Shifting Gears

Despite an eventful start to the year with elections in major European countries, investment volume in EMEA held up well in Q1 2017 although it declined by 1.3% compared with Q1 2016. While investment volume remains in line with 2016, there are some distinct changes in investor behavior in EMEA.

There is a clear shift in focus away from capital gains through yield compression and towards stable income-growth strategies. In part, this is the result of muted expectations of further capital gains in the prime segment after years of strong yield compression. This is particularly evident for opportunistic investors who are either seeking to exit the prime segment now they have met their target returns, or are looking into alternative asset classes. Another part of the story is that certain markets in Europe are recording aggressive rent growth after years of limited rent increases. Despite the upturn in occupier markets, the development pipeline is generally still limited, which fuels expectations for more rent growth to come.

Investors are looking at new asset classes to achieve returns. One of the most prominent examples of an asset class that is moving into the mainstream is light-industrial (or “multi-let”) and the €1.28 billion acquisition of a light-industrial portfolio by Blackstone and M7 Real Estate illustrates that this market is now opening up to investors trying to build scale. While the light-industrial market is traditionally characterized by fragmented ownership and occupiers from small- and medium-sized enterprises, the growing importance of e-commerce and last-mile deliveries is supporting occupier and investor interest. These assets are typically located in or around major cities and are considered a hedge against traditional retail by some investors, particularly during times of structural change reshaping retail in many markets nowadays.

Investors in EMEA also are cautiously moving up the risk curve in terms of geographies. The reason for this is twofold: Strong competition in gateway markets is forcing investors to broaden their horizon, and a more broad-based economic upturn and dropping vacancy rates are allowing investors to look at new markets without materially altering their investment requirements. In the major capital cities in Europe, new sub-markets come into play and strong regional centers also draw investor interest.

All in all, this means that a wider range of assets and locations can count on investor demand. However, regarding overall investment volume, Europe’s major capital cities are expected to remain a driving force behind trading activity. Over the past 10 years, the top-10 most liquid city markets in Europe (as measured by investment activity) accounted for almost 40% of total real estate investments in the region.

Over the past three years, the five most liquid markets in Europe (by investment activity) were London, Paris, Berlin, Madrid and Munich. London and Paris have been uncontested as main gateway cities in terms of investment activity and offer a vibrant mix of office, retail, residential and light-industrial assets. Berlin, Madrid and Munich have seen a sharp upturn in trading activity in recent years. Germany has proved relatively stable in times of economic turmoil. While its rents took a hit from the financial crisis, Madrid is the capital city of one of the fastest-growing economies in the Eurozone and investors are anticipating positive rent growth as a result of solid occupier market performance.

Other markets that have seen a rise in investment market activity are Milan, Amsterdam, Dublin, the capital cities in the Nordics (Copenhagen, Helsinki, Oslo and Stockholm) and other large German cities such as Frankfurt, Hamburg and Düsseldorf. While smaller than the traditional gateway markets, these cities have a similar functional mix and attract a wide range of international office occupiers, retailers and tourists. One common feature is that these cities have generally seen limited rent growth coming out of the financial crisis and construction activity did not catch up with rapidly improving market fundamentals. Over the past 18 months, vacancy has been absorbed by growing leasing activity and transformations of obsolete buildings into alternative functions.

In Europe, rent growth is most significant for office property. To a lesser extent, rents for industrial property are also rising—particularly in supply-constrained areas. As for residential, both vacant possession values and rent values have risen sharply as demographic pressures in the major cities are mounting. A structural shortage of housing makes residential particularly attractive to developers. However, competition for land and the relative attractiveness of residential projects are at the expense of development potential in the other sectors. The limited development pipeline is now resulting in rapid rent growth, and investors are looking to capitalize on prospects for further rent growth on the back of improving occupier markets. further rent growth on the back of improving occupier markets.

By Raphaël Rietema, Capital Markets, EMEA Research, CBRE.

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