European Real Estate Snapshot

March 2019

European Markets Overview

Key Themes European markets in Q4 2018

The total investment in European real estate reached €93.9bn in Q4 2018 driving the annual investment volume to €311.9bn, comparable to the level reached in 2017. Office deals were the largest contributor, comprising ca. 41% of the total annual investment. Germany had the highest level of investment (€77.4bn), followed by UK (€72.7bn) and France (€31.1bn). Compared to the investment volumes of last year, Spain performed extremely well, achieving ca. 57% rise in investment volumes, driven by several large deals in second half of the year.

Germany

• Office space lettings were strong in the top 5 German markets (Munich, Berlin, Frankfurt, Hamburg and Dusseldorf) throughout 2018 with the full year take-up volume of 3.3m sq. m., of which 29% was in Q4, making it the strongest quarter. Strong demand was observed in Munich and Berlin, together contributing 55% of the total take-up. The average office vacancy rate was around 3.9%. Office investment volumes reached €30.8bn in 2018 (21% y-o-y growth). Prime yield ranged from 2.5% (Munich) to 3.3% (Dusseldorf).
• In the industrial and logistics segment, demand remained high in the fourth quarter with the annual take-up for 2018 reaching close to 7mn sq. m. Prime rents for logistics sales increased in Frankfurt and Munich. Investment volume reached €6.8bn for 2018 and net initial yields for prime assets ranged from 4.1% (Hamburg) to 4.4% (Cologne).
• In the residential segment, annual investment volume reached €15.1bn in 2018, registering its third highest investment volume in last 10 years.
• In Q4 2018 investment volume for retail assets were €2.1bn, out of the total annual investment volume of €10.5bn (18% annual decline). Foreign investment contributed 42% of the total retail investment volume. Prime yields from high street shops ranged from 2.8% (Munich) to 4.5% (Leipzig).

United Kingdom

• The second half of 2018 witnessed the highest level of take-ups of office spaces in a decade, with majority of the demand driven by flexible office operators. Key expansion locations included Slough, Hammersmith, Stockley Park, Reading, Birmingham, Bristol and Glasgow. The vacancy rate for office spaces across the UK market was around 7.3%. Investment turnover for the full year totalled £22.1bn, a year-on-year fall of 12%. Investment in London offices fell to its lowest level since the EU referendum, mainly due to a fall in the number of large unit sales. However, investment appetite for regional office investments soared in 2018, on the back of strong occupier fundamentals in core regional cities.
• The UK logistics market remained resilient with a take-up of 11.1mn sq. ft. in Q4 2018, taking the annual take-up volume to 35.9mn sq. ft., the highest level since 2008. The leasing market had a record-breaking year due to e-commerce growth. Investor demand remained strong with transaction volume of £6.7bn in 2018, in line with the five year average. For the December'18 quarter, prime industrial yields were around 4% in London and above 4% outside of London. Logistics location such as Edinburgh, Glasgow and Newcastle saw yields at 5.75%, 5.75% and 5.5%, respectively.
• In the residential market, a total of £3.1bn was invested in 2018, up 33% from 2017. In Q4 2018, £906.6mn of institutional investment into the UK's private rented sector was recorded. Investors diversified in Q4 of 2018, with most transactions being concentrated in regional centres. Highest level of investment was in Outer London/South East regions and prime regional centres. Prime net yields ranged from 3.15% to 4.25%, with the latter being achieved in prime regional locations.
• Occupational metrics for retail assets remained volatile during Q4 2018, with financial distress and administrations reported in the occupier market. The retail vacancy rate was around 12%. 2018 was the quietest year for retail investments in the UK in almost 20 years at an investment volume of £7.3bn. Prime retail yields for Q4 2018 was majorly stable for prime high street shops with outward movement in secondary locations. Prime yields were reported at 4.5%, 2.5%, 4.5% and 5.0%, respectively for London (city), London (west end), Birmingham and Edinburgh.

France

• Office take-up in Q4 2018 was down 27% year-on-year, but due to a high level of activity in the first half of the year, the take up at the end of the year stood at 2.5mn sq. m. (-5% y-o-y). For the third consecutive year, Paris performed above 1mn sq. m. while Outer Suburbs surprised the market with the only increasing take-up over 2018 (+26% y-o-y). €22.9bn was invested in office spaces over 2018; this represents a new record, a 15% y-o-y increase and is 10% higher than in 2007 (€20.7bn), the previous benchmark year. Domestic investor's market-share fell to 57% in 2018 from 70% a year ago.
• Logistics take-up reached 3.3mn sq. m in 2018. Despite the sharp decline (-21% y-o-y) it was still above its 10 years average for the third year a row. Investment volume reached €3.8bn in 2018 in the French industrial segment. Prime industrial yields ranged from 4.5% (Paris) to 5.5% (Lille) in Q4 2018.
• The 4th quarter retail investment market reached €4.6bn, 10% higher than in 2017, due to the emergence of 11 major deals (those over €100mn). Prime retail yields for Q4 2018 were majorly stable for prime high street shops with outward movement in secondary locations. Prime yields for high street shops ranged from 2.5% (Paris) to 5.0% (Marseille).

