ABERDEEN PROPERTY INVESTORS: European Property Snapshot - October 2008
Thursday 27 November 2008 at 17:12
Property market returns will weaken in 2008 and 2009 across Europe, with rental growth
decelerating as the economic slowdown gathers pace. Capital values will also decline,
particularly in locations where yields had fallen to extremely low levels. Nevertheless, the
correction has already been rapid in markets such as the UK, and yields in such locations
will rise to levels that could prove attractive to investors in 2009.
THE ECONOMY
Overview
The US sub-prime mortgage market crisis has turned into a full scale banking panic, prompted by the failure of Lehman Brothers. Credit market stress is the highest since the 1930s in the US, and the post-war period in the case of Germany. The crisis has jolted European governments into unprecedented banking sector capital injections, in an attempt to boost confidence and restart lending in the capital markets. Moreover, a number of central banks in Europe joined in a co-ordinated global move to cut interest rates by 50 basis points in October and further large moves are expected in the year ahead. Reduced risk taking though has forced Hungary and Denmark to raise interest rates to support their respective currencies.
European GDP in Q2 showed the first material drop since 1993 as consumer spending came under pressure from higher food and oil prices. Recent falls in commodity prices will provide relief to consumers, but this will not fully offset the damaging impact of markedly tighter bank lending conditions for households and companies. By Q3, inflation pressures had started to ease across the region from relatively high levels but at the same time unemployment rates had started to edge higher, especially in the UK and Spain, and consumer confidence has slumped.
Outlook
The eurozone economy will slow in 2009 to the weakest pace of growth since the early 1990s, hit by weakening global demand. Where housing booms are in the process of unwinding, such as the UK, Ireland and Spain, we see greatest risks of a recession in the next year. Compared to the Anglo-Saxon economies, the eurozone and the Nordics are in better shape due to a lack of external imbalances or high indebtedness on the part of households, although notable exceptions to this include Ireland, Spain and Denmark. Much lower interest rates and substantial support for the banking system should form the basis for a return of liquidity to the financial markets in 2009. Financial institutions will grapple for sometime with impaired capital markets and new problem loans; though a modest improvement in European activity is expected by the latter half of next year and into 2010. The risk for emerging Europe is for a sharper and prolonged slowdown due to its reliance upon foreign capital inflows to sustain growth, and has already led to the IMF providing support to Hungary and the Ukraine.
RECENT PROPERTY MARKET TRENDS
Offices
Take-up levels have weakened across Europe in Q3 2008, reflecting the economic slowdown. The most pronounced falls have been in London and Dublin, but Madrid and Paris have also slowed substantially. Rental levels have been mostly flat across Europe in the third quarter. However rents have started to fall sharply in the UK and Ireland. In contrast, some of the German cities have been more resilient and experienced modest rental growth. It should be noted that most lease terms in continental Europe are indexed, thus providing some support to investors. Yields are now rising in almost all locations. The sharpest increases have occurred so far in the UK and Ireland, followed by Spain and Norway.
Retail
The retail sector across continental Europe continues to perform well relative to the other sectors. Rental growth has continued, albeit at a slower pace than in 2007. Nevertheless, the slowing economy has caused consumer sentiment and retail spending growth to weaken sharply. Mid-range retailing is experiencing most difficulty, with luxury and value retailers performing more strongly so far. Development levels have been strong in a historical context for Europe as a whole, with Spain, Italy and some CEE countries experiencing particularly high levels of shopping centre completions. As with the other sectors, in 2008 investment transaction levels have fallen sharply on 2007 levels, by over 50% in most cases. Prime retail yields have been rising across Europe, but once again the sharpest rises have been in the UK and Ireland, with Spain and Norway also experiencing sharp increases in yields. So far, retail yields have risen by a smaller amount than for the office and industrial sectors.
Industrial
Demand in the first half of 2008 remained healthy on a pan-European basis. Take up reached 7.3 million square metres in H1 2008, up by 10% on H1 2007, and only 6% down on the record level in H2 2007. Nevertheless, take-up levels are expected to drop back in the second half of the year.
Speculative completions remained high across Europe in H1 2008, especially in Central and Eastern Europe. However, new starts have since fallen, due to both the lack of development finance and concerns over the weakening economy. Most markets have seen no rental growth, or prime rents edge down. The best performing markets so far this year include Prague and Bratislava. The worst have been the more established markets of Dublin, London and some Benelux cities. Particularly sharp increases in yields have been experienced in the UK, Ireland and CEE.
