Hunting for value from commercial real estate in Europe
With yields under pressure, investors are looking at alternative locations to find potential growth opportunities.
At first sight, the Arabellapark area of Munich might not be an obvious destination for commercial property investors seeking new opportunities. Situated outside Munich’s central business district (CBD), Arabellapark hasn’t got the established reputation of regions in Berlin or Frankfurt. Even so, it’s an area that has been attracting the attention of global real estate investors1.
Across Europe, property investors are thinking imaginatively about where to place their bets for the future. That makes sense in a marketplace significantly impacted by emerging new demographic shifts.
There is increasing pressure on residential housing in areas such as Berlin, where the technology sector’s growth in particular has attracted more young workers, prompting local government to freeze rents for five years2.
Similarly, Munich is home to Germany’s fastest-growing start-up scene3, with new ventures in fields including technology, health and biosciences vying for space in good locations beyond the CBD. It has not experienced the rampant price and rental inflation seen in Berlin’s office market over the past year and may therefore offer better value for commercial property investors4.
Indeed, with strong transport links, pedestrianised streets and green settings that appeal to young eco-conscious Germans, Arabellapark has great potential. It’s an example of exactly the type of opportunity that commercial property investors are now looking at amid concerns that more better-known areas of the market may be reaching full value.
Approaching the top of the cycle
After an extended bull run for commercial property across Europe, large parts of the market feel as if they’re close to the top of the cycle. In some sectors, capital growth and rental appreciation in Europe’s largest cities hit 10-year and 5-year highs respectively in 20185. Across the eurozone, commercial real estate growth rose above 4% during 2018, its highest level since the financial crisis a decade ago. But value hunters can still find opportunities.
“With yields remaining at multi-year lows, the challenge for investors will be in finding opportunities that can deliver the required returns,” says real estate specialist Knight Frank’s Head of Commercial Research William Matthews**. “We expect ongoing interest in assets further up the risk curve, with next tier cities and a wider range of property types increasingly coming into focus.”
So, for example, while prime office yields in central London currently stand at around 3.75%, this rises to 4.75% in Manchester and 5% in Birmingham. In France, Paris offers yields of 4%, while Marseille pays 4.55%. In Belgium, yields in Brussels stand at 4.25% but rise to 6% in Antwerp6. Yields in the central business district of Madrid are down to 3.25% by the end of last year, but available at 4.75% beyond the city’s ring road7.
Where those areas are attracting new business clusters, often around technology, or receiving investment in regeneration and infrastructure, they are particularly appealing.
The Arena area of Amsterdam is typical of this trend. Traditionally playing second fiddle to the Dutch city’s central business district, the area to the south-east of the centre (and home to Ajax’s football ground) is now attracting a host of media and technology companies, with its excellent road and rail links. Financial services businesses are coming too. ING, ABN AMRO, Nuon, Stryker and Adidas and all have locations in the area8.
Other examples include Bloomsbury and Waterloo in London, and Boulogne-Billancourt, Clichy, and Montreuil in Paris. Indeed, across Europe, young entrepreneurs and start-up businesses are seeking out new locations. In Lisbon in Portugal, for example, office leasings by technology companies have increased by 28%9, job creation by start-ups in Copenhagen is up 12.5%10 while Edinburgh now has more $1bn unicorn companies per capita than any other city in Europe11. Other European locations finding favour with entrepreneurs include the Baltic cities of Talinn and Vilnius in Estonia and Lithuanian and Eastern European cities such as Kraków in Poland.
Indeed, the start-up phenomenon favours many of Europe’s smaller cities – especially those with good universities generating well-educated workforces and an environment supportive of innovation. Malmö in Sweden and Mannheim in Germany are seeing increased attention from investors, for instance.
“Entrepreneurial endeavour is driving new trends in Europe’s commercial property markets,” says Syed Raza*, Managing Director, Global Banking and Credit Solutions Group at Barclays Private Bank. “As start-ups and pop-up businesses set up shop in new locations, they attract increasing numbers of workers to previously less popular locations and over time, these become hubs of entrepreneurialism; the effect is to re-energise the local property markets.”
In the UK, meanwhile, Cambridge is a standout example of how the combination of entrepreneurial innovation and academic support can create a market that is attractive to commercial property investors. With the number of businesses in the city up by a third since 2011, office rents have risen sharply, and investors are now exploring opportunities around the edge of the town as well as in the city centre12.
For investors, the benefits here go beyond access to new sources of yield and long-term price appreciation. They also provide a means with which to diversify the portfolio at this late stage in the market cycle. With yields so compressed in more conventional areas of the market, new locations represent an opportunity to mitigate risk.
Considering real estate options
It’s not just office space that is of interest, argues Lydia Brissy**, Director of European Research at real estate adviser Savills. “Beyond the limelight, some interesting niche markets also warrant exploration,” she says.
“Due to the nature of the economy of some countries, their political focus or demographic changes, other asset classes – including hospitality, the private rented sector, student housing or care homes in some specific markets – can offer investors great opportunities.”
The impact of online shopping
One big question for the commercial real estate sector is how to play the theme of online retail, where the rise of internet shopping appears to be inexorable. Industrial property – especially the warehousing required to underpin high-speed delivery models – has been a popular strategy.
In the UK, where online shopping penetration rates are significantly higher than in continental Europe13, prices in the logistics space are accordingly more elevated14. By contrast, yields remain more attractive in locations such as the Netherlands, Spain, Italy and Ireland, as well as across Eastern Europe15.
An alternative strategy for exploiting changes in consumer shopping habits is to go bottom fishing. At Barclays, Syed Raza* argues: “In some markets, we may see an increase in yields in the months to come as investors are turned off retail assets by the threat of online competitors to the bricks-and-mortar operators; in which case, assets with strong fundamentals, such as well-performing malls, may offer value.”
In other words, the greatest value in the retail space, as with other sectors of European commercial real estate, may now lie in areas that are off the beaten track, requiring investors to be both lateral-thinking and courageous.
“Commercial property investors seeking value at this stage of the cycle will need to look beyond the most obvious markets,” continues Barclays’ Syed Raza*. “There are still interesting opportunities, if you know where to look.”
In seeking out these value opportunities, it will also be crucial to remain conscious of the macro drivers of commercial property markets. Continued political uncertainty, from Brexit to Italy’s budget disputes with the European Union, will create both new possibilities and emerging threats.
These could contribute to shifting investor sentiment in markets across Europe. For example, prime residential property prices in London dipped around 2% last year, potentially as a result of changes to tax rules and Brexit, while prime house prices in Berlin rose 9.1%16.
Against this backdrop, commercial property investors in Europe must tread carefully. At this late stage in the cycle, the sector still offers the potential for good returns, but it will be crucial to be selective, seeking out the less obvious opportunities rather than depending on traditional markets.
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*These individuals are employed by Barclays Bank PLC, not Barclays (Bank) Suisse SA.
**These individuals are not employed Barclays (Bank) Suisse SA.
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