2011 European Real Estate Investment Outlook and Market Perspective

RREEF Research 2011 European Real Estate Investment April 2011 Outlook and Market Perspective Executive Summary The recovery of the European real estate sector commenced in 2009 and accelerated significantly in 2010, however, performance was not evenly distributed across the continent. Significant variation persists across markets and sectors in terms of economy, market fundamentals and outlook. This situation presents unique investment opportunities, however given the variation in the pace of growth across geography and sector, a strategic approach to investing has never been more important. In this paper, we review the current market situation and present the outlook for European real estate based on the RREEF research house view. This allows us to identify specific markets which offer attractive core investment prospects for investors in the office and retail sectors. Looking ahead, we also identify potential investment strategies further up the risk spectrum which warrant a closer look for investors seeking higher yields and a play on the recovery. The major investment themes are the following: Office: Total returns for the office sector will be largely driven by rental growth as near term yield compression will likely be countered by expansion in the latter years of the forecast. In the near term, London and Paris followed by Warsaw and Stockholm, are likely to be among the outperformers, while the late recovery markets like Madrid, Dublin, or Budapest could provide attractive return opportunities after 2013. Shopping Centre: Prime European shopping centres are expected to deliver strong overall returns driven by gradual yield expansion and only modest rental growth. While stock picking will remain crucial to achieving outperformance in this sector. Germany, France, Poland, the UK and Sweden are forecast to be the top performers amongst European markets. Core opportunities in late recovery markets: Late recovery markets may offer the opportunity to acquire core product at relatively attractive yield levels in light of the uncertainties. A primary example of this strategy is Spain which will likely offer attractive investment opportunities over the medium term as it recovers. There are a number of risks/road blocks over the near term that require close monitoring, which we discuss. The implication of these trends for real estate investors is the uncertainty regarding which sectors of the economy will drive the economic recovery and thus which real estate sector is best poised to benefit and reward investors. Core plus/Value Add: There will likely be attractive risk-adjusted returns for investors willing to move up the risk spectrum by considering secondary assets and secondary markets in the major European centres. Given the expected shortage of high quality product resulting from the effective shut down of the development pipelines, rental and value gains can be expected for office space in the medium term. The target markets for this strategy should be those most likely to benefit from a strong recovery in office space demand with limited new supply, which in the medium term, should force tenants to search for more affordable alternatives to increasingly expensive CBD locations. 1| P a g e RREEF Research April 2011 Prepared by: Simon Durkin Director Head of European Research simon.durkin@rreef.com Marc Feliciano Managing Director Head of Performance and Risk marc.feliciano@rreef.com Jaroslaw Morawski Vice President European Research jaroslaw.morawski@rreef.com Kurt W Roeloffs Managing Director Global Chief Investment Officer kurt.w.roeloffs@rreef.com Henry Stratton Assistant Vice President European Research henry.stratton@rreef.com Maren Vaeth Vice President European Research maren.vaeth@rreef.com Table of Contents: Page 1. Economy................................................................................... 3 2. Real Estate Performance ........................................................ 6 3. Capital Markets ........................................................................ 8 Transaction Volumes ........................................................................... 8 Debt Conditions ...................................................................................9 Prime Yield Compression....................................................................9 Capital Market Trends........................................................................ 10 4. Property Markets ................................................................... 12 Office .................................................................................................. 12 Market Highlights................................................................................12 Outlook ...............................................................................................13 Capital Markets ..................................................................................17 Performance ....................................................................................... 18 Retail .................................................................................................. 19 Market Highlights................................................................................19 Outlook ...............................................................................................22 Capital Markets ..................................................................................24 Performance ....................................................................................... 25 5. Risks to Outlook .................................................................... 27 6. Megatrends ............................................................................. 29 An Ageing Europe .............................................................................. 29 Merging Real and Virtual Worlds ....................................................... 29 Social Responsibility .......................................................................... 