Residential
Residential property demand has suffered in the wake of tighter lending standards applied by banks since the latter half of 2007. In the case of Spain and Ireland, price falls will be exacerbated by an overhang of stock, due to extremely high levels of home building. Price declines are evident across much of Europe, with the exception of Germany. Previously overheated markets of the UK, Spain, Ireland and Denmark have shown the largest falls in prices this year, while the Nordic region generally has suffered due to its liberal mortgage finance system being exposed to the shut-down of capital markets. The outlook is for a downswing in housing activity for the next 18-24 months, as bank lending terms will stay restrictive for some time, while housing affordability will be further strained by a weaker labour market.
Investment market
The current conditions within global capital markets are having a profound impact on European property markets. Capital values are falling, following the steep rise in the cost of borrowing and decreasing risk appetite among investors and property lenders. Since mid-2007, yields for commercial property have risen by about 50 basis points in German markets and up to 200 basis points for some locations in the UK. The UK has been quickest to respond, due to a sharp falls in yields in previous years and higher liquidity, providing more transactional evidence. Other markets that have already seen a strong yield correction include Spain, Ireland and Norway.
The level of investment activity across Europe stabilised in the third quarter compared to the second quarter. Investment transactions in Q3 amounted e26.4 billion, which is almost 60% down on the same period last year.
The current downturn in European property markets has been indiscriminate in terms of property types. Market stress is strongly related to funding and gearing. Distressed property owners are increasingly found throughout the entire property spectrum, from residential property in Germany to retail property in Central and Eastern Europe and on to central London offices. Capital values are currently falling further for secondary property rather than prime.
Outlook
With the real economy now starting to feel the impact from the financial crisis, occupier demand is softening. A fall in demand is expected for at least another 12 months, being most pronounced in the office sector. Demand for retail space is expected to be most resilient, as in previous downturns, and especially in the non-cyclical food sector. Demand for logistics space is expected to stay at relatively good levels, as much of demand stems from ongoing rationalisation in global supply chains and cost cutting. However, logistics demand will not be immune to slowing world trade growth. The only sector actually benefiting from the current environment is the rented housing sector, where demand is increasing, due to capital falls, mounting uncertainties in the owner-occupier market and the increased difficulty in obtaining mortgage financing.
There is uncertainty as to how long the financial crisis is expected to persist. As debt securitisation markets are likely to stay closed in the foreseeable future, property lending is likely to become more traditional again, with banks being more cautious, requiring higher compensation for risk that sits longer in their books. Yield spreads over risk-free rates are expected to return to levels witnessed before the recent boom in property debt securitisation.
There are also some promising signs. Governments in Europe are now determined to restore confidence among financial institutions and consumers, which should eventually enhance liquidity in property lending markets. Another positive development is the drop in expected development activity. Higher financing and construction costs, coupled with weaker tenant demand, are cutting the new construction pipeline quite dramatically. This will allow rental growth to recover again once economic fundamentals start to improve. For the next 12 months, property investors are advised to remain cautious as further capital falls are anticipated. However, as the process of price correction progresses, property investors should become more alert to opportunities. UK property prices have already become more attractive, with yields now being higher than in many other markets on the continent. Other markets, where prices are correcting quickly, now include Paris, Madrid, Oslo, Dublin and some markets in CEE. More frequent forced sales may offer attractive buying opportunities, especially for equity investors.
Lastly, we would advise investors to focus more on market fundamentals. Countries that have sound financial fundamentals, for instance, those with high savings ratios, balanced current accounts and limited public and private debt, are likely to recover first. Property market fundamentals will also gain the importance they deserve. Demand factors, such as population growth, economic growth, structural changes in the economy and supply factors such as land availability and zoning constraints, will become more decisive. The quality of active asset management will also play an important part going forward. With the era of windfall profits by yield compression now over, pro-active managers possessing property management capabilities are expected to outperform.
Important Information
For professional use only
This document is strictly for information purposes only and should not under any circumstances be considered as an offer or solicitation to deal in the property market. Accordingly, no warranty whatsoever is given and no liability whatsoever is accepted for any loss arising whether directly or indirectly as a result of the reader acting on any information, opinion or estimate contained in this document. The information contained herein, including any expressions of opinion or forecast have been obtained from or based upon sources believed by us to be reliable, but is not guaranteed as to accuracy, adequacy or completeness.
Some of the information in this document may contain projections or other forward looking statements regarding future events or future financial performance of countries, markets or companies and actual events or results may differ materially. Any research or analysis used in the preparation of this document has been procured by the company for its own use and may have been acted on for its own purpose. Aberdeen Property Investors does not accept responsibility for any loss arising from the use hereof. The value of investments and any income from them may go down as well as up; they can be affected by exchange rate movements between currencies and it is possible that investors may not get back the full amount invested. Past performance is no guarantee of future performance. No part of this document may be copied or duplicated in any form or by any means or redistributed without the written consent of Aberdeen Property Investors. Issued and approved by Aberdeen Property Investors UK Limited which is authorised and regulated in the UK by the Financial Services Authority.
