In Q3 2020, CBRE projected higher real estate returns for the December 2020 to December 2025 period than for its Q4 2019 forecast. On average, it now expects geared total returns on prime offices to be 3.5 percent per year higher than it calculated at the end of 2019.
Dominic Smith, senior director, CBRE Research, notes that the situation has improved despite debt on offer now being generally more expensive and lower leverage, which reduces performance expectations by 0.7 percent per year.
Against this backdrop, CBRE examined the risk and return profile of both debt and equity to assess how an agnostic investor might assess returns across the two for the December 2020 to December 2025 period. It concluded plenty of European markets offer compelling returns to lenders and investors.
On debt, CBRE says the risk-reward relationship is strained, meaning attractive risk-adjusted returns are on offer for selective lenders. On equity, it says that an end-2020 entry is forecast to be “cyclically attractive” to most European real estate markets.
Compared with required returns, seven of the 16 prime office markets examined offer investors excess returns of 3 percent per year on both a geared and ungeared investment basis.
Examining lending returns further, CBRE found a mixed bag across Europe. It noted no uniform relationship between returns from property lending – expressed as margin plus fee – and exposure, in terms of loan-to-value, or the proportion of the return earned above the risk-free rate.
“This offers opportunities for lenders able to select sectors and markets,” says Smith.
Setting the score
CBRE then gave each market a ‘standard score’ for debt performance to express the return generated by debt on an absolute basis, in relative terms – compared with equity – and accounting for LTV exposure. “The scores themselves are not especially meaningful, but their relativities are,” explains Smith.
Assessing the scores for markets within each sector – offices, retail and logistics – London was the only major market with a positive score overall. For offices, smaller markets with higher scores included Dublin, Oslo, Warsaw, Lisbon and Madrid. For prime retail, Helsinki, Milan, London, Lisbon and Dublin had the highest scores. In logistics, Finland, Norway, Portugal and the UK scored well.
CBRE also examined returns from an equity investment perspective. On an ungeared basis, it found most prime office markets will deliver total returns, as per CBRE’s total return forecast, above investors’ required returns, calculated as risk premium plus the risk-free rate. For Vienna, Brussels, Copenhagen, Frankfurt, Oslo and London, returns are expected to be more than 3 percent per year above required returns.
“For so many markets to be delivering excess returns shows the cyclically favourable entry point prevailing across European office markets,” Smith says.
CBRE also considered returns on a geared basis, by adjusting the ungeared risk premium per the level of additional volatility in capital growth at the LTV prevailing in each market. It found most prime office markets will deliver more than the required returns. Brussels, Copenhagen, Frankfurt and Oslo are expected to be 10 percent per year above required returns.
“This emphasises the extent to which gearing, on historically very affordable terms, can be used to enhance performance in markets where values are expected to increase,” says Smith.
The relative attractiveness of markets is similar on a geared and ungeared basis. Of the larger markets, Frankfurt and London offer the most appeal. Oslo, Brussels, Vienna and Amsterdam are also compelling. CBRE also considered transaction volumes in the 2017 to 2019 period as a measure of liquidity. “Performance is one thing, but that performance must be accessible,” Smith says.