European property enjoyed its third best year on record in 2017, as volumes moved ahead 5 percent and capital values rose 6 percent due to increasing rents and falling yields. Despite fears over the prospect of rising interest rates, we expect another strong year ahead.
Indeed, while available stock isdifficult for investors to find, we are forecasting a small gain in European volumes due to more development, profit-taking and M&A activity.
However, it should be noted that growth in investment activity has been driven by overseas, rather than domestic, buyers. Foreign investors took a 52 percent share of the market last year – only the second time they have outpaced local buyers in 10 years – with Europeans followed by Americans as the main source of funds. Asian investors closed the gap rapidly, with a 104 percent increase in activity.
While the exact mix of who is buying what will shift over time, this trend towards increased cross-border investment is here to stay. The still high volume of dry powder ensures it will be sustained in the immediate term. Looking further out, long-term changes to allocation targets and greater diversification suggest that globalisation will increase across all real estate markets.
At the same time, the targets for foreign investment continue to change, partly due to differing attitudes to geopolitical risk. There is more Asian than North American interest in the UK as Brexit is assimilated, for example, while South Africa is leading investment into Central and Eastern Europe as investors view the relative maturity of markets as no handicap, given the benchmark set by their own young republic.
Overall, the UK remains the largest global target, but Germany is becoming the primary or secondary target for many. Next in line are France and the Netherlands, followed by Spain, the Nordics, Ireland, Belgium and Poland.
While many investors are clearly committed to Europe, the ending of quantitative easing will bring with it a reduction in liquidity and a change in investor requirements.
However, the make-up of who is in the investor pool does tend to change more regularly than some expect, regardless. China’s rapid move up the rankings already shows this, as does the increased importance of South Korea and South Africa, which have emerged in the last two to three years.
Expect to see a further change in the composition of real estate capital during 2018, as new sources such as Japan and Australia emerge. While some investors are likely to further concentrate on their domestic markets in a bid to reduce risk, others will look at new global regions, to diversify their portfolios.
Over time, Asia will overtake North America as the primary source of global capital coming into European real estate. This is unlikely to happen in 2018, given the ongoing capital controls in China and the increased interest in core and core-plus segments of the European markets among US and Canadian players, but the trend suggests the balance will shift in the coming years.
Strategies will also need to change. With returns squeezed as QE slows, more investors will consider either moving up the risk curve – or reducing their ambitions. Increased leverage is one route for some to boost returns and with refinancing also likely to increase as yields stabilise, higher loan demand may be seen. However, many current investors are low risk takers, often using limited leverage and with a further increase in debt fund capital being raised, we expect the lending market to remain very competitive.
While there are political risks to consider, Europe will remain a target for global capital due to the range of positive factors underpinning markets. London has long-term appeal, there is growth across Central and Eastern Europe and there is real reform in markets like Spain and France, for example. The outlook for well-managed and well-positioned real estate is getting better, if investors stay aware of what users want. Property performance, after all, is always about the getting the fundamentals right.