A primary driver of investment into real estate has been volatility and lower returns in other asset classes such as equities. Yet while core assets are currently being viewed as pricey, they also are expected to trade at lower yields for some time to come, property services firm Colliers International said in its 'View from the Top' report, released at this year's MIPIM conference.
In December 2015, for example, total returns on UK real estate exceeded equities by more than 10 percent. Yet the property market also has been subject to yield compression. Prime office yields in key European markets currently are on average 75 basis points lower, ranging from 3.25 percent to 4.5 percent, than at the previous market peak in 2007, when yields ranged from 4 percent to 5.25 percent, according to the report.
“Core property looks expensive by historical standards,” said Damian Harrington, head of EMEA research at Colliers. “This suggests a substantial pricing correction could be in the offing.”
However, Harrington pointed out that the underlying yield pressures for core real estate are different today than prior to the global financial crisis. In 2007, 10-year bond yields were about equal to prime office yields, but in early 2016, are on average 2.75 percent lower than prime office yields. “Clearly, there is scope for core assets to continue trading at lower yields with little outward shift for some time – perhaps in perpetuity,” said Harrington. This is especially the case with gross domestic product growth poised to remain moderate in developed countries for the foreseeable future and monetary policy to stay accommodative.
But despite lower yields and the general perception that core assets are now fully priced, Colliers made the case that such properties were not necessarily overvalued, at least in some parts of Europe. “In the UK, the results of recent ‘fair value’ analysis suggests that given strong rental growth expectations and low ten year bond rates, that core property in many cases is not far off ‘fair value,’” the report said.