30 2| P a g e RREEF Research 1. Economy Economic activity slowed in Europe during the second half of 2010. GDP growth of 0.3 per cent during the third quarter followed 1.0 per cent growth in the second quarter. Performance across countries varied markedly, with Germany, Poland and the Nordics outperforming and Southern Europe underperforming.1 In part, the modest growth for Euroland was due to fiscal tightening as well as the recent turnaround in the euro/dollar and pound/dollar exchange rates and their impact on respective exports. Europe’s slowing growth also mirrors the continuing uncertainty surrounding the timing, structure and associated impact of policy normalisation within the European Monetary Union. Chart 1 Euro Exchange Rate 2006-2011 USD/EUR 1,7 1,6 1,5 1,4 1,3 1,2 1,1 1,0 USD/EUR USD/GBP USD/GBP 2,2 2,0 1,8 1,6 1,4 1,2 1,0 Source: ECB, Bank of England As of March 2011 In the first half of 2010, the impact of fiscal consolidation on domestic demand was largely offset by the boost to net exports resulting from the depreciation of the euro against the dollar. In particular, Germany proved more resilient than most economies. The main driver was exports, which benefited from the strong recovery in Asia and the competitive euro. Other factors included the fundamental strength of the economy, which required only limited fiscal tightening, a private sector that is not overleveraged, and a relatively less indebted consumer. In effect, the German labour market remained remarkably stable throughout the crisis, which is likely to translate into stronger growth in private consumption in the near future. The sovereign debt crisis in Europe’s peripheral economies, most notably Greece, Spain, Ireland and Portugal, resulted in fiscal tightening, which will continue to restrict economic growth prospects in the near term. The European Union is however delivering positive reforms and with the exception of Greece, economic growth has exceeded expectations in the perihpheral countries. In Spain, the deficit, while still amongst the highest in Euroland, is falling sharply and major Spanish banks are largely solvent. In contrast, despite implementing major policies, deficits increased in Ireland and Portugal during the year with both now preparing for a second wave of austerity measures. Like Greece, these markets remain dependent on the Europen Central Bank (ECB) extending its extraordinary support framework, and it still cannot be ruled out that they will file for direct support from the European Financial Stability Facilities (EFSF) during 2011. 1 Global Insight, Eurozone Country Intelligence, January 2011 3| P a g e RREEF Research Chart 2 Sovereign Misery Index 2010 Fiscal Deficit Government Debt Unemployment GDP Growth 2010-12 (reversed) 6.0 5.0 4.0 3.0 2.0 1.0 0.0 -1.0 -2.0 -3.0 Source: Global Insight, OECD, RREEF Research As of December 2010 Note: Fiscal deficit and government debt are presented as % of GDP in 2010 (expected); expected real GDP growth reversed; all variables z-scored within the 20 main European economies (i.e. 0 mean “equal to the unweighted European average”) The ultimate outcome of the European Sovereign debt crisis remains unclear but there are a number of possible outcomes which have been deliberated in the market. Eventual stabilisation and normalisation is largely regarded as the most probable but is likely to be dictated by Germany’s willingness to be the foundation of any bailout. While this remains a hugely political topic in Germany, its export driven economy has been one of the major benefactors of the competitive euro. It would, therefore, be unlikely for Germany to enact any policy which threatens to materially impact this competitiveness. Chart 3 Fiscal Balance as % of GDP 2011f 2012f Ireland Greece UK Spain Portugal France Poland Czech Republic Netherlands Italy Denmark Hungary Germany Finland Sweden -10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 % GDP Source: DB Global Markets Research As of February 2011 Note: f indicates forecast 4| P a g e RREEF Research Alongside Germany, the Nordics and CEE markets (Poland, Czech Republic and Hungary) are expected to grow relatively fast, aided by the global economic recovery and a favourable policy backdrop. Sweden, for example, is at the forefront of the European recovery with sound public finances and a framework designed to boost its growth prospects. The Nordics and much of CEE is forecast to outperform the wider European region through 2011 and 2012. Economic growth for the Eurozone is forecast to be 1.5 per cent in 2011 and 1.6 per cent in 20122. Nevertheless, the economic recovery in Europe is likely to continue to face economic and financial sector headwinds while benefiting from the impact of monetary stimulus enacted during the crisis (notably low interest rates). The spread of a sovereign debt crisis across peripheral Europe poses the most immediate risk to regional economic performance. Even without another Greek-style crisis erupting in 2011, fiscal realism in general is expected to compound economic pressures and stifle growth in southern and peripheral Europe. Chart 4 European GDP Growth 2011-2015f 2011-12 2013-15 Italy Spain Portugal Greece Ireland Netherlands Belgium Denmark Austria Germany France Norway UK Finland Sweden Hungary Czech Rep. Poland -2 -1 0 1 2 3 4 5 6 Source: Global Insight As of February 2011 Note: f indicates forecast Inflationary pressures became more pronounced in the Eurozone towards the end of 2010, driven predominantly by rising food and oil prices. While the labour markets and consumer confidence across Europe are still too weak to induce increasing consumer prices, exogenous cost factors – in particular energy costs – could have this effect, which would put the ECB in a difficult position. Maintaining its main goal of ensuring euro stability would force the central bank to tighten monetary policy earlier and more sharply than would be the case to support its second objective to support economic stability and growth across the Eurozone. The ECB rate increase of 25 basis points in early April is the first increase after nearly two years and further steps are expected later this year. While the main scenario is still that of low inflation and low interest rates in the near term, there is a risk that interest rates move up quicker than expected as the ECB reacts to higher inflationary pressures. This in turn could impact the broader economic recovery. 2 Global Insight, Eurozone Country Intelligence, January 2011 5| P a g e ... - tailieumienphi.vn