The view, published in IRE’s H2 2014 Real Estate House View: European Market Outlook, is in spite of yields on commercial property in the capital falling to a near record low of 5.7% in Q3 2014.
That said, the situation appears to be improving, with Aviva Investors forecasting earlier this week that yield compression will diminish after 2015, with rates predicted to reach 8% per annum over the following five years.
Kim Politzer, IRE’s research director for Europe, told Portfolio Adviser that despite the near record-low yields in the capital and a growing number of companies looking at UK secondary markets, areas just outside London’s Square Mile-West End belt continue to have strong growth potential.
She said: “We’re interested in the emerging markets around the edge of central London – places such as King’s Cross, London Bridge and South Bank. Then there are the markets developing out to the east beyond Canary Wharf, such as Stratford. They aren’t well established, but we think they will be in five years.
“We think there’s a compelling story. There hasn’t been a huge quantity of space developed in the last cycle, which is actually a drag on rents. If anything there are still shortages and we’re seeing those rents move forward quite quickly.”
High levels of capital flow into the UK real estate market has contributed to low yields, with European investment into the UK domestic market growing 19% year-on-year to £28.3bn.
Politzer said that growing faith in the economic recovery means that investors are happier to take on more risk.
“Until 12 to 18 months ago investors were focused on acquiring on prime assets with long leases,” she explained. “As people are beginning to see signs of economic recovery they are getting more confident that if one of their tenants leaves they will be able to find a replacement. People are willing to take those risks – rather than buying a building that is completely leased they will take one that still has two or three floors to lease. You get more yield for taking that risk.
“Another value-add strategy is taking on buildings that need complete refurbishment before being let. Investors are more willing to pull more ‘risk levers’.”
Southern Europe
The H2 2014 report also highlighted southern European property markets as likely to offer the strongest return over the next five years, following the stabilisation of prime location prices.
IRE recommended taking office vacancy risks in gateway cities (airport hub cities such as Munich, Paris and Amsterdam) due to “reasonable premium” prospects, along with potential opportunities to lock in rent increases.
Due to a shortage of ‘grade A’ space following a lack of sector development, Milan and Madrid in particular were tipped to break free of the relative struggles of their respective national economies.
“Milan looks more like a German city than an Italian one, despite problems in the national economy,” Politzer explained. “There is development of a new business district, Porta Nuova, and there will be opportunities to provide additional space to occupiers with the historic centre being limited in terms of offering modern office layouts. That has given momentum to the Milan market.
“In Madrid values have fallen hugely because the rents have been cut so aggressively. We think there is going to a sharp bounce back in those rents over the next three to five years. The people who have made the quick money in Spain have already made it – people who want to stay for the medium-term will get the benefit of that rental growth.”
But why should investors look at cities in struggling economies rather than their relatively healthy northern European counterparts?
“In southern Europe there hasn’t been as an aggressive pricing of real estate because of the problems since the sovereign debt crisis. But the spread of the pricing across London, Munich, Milan etc. is more than compensating for the additional economic risk of Spain and Italy versus Germany, the UK and France. Because there hasn’t been aggressive re-pricing there is scope for inward yield shift.”