Spain

• Prime office rents remained at €30.50 sq. m. per month, reaching a maximum of €38.50 sq. m. per month in the most sought-after areas of the CBD and vacancy rates were at 11.1% for Q4 of 2018. Office investment volume in Madrid and Barcelona totalled to ca. €2.4bn, 6.7% higher than the previous year. Prime yields remained stable at low levels of around 3.75% in Madrid and 4% in Barcelona.
• Logistics take-up remained high in 2018, with take-ups in Madrid up 2% and in Barcelona up 36% from their respective levels in 2017. Prime logistics rents in the capital rose to €5.50 sq. m. per month in the final quarter of the year, while in Barcelona they remained stable at €6.85 sq. m. per month. Vacancy rates for Q4 2018 were at 4.25% in Madrid and 3.5% in Barcelona. Logistics investment volume reached €1.2bn by the end of 2018, matching the figures achieved in 2017.
• Retail investment volume in 2018 was at ca. €3.7bn driven mainly by shopping centre and high street investment. High Street investment experienced significant growth in 2018, totalling around €1.3bn, 84% higher than the previous year.

Focus of the Month

The European REITs Landscape

The REIT structure has been growing globally and presenting opportunities to investors in the form of a diverse option pool to choose from. After their origination and popularity in the US, there is a growing demand for REITs in Europe as they serve as tax-efficient real estate investment vehicles. REITs create more liquidity, transparency and activity in the real estate market. REIT regimes have been improving in European countries and revenues are growing from portfolio additions through M&A, direct investments and ongoing development activities. These factors along with the fact that the European market is potentially untapped, present a wide variety of opportunities to local and foreign investors. However, risks of the overall CRE market, including possible threats to valuation caused by Brexit, as well as an ending of cap rate compression trends will affect the performance of REITs.

Overview

European REITs are becoming more popular and most CRE trends seen across the sector are fundamental to the performance of REITs

• Brexit – With the right policy support from the UK government, the uncertainties of Brexit have been countered and REITs continue to remain a high performing asset class and a major contributor to the economy.
• Macroeconomic factors – Most European REITs have fixed or have hedged their debt costs for the next 3-4 years and hence are less likely to be affected by a growing interest rate regime. Most rents are indexed to inflation which too protects real estate values from rising interest rates.
• Valuation – There is a disconnect between public and private real estate valuations. REITs are trading at a discount, whereas cap rates which indicate asset prices, remain steady. This has led to some REIT managers repurchasing their shares to boost share prices.
• Market disruptions – Disruption in retail and the emergence of co-working spaces has prompted some REIT landlords to reshape their leasing strategies.
• Market expansion – Spain too has been attracting international investors through its REIT regime. Poland is the most developed financial market in Central and Eastern Europe, and is in the process to pass a local REIT legislation.

UK REITs

A dynamic and flexible market which has proved attractive to investors

• Volume – Today, there are more than 70 UK REITS and in the last 5 years, more than 30 new REITs have listed on the LSE and have raised more than £12bn of equity.
• Market characteristics – The UK REITs market has been growing and investors are lured by the benefits of the REITs structure (tax advantage), the market liquidity and the global brand image of REITs.
• Residential – With the government aiming to build 300,000 new homes each year, a number of new REITs focussed on this sector are emerging. These are proving to be good platforms for investors looking for UK residential market exposure.
• Healthcare – UK's ageing population is leading to an increase in the demand for retirement living, care homes and medical centres. REITs are helping bridge the public sector funding constraints.

Retail

The sector is facing a stiff competition from e-commerce and is innovating to stay strong in the game

• Corporate consolidation – Consolidations in the listed retail REITs are taking place so that they are stronger and better equipped to deal with the competition from e-commerce, which results in technology costs going up and return on capital coming down.
• Retail innovations – E-commerce led disruptions are resulting in REIT landlords seeking less traditional tenants and improving the quality of their shopping spaces. REITS are actively redeveloping and renovating their assets to attract tenants. Tenant profiles are shifting from more traditional ones to those with a focus on lifestyle, luxury and entertainment.
• LXi REIT (a specialist inflation-protected very long income REIT) is providing forward funding for pre-let development of a portfolio of 13 Starbucks and Costa shops for a total of £23.4mn, with a net initial yield of 5.7%. It has been funded using the company's Scottish Widows loan. Rents are RPI linked and since the funding is on a fixed price basis, the company is not assuming any development risk, and will receive an income from the developer during the construction period.

Industrial

Demand for logistics REITs has surged with e-commerce growth, with higher rental growth as compared to other sectors

• E-commerce – Industrial REITs own a variety of warehouse properties. The growth of e-commerce has led to a surge in demand for logistics real estate, resulting in the occupancies of industrial properties owned by REITs being higher than other property types. REITs are reconfiguring the type of industrial space that they offer to be more effective in the "last mile logistics".
• Funding source – New facilities are being constructed and REITS are being used as a source of financing and investors are benefiting from the strong operating performance.
• Tritax Big Box REIT has completed contracts for forward funded development of new pre-let logistics facility near Durham. The maximum commitment is £147.3mn, with a net initial yield of 5.25%.

Healthcare

With an increasing demand for healthcare facilities, the sector is benefitting from investment from REITs

• Primary Healthcare properties (PHP) and MedicX Fund are merging to create a £2.3bn UK healthcare REIT. The two companies have complementary portfolios and the combined portfolio with increased scale and financial resources can invest further in the NHS-supporting estate, thus increasing their ability to meet the growing demand.
• AEW Long Lease REIT (AWEL) has acquired a long let care home in Nailsea, Bristol for £6.65 million, with a net initial yield of 5.8%. It has been funded through extension of the company’s existing debt facility with Canada Life Investments by £11 million. This has added to AEWL’s income stream that will be accretive to its dividend, and improve its diversification.

Funds in the Market

Recent Fund Activity

Recent Transactions

Snapshot of Key Deals

• Direct Acquisition
• Property Financing