© 2008 Aberdeen Property Investors. All rights reserved.
THE ECONOMY
Overview
The US sub-prime mortgage market crisis has turned into a full scale banking panic, prompted by the failure of Lehman Brothers. Credit market stress is the highest since the 1930s in the US, and the post-war period in the case of Germany. The crisis has jolted European governments into unprecedented banking sector capital injections, in an attempt to boost confidence and restart lending in the capital markets. Moreover, a number of central banks in Europe joined in a co-ordinated global move to cut interest rates by 50 basis points in October and further large moves are expected in the year ahead. Reduced risk taking though has forced Hungary and Denmark to raise interest rates to support their respective currencies.
European GDP in Q2 showed the first material drop since 1993 as consumer spending came under pressure from higher food and oil prices. Recent falls in commodity prices will provide relief to consumers, but this will not fully offset the damaging impact of markedly tighter bank lending conditions for households and companies. By Q3, inflation pressures had started to ease across the region from relatively high levels but at the same time unemployment rates had started to edge higher, especially in the UK and Spain, and consumer confidence has slumped.
Outlook
The eurozone economy will slow in 2009 to the weakest pace of growth since the early 1990s, hit by weakening global demand. Where housing booms are in the process of unwinding, such as the UK, Ireland and Spain, we see greatest risks of a recession in the next year. Compared to the Anglo-Saxon economies, the eurozone and the Nordics are in better shape due to a lack of external imbalances or high indebtedness on the part of households, although notable exceptions to this include Ireland, Spain and Denmark. Much lower interest rates and substantial support for the banking system should form the basis for a return of liquidity to the financial markets in 2009. Financial institutions will grapple for sometime with impaired capital markets and new problem loans; though a modest improvement in European activity is expected by the latter half of next year and into 2010. The risk for emerging Europe is for a sharper and prolonged slowdown due to its reliance upon foreign capital inflows to sustain growth, and has already led to the IMF providing support to Hungary and the Ukraine.
RECENT PROPERTY MARKET TRENDS
Offices
Take-up levels have weakened across Europe in Q3 2008, reflecting the economic slowdown. The most pronounced falls have been in London and Dublin, but Madrid and Paris have also slowed substantially. Rental levels have been mostly flat across Europe in the third quarter. However rents have started to fall sharply in the UK and Ireland. In contrast, some of the German cities have been more resilient and experienced modest rental growth. It should be noted that most lease terms in continental Europe are indexed, thus providing some support to investors. Yields are now rising in almost all locations. The sharpest increases have occurred so far in the UK and Ireland, followed by Spain and Norway.
Retail
The retail sector across continental Europe continues to perform well relative to the other sectors. Rental growth has continued, albeit at a slower pace than in 2007. Nevertheless, the slowing economy has caused consumer sentiment and retail spending growth to weaken sharply. Mid-range retailing is experiencing most difficulty, with luxury and value retailers performing more strongly so far. Development levels have been strong in a historical context for Europe as a whole, with Spain, Italy and some CEE countries experiencing particularly high levels of shopping centre completions. As with the other sectors, in 2008 investment transaction levels have fallen sharply on 2007 levels, by over 50% in most cases. Prime retail yields have been rising across Europe, but once again the sharpest rises have been in the UK and Ireland, with Spain and Norway also experiencing sharp increases in yields. So far, retail yields have risen by a smaller amount than for the office and industrial sectors.
Industrial
Demand in the first half of 2008 remained healthy on a pan-European basis. Take up reached 7.3 million square metres in H1 2008, up by 10% on H1 2007, and only 6% down on the record level in H2 2007. Nevertheless, take-up levels are expected to drop back in the second half of the year.
Speculative completions remained high across Europe in H1 2008, especially in Central and Eastern Europe. However, new starts have since fallen, due to both the lack of development finance and concerns over the weakening economy. Most markets have seen no rental growth, or prime rents edge down. The best performing markets so far this year include Prague and Bratislava. The worst have been the more established markets of Dublin, London and some Benelux cities. Particularly sharp increases in yields have been experienced in the UK, Ireland and CEE.
Residential
Residential property demand has suffered in the wake of tighter lending standards applied by banks since the latter half of 2007. In the case of Spain and Ireland, price falls will be exacerbated by an overhang of stock, due to extremely high levels of home building. Price declines are evident across much of Europe, with the exception of Germany. Previously overheated markets of the UK, Spain, Ireland and Denmark have shown the largest falls in prices this year, while the Nordic region generally has suffered due to its liberal mortgage finance system being exposed to the shut-down of capital markets. The outlook is for a downswing in housing activity for the next 18-24 months, as bank lending terms will stay restrictive for some time, while housing affordability will be further strained by a weaker labour market.
