European commercial real estate: Update on the retail sector

European commercial property has experienced something of a renaissance in the eyes of institutional investors, with investment volumes rocketing and even topping 2007 levels in some instances. According to Knight Frank’s latest European Quarterly Report, a total of €64.5 billion was invested in European commercial property in Q4 2015, taking volumes for the full year to €238.5 billion, a 25 percent increase on 2014.

Investors have been attracted by property’s potential to produce strong, stable income streams. Particularly at a time when the European Central Bank has introduced negative rates, real estate is much more appealing to many institutional investors versus keeping money in a bank account. 

The High Street retail segment, in particular, is thriving, along with large shopping centres, and continues to show 3 percent or 4 percent rental growth forecasts per year until 2020. This is against a backdrop of market yields converging to record low levels. Real estate is a cyclical asset class, and there will come a point when yields move out again. When that yield shift occurs, if there is no rental growth to compensate, property values will suffer. At the point when yields do shift, we expect High Street yields to move out 50–100 basis points from today’s current yields, but this will be hedged by the forecasted rental growth of 3–4 percent per year. Typically, yield fluctuations of prime assets also tend to be less volatile.

Prime High Street retail stands apart from secondary products and secondary locations, which continue to see yield compression and are potentially overpriced. When the yield shift occurs, secondary products could see yields move between 150 and 300 basis points.

The High Street segment is very resilient compared to other parts of the European real estate market, as there is high demand from international retailers for prime High Street properties. Rental increases of 3–4 percent per year represent an average but there are situations where property managers can command more than that, especially through tenant rotations.

The most interesting locations for High Street investors are the capital cities and other gateway cities in Europe, where there is a good combination of tourism and a luxury segment. Tourism and luxury tend to be disconnected from the local economy. Even if we see modest GDP growth going forward, tourism and luxury segments are very resilient and are still growing.

Pricing could be perceived as high within the real estate market at the moment, but we need to keep in mind that the current context is one of prolonged economic or market recovery. Historically, when the market corrects itself, inflation is the result. If there is inflation, there is economic growth, and if there is economic growth, there is an increase in employment, more demand for office and logistics assets and hence rental growth. With inflation in Europe so lethargic, and the ECB running out of options to stimulate it, there will be a lag before rental growth comes through in other real estate sectors beyond retail. The apparent high prices seen today should eventually be hedged by economic growth, and by rental growth in all sectors, in time.


Source: IREI