Why European property remains attractive after Brexit
The European economic and property market news has focused on the outcome of the UK Brexit referendum and the potential impact on the wider European region. So far, the vote does not appear to have had a marked adverse impact on the Eurozone economy.
Downward revisions to the consensus eurozone GDP forecasts suggest that the region’s occupier markets could now be in a period of slower rental value growth than previously expected, reflecting a weaker overall growth environment. However, the European recovery remains underpinned by improving consumer confidence, which continues to boost rental growth performance – particularly in the retail sector.
The Paris prime retail shop market has experienced the strongest growth, expanding over 20% since the start of 2016. Moreover, given that UK-based retailers don’t represent a dominant source of demand in Europe, we believe the continued physical expansion of international retailers on prime European pitches will be unaffected by the Brexit referendum result. With three-year average rental growth of 2.7% per annum forecast, retail shops and shopping sectors lead our latest European sector projections.
Stockholm, Barcelona and Paris drive growth in office sector markets
Reflecting recent buoyancy in office-based employment, office sector markets achieved year-to-date rental growth of up to 11.5% in Stockholm, 5.0% in Barcelona and 4.8% in Paris. At 10.3%, the office vacancy rate in Madrid remains among the highest across the eurozone, but continues to trend down: take-up was up by 25% in the four quarters leading up to the second quarter of 2016.
The Paris Central Business District (CBD) also showed healthy growth over the same period, with a 34% increase in take-up.
This pick-up in demand was seen particularly in small and medium-sized spaces, which are experiencing falls in incentives. Indeed, incentives are higher for spaces over 5,000sqm (24%), but more moderate for medium sized spaces between 1,000sqm and 5,000sqm (18%) and small spaces under 1,000sqm (13%).
The gradual shift of the CBD market from the west of Paris to the centre and east of the city is now an evident trend, driven by the arrival of companies from the co-working sector, which have made areas like Opéra their neighbourhood of choice.
European office sector to generate average rental growth of 2.3% per annum over next three years
Besides improving labour markets, the performance of the European office sector will be further underpinned by tight pipelines compared to history. Most European centres – apart from Stockholm – currently benefit from lower-than-historic average supply under construction over the next five years. Swedish GDP forecasts look relatively healthy, giving developers the confidence to meet future demand requirements with new building starts. Overall, we expect the European office sector to generate average rental growth of 2.3% per annum over the next three years.
Selected European cities defy broadly flat rental growth in Q2
In the industrial sector, rental growth was generally flat in the second quarter, with some notable exceptions. The healthy economic environment in Spain, for example, is evident in occupier demand for industrial property, generating a year-to-date rental growth of 5.3% in Madrid. Take-up in both Madrid and Barcelona has been supported by a high availability of stock and low rental values. Headline rents in both cities fell by around one-third following the global financial crisis, and therefore have greater scope to recover. So far in 2016, Amsterdam (2.9% year to date) and Lyon (2.2% year to date) also benefited from positive rental growth.
Following the Brexit vote, demand for logistics space is most likely to suffer in markets with strong goods trade ties with the UK. In Europe, the most resilient logistics locations will be those on established distribution networks such as the ‘dorsale’ (backbone) area in France, stretching from Lille to Marseille through the Paris region. Further east, Poznan and Lodz are among the major regional industrial hubs in Poland. Leasing activity here has been driven by low labour and property costs, expansion of e-commerce, and proximity to major European distribution networks. In the long term, Brexit could prompt a rethink of European crossborder supply chains. We expect the European industrial sector to generate 1.1% pa average rental growth over the next three years.
Despite the high but cautious, demand environment, investment volumes in Europe excluding the UK rose to €39.9 billion in the second quarter – up from €34.3 billion in the first quarter. All-property investments increased by up to 110% in Sweden, while the largest fall – in Benelux – was more restrained (-27% in the Netherlands). The return to safe haven and liquid core markets is evident, with particularly significant quarterly year-on-year increases in volumes in France (+68%) and Sweden (+74%).
We believe the long-term impact of the Brexit result is likely to be limited, but this evolving situation will need to be closely monitored for some time to come.
While economic sentiment may be a little more subdued, growth is set to continue, and the adverse impact on rental growth is likely to be modest. Furthermore, a positive yield impact on European property, underpinned by very low bond yields, will support the return outlook. As a result, real estate in the region is set to remain an attractive proposition for many investors, from all corners of the globe
Richard Gwilliam is head of Property Research at M&G Real Estate
1 Dec 2016