may be halted before it has really begun, due to the weaker economic outlook for next year and the unnerving effect of stock market losses. Companies are abandoning plans to move offices or take more space.
“Demand is on hold; occupiers are trying to assess what is going to happen in their markets,” says James Max, international investment agent at DTZ Debenham Thorpe in London. But Max is confident that “as the dust clears at the beginning of next year”, demand from both occupiers and investors will return in force.
In particular, he expects German open-ended funds to come back as strong buyers in overseas markets. “The German funds are going to become much more important than they have been this year,” he predicts.
The impact of the euro is seen as both a threat and an opportunity to investors. A threat in the short term because of indecision and potential instability; an opportunity in the medium to long term because of the inevitable growth in cross-border investment.
“Suddenly a lot of psychological barriers will disappear,” says Max. “As markets become more assessable, they will become more accessible.”
There is already evidence that markets that have been traditionally tightly controlled by domestic institutions and property companies are yielding to the new openness.
The volume of international investment into Madrid, for example, has increased sharply in the last 12 months, with US money leading the trend. Investors are following several routes: buying standing investments, entering development joint ventures with local partners, and acquiring equity stakes in Spanish property companies.
The first signs of rental growth returned to Madrid in 1996, but the recovery has been slow, and prime rents at Pts 3,050 per m2 a month are still well below their 1991 level of Pts 5,440.
UK institution Standard Life made its first moves in Spain this year, buying office buildings in Madrid and Barcelona. Martin McGuire, head of continental European investment, says the fund is close to acquiring two further office properties in Madrid.
“We still see central Madrid as a market to be considering now, given where it is in the property cycle,” comments McGuire.
As well as strong prospects for higher rents, agents are predicting that yields will come in further. Knight Frank, which quotes prime yields in the city of 5.75%, is expecting that they could drop as low as 5% next year. This is bullish talk, considering that at today’s level, Madrid is already more highly valued than it has been at any time during the 1990s. Just four years ago, prime yields in the city were at 7.5%.
In Paris, the other hot market of the moment, the outlook is less clear. Oliver Ash, European director at UK property company Hammerson, says the prospects for prime rental growth are “difficult to call”. “There is demand for the top slice at about FFr 3,000 [per m2 a year], but in the current economic climate the air is pretty thin above that level.”
Hammerson is working on the refurbishment of a building in rue de Courcelles, which will provide 17,000 m2 of space, and is looking at other office projects in and around Paris, says Ash. “We are keen to keep working on top quality space, but we are a bit cautious on rents.”
Paris agents are less cautious, pointing to the recent string of lettings at FFr 3,150 to FFr 3,300. Thierry Laroue-Pont, European partner at Jones Lang Wootton, believes there will be a “positive evolution in rental values” during the next 12 months, as the already small supply of new, top quality space is depleted.
Germany is the biggest unknown of all the European markets. Investors feel instinctively that the country offers huge opportunities, but it has been traditionally extremely hard for overseas buyers to penetrate.
With rents just starting to come back in Frankfurt, international investors are looking again. The federal structure makes it “difficult to analyse and risky” says Ash, but Hammerson is seriously considering getting back into the retail market. Morgan Stanley has also said it is turning its attention to Germany.
Yields in Frankfurt have moved in a very narrow band between 5% and 5.75%; this year they are at their lowest level since 1991. Demand from German funds and institutions has kept the market more or less closed to outside investors looking for higher yields.
The impact of the euro could start to loosen this grip, from two fronts. First, German investors are increasingly looking to build up their portfolios outside their home market, driven by the need for higher returns. The price transparency and removal of exchange rate risk heralded by the single currency will speed up this process, undermining the strength of demand for German product.
And second, a broader re-rating of property yields as a result of the single currency has been widely predicted. One theory is that this process could weaken yields in Germany.
There are in fact longer-term forces at work in the valuation of property investments, post-euro. The low interest rates in the eurozone have already created a situation where property yields are higher than government bond yields in all 11 markets included in the EuroProperty survey.
The target rate of return for property is therefore likely to fall, believes Kiran Patel, associate director of research at UK insurer Legal & General. In the UK for example, the “new paradigm” of low interest rates and low inflation means investors have adjusted their total return criteria for property from 11% to 12% to around 8%, says Patel.
As the same interest rates are applied to all countries participating in the euro, there should in theory be one target rate of return for property.
Some investors argue that the adjustment in property prices has already occurred: prime yields are perceived to be closer between different markets now than they were five years ago.
But the EuroProperty survey reveals that the variation between markets is the same now as it was in 1991. Leaving Portugal out of the equation, where property yields have remained out of kilter with the rest of western Europe, there is still a gap of nearly two percentage points between the highest and lowest rated markets.
This year, the two ends of the spectrum are London’s West End at 5.0%, and Brussels at 6.9%; seven years ago, Berlin was priced at 4.8%, while Brussels stood at 6.6%.
Hammerson’s Ash is sceptical that the euro will have a dramatic impact on this pattern. “The fears that yields in Germany might go up [as a result of convergence] have proved unfounded, and there is no reason to expect yields to increase.”
Europe’s property markets will continue to reflect regional differences, in the way that national markets show different rates of returns from one city to another. “It is still logical that different yields should apply across Europe,” he says.
The challenge facing investors now is to determine which of the newly recovering markets offer the best prospects for total returns, in view of the unprecedented financial and economic changes that are occurring in Europe.
Europe’s top office centres – how they performed
|
1991 |
1992 |
1993 |
1994 |
1995 |
1996 |
1997 |
1998 |
Growth pa(%) |
||
|
Amsterdam |
NLG/m2/pa |
485 |
470 |
440 |
430 |
449 |
475 |
516 |
576 |
2.5 |
|
Berlin |
DM/m2/month |
85 |
73 |
73 |
58 |
50 |
48 |
43.90 |
43.38 |
-9.2 |
|
Brussels |
BFr/m2/pa |
8450 |
8950 |
8750 |
8050 |
8150 |
8150 |
8250 |
8300 |
-0.3 |
|
Frankfurt |
DM/m2/month |
90 |
82 |
73 |
66 |
62 |
61 |
61.10 |
64.6 |
-4.6 |
|
Lisbon |
Esc/m2/month |
6588 |
6488 |
4725 |
4100 |
3825 |
3850 |
3925 |
4088 |
-6.6 |
|
London WE |
£/ft2/pa |
51.00 |
40.50 |
37.00 |
39.50 |
41.50 |
44.50 |
48.20 |
51.70 |
0.2 |
|
London City |
£/ft2/pa |
42.50 |
33 |
31.50 |
33.50 |
37.50 |
42.50 |
45.52 |
49.30 |
2.1 |
|
Madrid |
Pts/m2/month |
5440 |
4300 |
2840 |
2580 |
2550 |
2610 |
2840 |
3050 |
-7.9 |
|
Milan |
L/m2/pa |
785000 |
670000 |
590000 |
485000 |
436000 |
426000 |
432000 |
448750 |
-7.5 |
|
Paris |
FFr/m2/pa |
4340 |
4000 |
3520 |
3240 |
2870 |
2770 |
2890 |
3120 |
-4.6 |
|
Stockholm |
SKr/m2/pa |
2650 |
2238 |
2150 |
2300 |
2560 |
2850 |
3100 |
3300 |
3.2 |
