Craig Wright, real estate investment analyst at Standard Life Investments, assesses the potential impact of recent and forthcoming elections across Europe on the property investment landscape
As we are acutely aware, political events can drive short-term risk aversion among investors across asset classes and influence longer-term market trends. Following recent events, increased uncertainty has manifested itself in currency markets, equities and bonds, with spreads widening in markets considered most at risk from a political shock.
Real estate is not immune, of course. As we move through a two-year period of national elections in Europe, obvious questions are raised about the potential impacts of change on the European real estate market. These questions have been intensified by the UK’s surprise EU referendum result, which has had a profound impact on financial markets. The focus on UK real estate was intense as the market searched for hard evidence of fallout. However, overall market performance has been more stable than initially feared, owing to real estate’s dependence on slower moving economic fundamentals.
According to data from the IPD/MSCI UK monthly index, during the three months after the referendum result, all property capital values fell by 3.6% in the UK, but grew by 2% over the following six months as evidence emerged that market fundamentals were holding up well, particularly in relation to occupier demand and global capital flows.
The outlook for UK property was already softening as the cycle was quite advanced by the time the referendum took place. As a result, our expectations have not changed dramatically. We expect returns from the UK market to be driven by healthy levels of rental income at this later stage in the cycle.
Moving to the Continent and away from referenda, the build up to the Dutch general election proved divisive, due to the strong polling of the far right candidate Geert Wilders. While tensions ran high, from a real estate perspective the market experienced no discernable negative impact. Investor appetite remained strong throughout and the real estate market continued to perform extremely well in both a European and global context. Total returns in the Netherlands in Q4 2016 recorded 3.2% on the quarter, taking the annual return to 12.2%, according to the IPD/MSCI/ROZ Netherlands quarterly index.
The decisive outcome of the French presidential election has been well received by markets. In a similar situation to the Netherlands, the relief for Europe is that France will not face a referendum on EU and eurozone membership. However, it is important to remain focused on the fundamentals and to note that Macron takes the reins of a country lacking economic growth, having once again underperformed eurozone GDP growth by 20 basis points in Q1 2017.
We believe the impact of the new political regime in France on our central scenario for real estate will range from benign to a modest net-positive on a three year horizon, which remains positive. With lower immediate political risk, we expect the Paris office market will continue to perform well, given its importance as a global destination for capital, its market size, transparency and deep pool of liquidity. France ranks fourth out of 27 European countries in the Standard Life Investments Global Real Estate Implementation Risk Tool, also benefitting from low levels of corruption and above average levels of innovation. The key risk for Paris offices remains lacklustre tenant demand along with high levels of office development, particularly the latter in La Défense and the Western Business District.
The upcoming German general election appears less of a concern to markets. The most likely outcome will be a coalition, headed by either Angela Merkel or Martin Schulz – both committed Europeans. The Alternative fur Deutschland is not unexpected to be significantly represented in any coalition, despite the column inches it attracts. There will be comfort that the German elections are less likely to be as extreme or polarised than they were in France; and the German real estate market is not expected to be impacted by the outcome.
We believe the strong occupier fundamentals in Germany will support modest income growth, while low interest rates and monetary policy continue to support our yield forecasts for the medium term. Vacancy rates are at record lows and rents are typically rising ahead of expectations. Germany ranks second within Europe in the Standard Life Investments GREIR metric, supporting attractive risk-adjusted returns from German real estate markets.
Looking further ahead, Italy poses a greater risk. A general election will be held before 23 May 2018, but could be brought forward. Current polling suggests the Democratic Party led by Matteo Renzi and the Five Star Movement led by Beppe Grillo are leading by quite some margin, although Lega Nord and Silvio Berlusconi’s Forza Italia have some traction with voters. The risk is that a coalition of euro-sceptic parties could be formed, which is concerning for an electorate less convinced by the benefits of being in the euro, compared to say France and Germany.
Italy is the EU’s fourth largest economy and the ramifications of a return to the lira would inevitably damage the eurozone. We believe the Italian real estate market is experiencing a modest rebound in performance, but with fundamentals still weak as a result of the slow economic recovery and high levels of supply, downside risks remain. Italy’s relative fragility is highlighted in its risk rating, ranking 15th out of 27 European countries included in our GREIR index.
The higher-risk nature of the Italian market is driven by a lack of transparency, above average levels of corruption and a lack of competitiveness, according to the model inputs. This leads us to believe investors will treat Italy with greater caution in the event of significant political change, relative to those markets with lower risk scores.
While it is a mixed picture, political risk is clearly elevated across Europe. Important though this is, we are focused on the market fundamentals – both from a capital markets and occupier perspective. Whatever the political future holds, careful consideration of market fundamentals and the appropriate use of risk frameworks can help investors avoid the full impact of political change on investment performance.
