Investment and occupier demand plunged further in Q2. As expected, the retail sector bore the brunt of the impact, with capital values falling by almost 9% y/y. This drove down all-property capital value growth to just 3% y/y, the lowest since 2012 Q4. (See Chart 1.) However, the impact on property values outside of retail was more modest. That said, with the rebound phase of the recovery coming to an end, we expect occupiers to continue to adjust their requirements to lower levels of activity and the still-uncertain outlook. We think that this will result in more significant declines in rents and rises in yields across all sectors and many markets in H2.
- Investment and occupier demand plunged further in Q2. As expected, the retail sector bore the brunt of the impact, with capital values falling by almost 9% y/y. This drove down all-property capital value growth to just 3% y/y, the lowest since 2012 Q4. (See Chart 1.) However, the impact on property values outside of retail was more modest. That said, with the rebound phase of the recovery coming to an end, we expect occupiers to continue to adjust their requirements to lower levels of activity and the still-uncertain outlook. We think that this will result in more significant declines in rents and rises in yields across all sectors and many markets in H2.
- Euro-zone economic indicators highlight that the recovery in economic activity is underway, but rising virus numbers pose a significant downside risk.
- Country-level economic indicators show that Q2 GDP fell the most in Portugal and Spain. Despite rising debt burdens, significant monetary support is forecast to keep bond yields low, even in ‘riskier’ countries.
- Commercial property investment market indicators point to differences in investment performance across countries this year. Office and retail yields rose in Q2, with further rises expected by year-end.
- Commercial property occupier market indicators suggest that some of the weakness in occupier demand in Q2 will persist, weighing more heavily on rental values in the second half of the year.
Chart 1: Contributions to Annual Weighted Euro-zone All-Property Capital Value Growth (%-pts)
Source: Capital Economics
- Given strict lockdown measures during most of the quarter, euro-zone GDP plunged by 12.1 % q/q in Q2, the worst quarterly outturn in the post-war period. Since then, the rebound in the Composite PMI for July points to a recovery in economy activity (2). And the sharp pick-up in the “backlog of orders” component of the Manufacturing PMI implies a return to normality for industry (3). That said, the rise in new infections increases the likelihood of a second wave of confinement measures, which would derail the recovery (4).
- The euro-zone unemployment rate crept up to 7.8% in June, but is still low considering the collapse in economic activity (5). This reflects that short-time working schemes have prevented unemployment from rising sharply. Meanwhile, employment dropped by 2.8% q/q in Q2, representing 4.5m job losses. And while surveys of euro-zone firms’ hiring intentions picked up in July (6), we expect the unemployment rate to rise further as governments start to roll back short-time working schemes and short-term contracts end.
- July’s increase in inflation was driven by delayed summer sales and we forecast headline inflation to stagnate in the coming months. Coupled with low inflation expectations, we think that inflation will remain well below the ECB’s target for some time to come (7). This, in turn, should provide the ECB with ample room to loosen monetary policy. We expect the ECB to expand its asset purchase programme from €1.35trn to €1.85trn by the end of this year.
Chart 2: Euro-zone Composite PMI & GDP
Chart 3: Euro-zone Mfg PMI Backlog of Work
Chart 4: Euro-zone Confirmed Infections
Chart 5: Euro-zone Unemployment
Chart 6: Employment & Firms’ Hiring Intentions
Chart 7: Consumer Price Inflation (% y/y)
Sources: Refinitiv, IHS Markit, WHO, Capital Economics
- The scale of contraction in GDP in Q2 varied by country. GDP fell by a comparatively modest 10.1% q/q in Germany, but a sharp 18.5% q/q in Spain (8). These differences can primarily be explained by the duration and strictness of the national lockdowns. Business surveys have been more difficult to interpret in current circumstances, but generally point to a recovery in all countries in July. That said, rising virus numbers pose the greatest downside risk to the Spanish recovery at this stage (9).