Investment market
The current conditions within global capital markets are having a profound impact on European property markets. Capital values are falling, following the steep rise in the cost of borrowing and decreasing risk appetite among investors and property lenders. Since mid-2007, yields for commercial property have risen by about 50 basis points in German markets and up to 200 basis points for some locations in the UK. The UK has been quickest to respond, due to a sharp falls in yields in previous years and higher liquidity, providing more transactional evidence. Other markets that have already seen a strong yield correction include Spain, Ireland and Norway.
The level of investment activity across Europe stabilised in the third quarter compared to the second quarter. Investment transactions in Q3 amounted e26.4 billion, which is almost 60% down on the same period last year.
The current downturn in European property markets has been indiscriminate in terms of property types. Market stress is strongly related to funding and gearing. Distressed property owners are increasingly found throughout the entire property spectrum, from residential property in Germany to retail property in Central and Eastern Europe and on to central London offices. Capital values are currently falling further for secondary property rather than prime.
Outlook
With the real economy now starting to feel the impact from the financial crisis, occupier demand is softening. A fall in demand is expected for at least another 12 months, being most pronounced in the office sector. Demand for retail space is expected to be most resilient, as in previous downturns, and especially in the non-cyclical food sector. Demand for logistics space is expected to stay at relatively good levels, as much of demand stems from ongoing rationalisation in global supply chains and cost cutting. However, logistics demand will not be immune to slowing world trade growth. The only sector actually benefiting from the current environment is the rented housing sector, where demand is increasing, due to capital falls, mounting uncertainties in the owner-occupier market and the increased difficulty in obtaining mortgage financing.
There is uncertainty as to how long the financial crisis is expected to persist. As debt securitisation markets are likely to stay closed in the foreseeable future, property lending is likely to become more traditional again, with banks being more cautious, requiring higher compensation for risk that sits longer in their books. Yield spreads over risk-free rates are expected to return to levels witnessed before the recent boom in property debt securitisation.
There are also some promising signs. Governments in Europe are now determined to restore confidence among financial institutions and consumers, which should eventually enhance liquidity in property lending markets. Another positive development is the drop in expected development activity. Higher financing and construction costs, coupled with weaker tenant demand, are cutting the new construction pipeline quite dramatically. This will allow rental growth to recover again once economic fundamentals start to improve. For the next 12 months, property investors are advised to remain cautious as further capital falls are anticipated. However, as the process of price correction progresses, property investors should become more alert to opportunities. UK property prices have already become more attractive, with yields now being higher than in many other markets on the continent. Other markets, where prices are correcting quickly, now include Paris, Madrid, Oslo, Dublin and some markets in CEE. More frequent forced sales may offer attractive buying opportunities, especially for equity investors.
Lastly, we would advise investors to focus more on market fundamentals. Countries that have sound financial fundamentals, for instance, those with high savings ratios, balanced current accounts and limited public and private debt, are likely to recover first. Property market fundamentals will also gain the importance they deserve. Demand factors, such as population growth, economic growth, structural changes in the economy and supply factors such as land availability and zoning constraints, will become more decisive. The quality of active asset management will also play an important part going forward. With the era of windfall profits by yield compression now over, pro-active managers possessing property management capabilities are expected to outperform.
Important Information
For professional use only
This document is strictly for information purposes only and should not under any circumstances be considered as an offer or solicitation to deal in the property market. Accordingly, no warranty whatsoever is given and no liability whatsoever is accepted for any loss arising whether directly or indirectly as a result of the reader acting on any information, opinion or estimate contained in this document. The information contained herein, including any expressions of opinion or forecast have been obtained from or based upon sources believed by us to be reliable, but is not guaranteed as to accuracy, adequacy or completeness.
Some of the information in this document may contain projections or other forward looking statements regarding future events or future financial performance of countries, markets or companies and actual events or results may differ materially. Any research or analysis used in the preparation of this document has been procured by the company for its own use and may have been acted on for its own purpose. Aberdeen Property Investors does not accept responsibility for any loss arising from the use hereof. The value of investments and any income from them may go down as well as up; they can be affected by exchange rate movements between currencies and it is possible that investors may not get back the full amount invested. Past performance is no guarantee of future performance. No part of this document may be copied or duplicated in any form or by any means or redistributed without the written consent of Aberdeen Property Investors. Issued and approved by Aberdeen Property Investors UK Limited which is authorised and regulated in the UK by the Financial Services Authority.
© 2008 Aberdeen Property Investors. All rights reserved.