2014 was characterised by the en masse arrival in Spain of international investors and by the creation of large Spain-REITs, Sociedades Anónimas Cotizadas de Inversión en el Mercado Inmobiliario or SOCIMIs. After seven years of being a no-go area, Spain has transformed into one of the hottest markets for investors. Last year alone, more than €7 billion was invested in commercial real estate — almost three times the amount invested in 2013, when transaction activity stood at €2.5 billion.
The influx of investor interest is mainly due to Spain’s economic recovery and the attractive price levels. Spain has been one of the best performers in the euro zone, with consistent quarterly GDP growth since mid-2013. Euro zone growth has been mixed, rising by 0.8 percent in 2014 whereas Spain’s GDP grew at 1.4 percent over the same period — Spain is expected to grow by 2.8 percent in 2015 and by 2.5 percent in 2016.
The recovery is demonstrated by all the main economic indicators, such as increased consumer confidence, an improved labour market, greater disposable income and higher household consumption, as well as by improved access to financing.
Real estate market implications
As mentioned above, 2014 was a successful year for the Spanish real estate market. The commercial property sector saw investment volumes of €7.2 billion, of which 43 percent was in the capital, Madrid. 72 percent of the volume was in the office and retail sectors while the remainder was in industrial/logistics (8 percent), hotels (14 percent) and bank units (6 percent). It should be emphasised that the investment volume seen in 2014 across both the logistics and hotel sectors in Spain represented the largest year-on-year increase across the entire real estate market.
It is important to note the distribution of the investor origin, with 44 percent of demand coming from domestic investors, while international investors accounted for the majority (North America, 40 percent of this; Europe, 37 percent; Latin America, 12 percent; and Asia, 11 percent). The rationale for the high proportion of domestic investment is the creation of SOCIMIs, which accounted for 70 percent of the domestic investment volume (or 30 percent of overall volume). Although SOCIMIs are a Spanish tax-efficient investment vehicle, a notable feature is the extent to which overseas investors have been taking stakes in these vehicles as a way of entering the Spanish market.
Investors generally have been capitalising on low prices and the potential of gaining from the impending upward growth cycle. The focus has mainly been on prime properties in prime locations, where we are already seeing a hardening of yields across all sectors of the market. This characteristic, coupled with the lack of prime stock, has caused many investors to redirect their search to prime properties in secondary or decentralised areas. In terms of strategy, the value-add approach — through repositioning, refurbishment, improvement of property management and development — is the preferred route for investors.
Retail stands out
€2.4 billion was invested in Spain’s High Streets and shopping centres in 2014. Growing GDP, falling unemployment and rising real wages have resulted in a higher and rising consumer confidence, an upturn in household disposable income and increased consumer spending, the key pillars for success in the Spanish retail market as in any retail market.
High Street: The continued recovery has fed into the Spanish High Street, with demand for prime High Street units increasing so much that there is now a shortage of space on the best streets. Many expanding domestic and international retailers are considering streets off the prime areas and secondary cities. Most of the demand over the past 18 months has been seen in Madrid, as a result of its above national–average income levels, larger population and the regional government’s positive stance toward retail developments and liberal opening hours.
The most popular streets in Madrid city centre are Gran Via/Preciados (with rents up to €2,700 per square metre per year), Fuencarral (€1,425 per square metre per year), Jose Ortega y Gasset and Serrano (both €2,300 per square metre per year), and Goya (€1,300 per square metre per year). Gran Via has been the only street that has shown countercyclical behaviour and where rental yields on the best section of the street have increased by more than CPI during the crisis, increasing by 40 percent since 2006 (and by 9 percent in 2014 alone).
The world’s biggest fashion brands, institutional investors, real estate companies, hotel specialists and developers have gravitated to Gran Via due to the pick-up in yield, the expected appreciation in value as well as the potential for (re)development through active management. Although the majority of investors are asking for the best locations in order to let them out to large international retail chain tenants, we are seeing an appetite for non-prime rental premises. Typically, institutional investors are behind those investments, although the market for transactions of less than €10 million is dominated by family offices and local private investors, who typically target 4 percent for prime premises.
Shopping centres: In 2014, Spain witnessed renewed interest in shopping centres by major retail brands. Attracted by increasing consumption, the improvement in consumer confidence and reductions in unemployment, retailers have seen increased sales and higher footfall in prime shopping centres and in those located in areas where the economic situation is more stable. The improvement in the economic outlook and the attractive pricing relative to comparable markets have both contributed to the increased appetite of international investors. Furthermore, SOCIMIs have provided additional liquidity and demand, having accounted for 50 percent of the total investment volume of shopping centre assets in 2014.