- Retail sales have generally recovered more quickly than industry. In fact, sales in June were above pre-virus levels in most euro-zone countries, except for Iberia and Italy (10). Meanwhile, unemployment rates barely moved again in June (11). However, we expect sharper rises in unemployment rates to hold back consumer spending further ahead, particularly in Spain and Italy given their subdued economic outlook and greater dependence on sectors such as tourism.
- The recovery will continue to be aided by fiscal stimulus, with support expected to be largest in Germany (12). However, higher government spending will put pressure on the countries with largest debt burdens, mostly those in southern Europe. That said, the EU Recovery Fund has shifted some of the fiscal burden to those most able to bear it. As such, we expect bond yields to remain low, even in ‘riskier’ countries (13).
Chart 8: GDP Growth (% q/q)
Chart 9: New Infections (7-Day Average)
Chart 10: Retail Sales Volumes (% change Feb. to Jun.)
Chart 11: Unemployment Rate by Country (%)
Chart 12: 2020 Direct Fiscal Support (% of 2019 GDP)
Chart 13: 10-Year Government Bond Yields (%)
Sources: Refinitiv, National Governments and Health Ministries, IMF, CE
- Although the peak disruption from the virus was felt in Q2, investment is likely to take time to recover because of lingering uncertainty and subdued economic activity. In Q2, pan-European (ex UK) investment fell by 30% y/y, while euro-zone investment was 40% y/y lower (14). Overall, we expect pan-European (ex UK) investment to be around 15% lower than its 2019 level this year. (See our Update.)
- That said, there will be differences across countries. Indeed, investor sentiment held up better in Germany than the likes of Iberia or Italy in Q2 (15). What’s more, solid Q1 performance meant that H1 activity fared better in some countries despite poor Q2 results, with Germany again the notable example (16). Meanwhile, investment was lower across all sectors (17).
- There is a risk that debt availability becomes a constraint on investment activity (18). However, indicators of equity availability have been more encouraging. Indeed, preliminary Preqin data for Q2 point to an improvement in capital raised globally compared with earlier in the year. Even so, the sharp drop in reported investment enquiries so far points to capital value growth of around minus 10% y/y at the euro-zone level by year-end (19).
Chart 14: Euro-zone Investment (€Bn)
Chart 15: Q2 Investment Sentiment (Net Balance, %)
Chart 16: Investment by Country (% y/y)
Chart 17: Pan-European Investment by Sector (4 Qtr. Rolling Avg., €Bn)
Chart 18: Changes in Euro-zone Credit Conditions for Loans to Firms (Net Balance, %)
Chart 19: Euro-zone* RICS’ Investment Enquiries and All-Property Capital Value Growth
Sources: CBRE, Refinitiv, RICS, Capital Economics
Investment Market Indicators (cont.)
- There were upward shifts in prime retail and office yields in Q2 (20). However, with the impact of the virus yet to fully play out in rental markets, we think that there could be more increases yet to come this year. Indeed, although we do not expect to see movements of anywhere near the magnitude of the GFC, yield rises so far have been muted given the significant hit to rental values still expected (21).
- Unsurprisingly, retail yields have been subject to the most upward movement so far and the impact has been broad-based (22). Most markets saw increases of around 15bps-20bps in Q2. However, Paris, Athens and Dublin retail yields increased by a more substantial 30bps, 50bps and 70bps respectively. Some prime office and industrial yields also rose in Q2, albeit by 15bps or less (23). In contrast, industrial yields continued to edge down in Vienna, Barcelona and Dublin (24).
- Beyond 2021, as rental growth picks up and investor sentiment improves, we continue to think that there is scope for some of these rises in yields to be reversed. (See our Update). Indeed, the spread of property to bond yields remains wide (25). And, with interest rates and bond yields forecast to remain low, this is not expected to change over the forecast horizon.
