Investors in Europe moving down the risk curve - Capital Economics
European Commercial Property

Investors in Europe moving down the risk curve

European Commercial Property Update
Written by Amy Wood
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Although rental growth prospects for prime property are weak compared to recent years, the outlook is better than for secondary property. As such, we think that investors will continue to focus on prime assets this year, allowing prime office and industrial yields to edge down further.

  • Although rental growth prospects for prime property are weak compared to recent years, the outlook is better than for secondary property. As such, we think that investors will continue to focus on prime assets this year, allowing prime office and industrial yields to edge down further.
  • As might be expected in times of economic downturn and heightened uncertainty, there was a growing preference for prime assets in Europe last year. Timelier data for the UK show that this was most apparent for offices and retail, with the spread between prime and non-prime yields trending upwards. (See Chart 1.)
  • However, the vaccine rollout has improved the outlook for economic activity and will help to reduce uncertainty later in the year. In turn, we expect European property investment to reach a trough in Q2. (See here.) But we don’t think that this will cause investors to shift from prime to secondary assets.
  • First, recent surveys suggest that investors prefer core strategies this year. Indeed, the INREV Investor Intentions survey for 2021 suggested that most new capital is planned to target core strategies, in contrast to previous years.
  • Second, there are stark differences between expectations for prime and secondary rental values. The latest RICS Commercial Property Survey showed a much more negative rental outlook for secondary property across the sectors, which we think will underpin required property yields. (See Chart 2.)
  • Third, although prime yields are at very low levels, valuations do not appear stretched in most continental European markets. (See here.) And the story is similar for UK prime property. What’s more, with alternative asset yields likely to remain near current levels or lower, the backdrop remains supportive in 2021.
  • Finally, our view that there will be a post-COVID shift towards more remote working suggests that there is significant excess capacity in offices. All else equal, this will raise the spread between prime and secondary offices relative to the past. In turn, offices spreads are likely to mirror more closely that in retail.
  • Admittedly, there has been less evidence that investors have become more risk averse towards industrial property. This is consistent with the more positive rental outlook relative to the other sectors and low supply. But the distinction between prime and secondary is less clear for industrial. And we think that secondary industrial assets will also become less attractive, especially as the recovery in other sectors gets underway.
  • As such, we think that demand for prime property will continue to hold up relative to secondary this year. However, the spreads between prime and secondary yields may unwind more quickly than they did after the global financial crisis since there has not been the same disruption this time round.

Chart 1: UK Non-Prime Property Yield Less Prime Property Yield* (Bps)

Chart 2: Q3 RICS Expectations for Annual Change in UK and Euro-zone* Rental Values (%)

Sources: MSCI, Capital Economics *Calculated using MSCI quartiles

Sources: RICS, Capital Economics *Weighed by GDP in PPP terms


Amy Wood, Property Economist, amy.wood@capitaleconomics.com