Yield-hun­gry in­vestors seek Euro­pean com­mer­cial real es­tate with high­est rental growth po­ten­tial

Financial Mirror (Cyprus) - - FRONT PAGE -

In­vestor de­mand will re­main high, as re­turns on com­mer­cial real es­tate in Europe are more at­trac­tive in the low in­ter­est rate en­vi­ron­ment than al­ter­na­tive in­vest­ments, ac­cord­ing to Moody’s In­vestors Ser­vice.

“With lit­tle prospect of de­clin­ing yields, in­vestors will be seek­ing those mar­kets that of­fer the high­est rental growth po­ten­tial. It’s a bal­anc­ing act be­tween the de­fen­sive at­tributes of low yield­ing prime prop­er­ties and searching fur­ther afield for ad­di­tional yield pickup,” said An­drea Daniels, an As­so­ciate Manag­ing Di­rec­tor at Moody’s.

“CRE fun­da­men­tals are sta­ble, but re­turns will not be uni­form. Re­bound mar­kets like Lon­don, Ire­land and Spain and re­tail lo­gis­tics prop­er­ties will achieve the high­est rental growth. The prop­erty yield spread over govern­ment bonds is high, de­spite prime yields be­ing at his­toric lows in core mar­kets - even be­low lev­els seen in 2007. This gap will re­main through to 2018,” said Stephen Hughes an As­sis­tant Vice President at Moody’s.

The rat­ing agency said a large seg­ment of CRE in­vestors will con­tinue to fo­cus on prime of­fice and re­tail prop­er­ties in the ma­jor Euro­pean cities. These prop­er­ties are typ­i­cally sought af­ter by real es­tate in­vest­ment trusts (REITS), sov­er­eign wealth funds and in­sur­ance com­pa­nies due to in­vestor per­cep­tion of be­ing highly liq­uid, with less down­side risk in the short to medium term. A sec­ond group of in­vestors, no­tably private eq­uity com­pa­nies and var­i­ous prop­erty funds, will move up the risk curve to pur­chase good-qual­ity sec­ondary prop­er­ties. These prop­er­ties will re­quire a more hands-on ap­proach to prop­erty man­age­ment, but do of­fer higher re­turns when turned around. How­ever, we ex­pect lit­tle de­mand for ter­tiary prop­er­ties.

At the CREFC Europe Spring Con­fer­ence last week, Moody’s found that many par­tic­i­pants echoed the rat­ing agency’s view that the com­mer­cial real es­tate lend­ing land­scape will re­main com­pet­i­tive, with a greater di­ver­si­fi­ca­tion of lend­ing sources go­ing for­ward.

In­ter­est rates be­ing close to zero will con­strain any fur­ther downward yield move­ments. Yields will re­main di­ver­gent be­tween prime, sec­ondary and ter­tiary prop­er­ties. This con­trasts with the peak of the mar­ket in 2007, where in­vestors barely dif­fer­en­ti­ated be­tween prop­erty qual­ity. In 2007, spreads be­tween the best and worst prop­er­ties in a given mar­ket were neg­li­gi­ble; typ­i­cally less than 1%. This has now widened to over 5% in many mar­kets. Although we be­lieve that pric­ing of good sec­ondary prop­er­ties can po­ten­tially move closer to that of prime prop­er­ties, we still ex­pect a pro­nounced yield gap to re­main in place up to 2018.

The bulk of new CRE lend­ing is heav­ily weighted to­wards the main mar­kets of UK and Ger­many, with fewer lenders look­ing to­wards more pe­riph­eral coun­tries. Cur­rent lend­ing terms ap­pear rel­a­tively con­ser­va­tive with all prop­erty LTV ra­tios at around 60-65%, and mar­gins be­low 200bps in most core Euro­pean cities.

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