Treat European growth with caution

The eurozone is rebounding and property markets look resolute, but lenders should not be complacent.

Pundits’ opinions on this week’s global stock markets plunge have tended towards the same conclusion; it was a correction, a realignment following a years-long bull run. Normal service will be resumed, no need to panic.

It’s a reasonable response, perhaps, given the rebound witnessed on Wednesday. However, the root cause of it – investors’ fears of the likelihood of rising interest rates – serves as a reminder that the macroeconomic backdrop is changing, even if there is a return to calm by the weekend.

The turmoil in the equities markets will no doubt be a topic of conversation among property finance people at next month’s MIPIM in Cannes. With attendees from all parts of the continent and beyond, the gathering remains a useful opportunity to gauge the strength of European real estate capital markets.

Expect to hear plenty of talk of growth. Not since the global financial crisis has there been such uniform growth across global economies, and the eurozone is playing catch-up convincingly. The European Commission’s most recent forecasts put 2018’s euro area GDP growth at 2.3 percent, on the back of 2.4 percent in 2017 – the fastest pace in a decade.

On the political front, there remain concerns; Brexit rumbles on and the prospect of a populist surge in Italy’s upcoming election is a worry. However, France’s centrist president Emmanuel Macron continues to charm businesspeople and Europhiles and his election last year is viewed by many to have positively altered investors’ perceptions of Europe. The political deadlock in safe-haven Germany even seems to have been broken, with Angela Merkel finally forming a coalition government.

Political and economic conditions in Europe are contributing to the continued attractiveness of commercial real estate markets, and the prospect of financing them. GDP growth has boosted occupier markets and capital from around the world continues to target the continent’s major cities.

There is much to be cheerful about, but a note of caution is necessary. The short-lived meltdown in equities markets indicates investors’ expectations that monetary policy is changing globally. This is most pronounced in the US, admittedly. The Bank of England this week froze rates at 0.5 percent, but it did warn that rates will need to rise sooner and by more than predicted in Q4 2017. The European Central Bank is not expected to raise rates imminently, although its unwinding of quantitative easing this year demonstrates that the direction of policy is changing.

A rate spike may look unlikely now, but real estate is a long-term game and those writing five-year loans now should consider that monetary policy could look significantly different by the time of the loans’ maturity.

One respondent to a survey in PwC and the Urban Land Institute’s Emerging Trends Europe report put it nicely: “As long as rates stay low, 3 percent yields look attractive, but in a couple of years we may look at this period as being crazy.”

Overall, European growth is supporting property markets for the time being. Returns expectations might have been dialled back, but the yield gap between property and bonds still looks compelling. There is little sign that institutional investors are reducing their allocations to real estate, while lenders continue to grow their books and private debt vehicles continue to raise capital.

But highly priced property markets warrant a defensive approach from lenders. It has never been more important to focus on financing quality assets in genuine growth locations and sectors, and sponsors with the most sensible business plans, to withstand the inevitable market downturn – whenever that may be.

The European growth story is exciting and it is leading lenders into new markets. In a series of upcoming features, Real Estate Capital will examine the prospects for property lending across individual European countries. There is opportunity out there, but those writing property debt in Europe today need to stay alive to the pitfalls.

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