Chart 20: Euro-zone Yield Changes by Sector (Bps, q/q)
Chart 21: Euro-zone Yields by Sector (%)
Chart 22: Change in Prime Retail Yields (2020 Q2, Bps)
Chart 23: Office and Industrial Yield Risers (2020 Q2, Bps, q/q)
Chart 24: Office and Industrial Yield Fallers (2020 Q2, Bps, q/q)
Chart 25: Euro-zone All-Property Prime Yield & German 10-Year Bond Yield
Sources: Refinitiv, Capital Economics
- Euro-zone office take-up plummeted in Q2 to levels well below even the GFC (26). The outturn was less than 1.1m sqm, further dragging down the four-quarter rolling average. While take-up is likely to pick up with restrictions easing, some of the underlying weakness in occupier demand is likely to persist. Indeed, as employment support wanes, we expect a drop in office demand by end-2020 (27). (See our Update.)
- At the city-level, the decline in take-up on a rolling four-quarter basis was broad-based compared to last year (28). At 90% q/q, Dublin recorded the largest fall in leasing activity in Q2, marking the lowest quarterly take-up in the city’s history. But although weakness in take-up meant that vacancy edged up in most markets, rates were still below their five-year average (29). Antwerp and Rome were outliers, with the vacancy rate in the latter rising above its five-year average in Q2.
- Still-low vacancy meant that prime office rents held up, with only Rotterdam recording a small quarterly decline in Q2 (30). But we think that it is only a matter of time before weakness in occupier demand weighs on office rents. This is consistent with the deterioration in surveyors’ rental expectations for the next 12 months (31).
Chart 26: Euro-zone Office Take-Up
Chart 27: Euro-zone Office-Based Employment & Office Take-Up
Chart 28: Office Take-Up by City, Q2 2020
Chart 29: Office Vacancy Rates (%)
Chart 30: Prime Office Rental Values Growth (Q2 2020)
Chart 31: RICS 12-Month Rent Expectations
Sources: RICS, Refinitiv, Capital Economics
Occupier Market Indicators (cont.)
- The retail sector suffered the largest quarterly rental falls in Q2, highlighting the malaise gripping the sector. Indeed, rents fell in 10 of the 19 euro-zone markets that we cover, with the decline most marked in Barcelona (32). Along with the hit to retail sales, the rise in supply availability in the past year will prove to be an additional headwind to retail rents (33).
- Meanwhile, prime industrial rents held steady in Q2 in most markets (34). And while increased demand for storage and online shopping might provide a boost to demand for industrials, we don’t think that the sector is immune. Indeed, according to the RICS survey, the net balance of occupier demand in the sector turned negative in Q2, albeit to a lesser extent than the other sectors (35).
- At the euro-zone level, the fall in retail rents pulled down the all-property annual rental growth from 3% in Q1 to 1.2% (36). Coupled with a tick-up in yields, annual capital value growth eased to 3%, marking the weakest growth rate since 2012 Q4 (37). With yields expected to continue to nudge up and sharper drops in rents yet to come, we think that the fall in capital values has further to go.
Chart 32: Prime Retail Rental Value Growth (Q2 2020)
Chart 33: RICS Retail Supply Availability for Sale
Chart 34: Prime Industrial Rental Value Growth
Chart 35: RICS Euro-zone Occupier Demand
Chart 36: Euro-zone Prime Property Rental Value Growth (% y/y)
Chart 37: Contributions to Annual Weighted Euro-zone All-Property Capital Value Growth (%-pts)
Sources: RICS, Capital Economics
Data and Forecast Summary
Table 1: Latest Euro-zone Economic and Market Indicators
Consumer Prices, %m/m(%y/y)
Retail Sales, %m/m(%y/y)
Industrial Production, %m/m(%y/y)
German Ifo Business Climate Index
Euro-zone Composite PMI
EC Euro-zone Economic Sentiment Indicator
Depo Rate, end period (%)
10 Yr Bond Yields, end period (%)
Equity Indices, end period
Table 2: Main Economic & Market Forecasts
%q/q(%y/y) unless stated
Unemployment Rate (%)
Depo Rate, end period (%)
10 yr. Ger. Bond Yield, end period (%)
$/euro, end period
£/euro, end period
Sources: Refinitiv, Capital Economics
Andrew Burrell, Chief Property Economist, firstname.lastname@example.org
Amy Wood, Property Economist, email@example.com
Yasemin Engin, Property Economist, firstname.lastname@example.org