We still witness ongoing demand for core/prime shopping centres despite the aggressive hardening in yields seen over the past two years (in from 6.75 percent in mid-2013 to 5.25 percent at present), and we believe that there is room for a further hardening of 75 basis points with minimal volatility. Second-tier assets, however, offer some margin for a pick-up in returns, leading to new transactions as investors accept marginal further risk.
Despite the expected yield compression in due course as a result of the low availability of space, we forecast rental growth of 20–30 percent over the next five years, depending on the particular shopping centre. Specific to Madrid, the vacancy rate in prime centres is low, at 8.7 percent, and we see this to be consistent across both urban and semi-urban centres, as well as in centres with both low and large gross leasable areas. Typical rents in prime are €190 per square metre per year.
In Madrid, which accounts for 20 percent of Spain’s GLA of shopping centre space, we have noticed a shift in population to the suburbs, which makes semi-urban centres all the more attractive.
Office recovery well underway
The recovery of the Spanish office market that has been seen since 2013 is a consequence of the new economic growth model that Spain has embarked on; this has been supported by structural reforms to stimulate competition, productivity and exports as well as by stability in public finances and a recapitalisation of the banking sector. The office market has also benefited from a weaker euro and lower oil prices, both of which support the industrial sector and exporters along with the improved labour market.
Investment volumes reached €2.8 billion in 2014, which is more than double the levels seen in 2013, and the highest level registered over the past 10 years, excluding 2006–2007. In terms of distribution, 61 percent of office investment was made in Madrid, followed by 24 percent in Barcelona and the remaining 15 percent in other locations throughout the country. The office market in Spain has seen a gradual improvement in occupier demand over the past year, with take-up levels bolstered by a larger number of transactions. Madrid prime office yields stand at 4.75 percent, but lot sizes of less than €30 million show yields of 50 basis points harder. Decentralised areas show a 100 basis point pick-up.
As economic conditions have improved, there has been a noted increase in demand, with take-up in Madrid increasing by 10 percent over the past year, and we expect this trend to continue throughout 2015 and 2016. We have seen notable interest from investors who have not traditionally formed part of the Spanish real estate market, such as South American, American, Israeli, Arab, Canadian, Chinese and Russian investors. SOCIMIs accounted for roughly one-third of total investment in the office market in 2014. Investors are certain, after rents fell by more than 40 percent from the peak of the market in 2007–2008, that these corrections have bottomed out, and foresee significant rental growth over the short to medium term. 70 percent of the volume seen in 2014 came from core or core-plus investors while 20 percent applied a value-add strategy.
Hotel activity set to grow further
Investment in Spanish hotels in 2014 amounted to €1 billion. The Spanish tourism sector witnessed a growth rate of 2.9 percent last year, double that of national GDP (1.4 percent), not only due to overseas demand from “sun-seekers” but also to an increased domestic demand. Domestic demand, both inland and on the coast, rose by 10 percent due to increased household income and the general improvement in the Spanish real economy. All this, coupled with a depreciating euro and falling oil prices, making travel cheaper, has resulted in the success seen in the Spanish hotel sector.
The hotel market in Spain is highly fragmented, with varying quality of assets. 58 percent of the existing hotel supply is independently operated; many of these assets are family-owned, with the remainder consisting of domestic and international hotel operators, meaning that the discrepancy in standards can be very apparent. Accordingly, the need for consolidation across the sector as well as asset repositioning presents a significant opportunity for investors with a value-add investment strategy. In 2014, Spain witnessed a RevPAR (revenue per available room) growth of 10 percent across the sector that has made the hotel asset class all the more appealing for international investment. Additionally, in spite of its seasonal behaviour, the hotel resort market has performed well over the last couple of years, with average occupancy rates well above the average for urban centres.
The outpacing of demand over supply in the hotel sector means that the key markets have recorded an increase in occupancy rates. Most transactions have taken place in Madrid, Barcelona and Mallorca, although over the past few months there has been increased demand in the Balearic Islands (especially Ibiza) and Canary Islands, as well as some other coastal areas. The trend over the past two years in Madrid and Barcelona has been to convert empty buildings into hotels and to follow change-of-use strategies where, for example, office buildings have been converted into hotels. This has been the route preferred by many investors for gaining greater returns compared to acquiring existing hotels that are being offered at very high asking prices.
Industrial/logistics picks up
The recent success of the industrial/logistics markets has been the result primarily of the improvement in private consumption; GDP growth was up 1.4 percent in 2014 and export levels were higher as a result of the drop in oil prices and the euro; improved access to financing also helped. Putting this into numbers, investment volume in the sector was more than €600 million last year (the highest level seen in the past 10 years), yields were in excess of 7 percent and take-up levels in Madrid were greater than 30 percent.
70 percent of the investor activity over the past year took place in the Madrid area while the rest was in Barcelona, Seville, Zaragoza and Valencia. 60 percent of demand came from institutional investors, 30 percent from SOCIMIs and 10 percent from family offices. Naturally, the amount of interest in this market has led to a fall in supply (despite there still being high levels of supply), a fall in vacancy levels over the past two years and rental price increases for the best quality assets. Less prime assets have seen a stabilisation of rental levels as most appetite is focused on prime at the moment.
Industrial properties: Industrial rents in Madrid, depending on the area, are either stabilising or are close to stabilising as rental corrections are ever smaller — prices fell by around 4 percent over 2014 to €3.15 per square metre per month. Approximately 20 percent of the space taken in industrial properties over the past year was for sale, while the remaining 80 percent was to let. Despite the industrial sector as a whole lagging slightly behind other real estate sectors, yields across prime assets have actually started to fall due to the ongoing shortage of large, high-quality assets — prime yields currently stand at 7 percent, having hardened by 50 basis points in 2015 alone and by an additional 75 basis points in 2014.
Logistics: The story in the logistics sector is similar to the industrial space in that rental prices for the best quality and located properties have begun to rise and remain stable in other markets. Prime units with solvent tenants and compulsory fixed-term contracts in the best connected areas have seen a 100 basis point hardening over the past six months to the existing 7.5 percent yield levels. Nevertheless, yields in secondary markets are seen at 8.5 percent and have been stable.
During 2014, and continuing on from the falls seen in 2013, vacancy rates fell from 16 percent to 14.5 percent. Furthermore, take-up last year registered its fourth consecutive year of growth, increasing by 35 percent compared to 2013, 90 percent of which was for lettings and the remainder for outright-purchase transactions. After six years of consecutive price falls, logistics rents on average followed different lines to those in the industrial sector and rose by 4 percent in Madrid, currently standing at just over €3 per square metre per month. There is a quantifiable relationship in the logistics space between rents and the distance from the most urban areas of Madrid — rents fall from €4.75 per square metre per month from within the most central and urban areas of the city to €2.50 per square metre per month in the outer regions.
Residential not yet affordable
The residential market in Spain has started to bear the fruits of the wider economic recovery that the country is experiencing, reflected by increased sales of residential properties. This is a trend that is expected to continue throughout 2015. Despite domestic demand increasing, overseas buyer interest continues to grow, as it has done since 2009 (rising by 17 percent in 2014 and increasing to 30 percent in 2015). Prices are now stabilising and, according to data provided by the Spanish authorities, the accumulated price correction since the top of the market in 2007–2008 stands at 32 percent for newbuild properties and 43 percent for pre-owned.
Despite the considerable reduction in prices, property values are still not affordable. This is demonstrated by the current “mortgage cover ratio”, which stands at over 6x, well below the ideal 4–4.5x. Accordingly, new residential supply coming to the market is still low. Newbuild properties that are coming to the market are generally very different to the current available stock and are being developed in markets where there is strong demand with affordable prices and strong sales rates. Over the past 18 months, we have seen a heightened interest among investors in land or buildings with refurbishment potential in these areas.
Over the past year, land and refurbishment deals have been carried out in the core real estate markets for an approximate value of €1.8 billion, of which 60 percent was in city centres. Furthermore, the largest amount was allocated to Madrid, where a large number of these deals (primarily residential) were completed. Part of this was due to foreign investment, as overseas investment funds have little access to asset classes that offer returns of 10–15 percent; a level that is viable in residential real estate.
The Spanish economy is set to be one of the strongest-performing economies in Europe over the next five years. Following yield compression, returns will be led by the continued rise in prime rental levels. Low supply of fully-let investments means taking on additional risk and investors focusing their attention on less core areas, with higher vacancy rates. Nevertheless, these areas present opportunities as there are class A buildings with class A tenants. v
Kris Van Lancker (firstname.lastname@example.org) is managing director at Optimus Global Investors, based in Madrid. Optimus Global Investors sources and manages real estate assets in Spain.