Twelve months ago, real estate professionals congregating along Cannes’s main La Croisette strip for the annual MIPIM conference were wary about Europe’s economy, but rosy about property valuations. Now, the sentiments have reversed, says Martin Towns, head of capital solutions at London-based real estate fund manager M&G Real Estate.
“There’s now a recognition that we’re further in the cycle, and cap rates are slightly lower, so people are more cautious about rates. But there’s optimism about the economy,” he remarks.
Europe’s economic growth consistently beat expectations last year, with gross domestic product growth reaching 2.7 percent, according to M&G’s March European market outlook report. This far exceeded the European Central Bank’s 1.7 percent forecast and marked the eurozone’s fastest growth rate since 2007.
Improving economic fundamentals was one factor cited for the rise in Europe’s popularity as a real estate investment destination, according to the latest CBRE Global Investor Intentions Survey. Europe is considered the most attractive regional market for 32 percent of investors, a close second to North America, which was most favored among 39 percent of investors, the report said.
“For the first time in many
years, we are considering
the French market. We did
not have the appetite for
France before, but we are
quite positive about what’s
going on in France”– Cornel Widmer
Europe attracted $173.7 billion in cross-border inflows in 2017, an increase of 27 percent, both the highest such volume and percentage increase among the regional property markets, according to the Cushman & Wakefield Global Investment Atlas 2018, which also was unveiled at MIPIM.
When discussing the eurozone’s positive economic prospects, nearly all the MIPIM delegates that spoke with PERE identified one strong driver of that optimism: the resurgence of France, which has transformed from an economic laggard to one of Europe’s strongest economies during the course of the year.
The country’s GDP growth reached 0.6 percent in the fourth quarter of last year, the fifth consecutive quarter where it exceeded 0.5 percent, according to the European Commission.
Annual GDP growth rose to 1.8 percent in 2017 from 1.2 percent in 2016, and is expected to increase to 2 percent in 2018.
This turnaround is happening after years of sluggish growth and is attributed in part to President Emmanuel Macron’s economic reforms, which seek to promote labor freedom and a market-driven economy.
“Economic growth in France had been held back by low productivity growth. This can be linked to relatively rigid labor markets and elevated public spending, rather than private investment, and in part, depressed consumer and business sentiment,” says Raimondo Amabile, head of Europe at PGIM Real Estate. “Macron is tackling these issues, providing positive economic impulses in France.”
Adds Amabile’s colleague, Germany head Sebastiano Ferrante: “You can see
how political change can have positive effects on the investment environment. Companies are starting to invest again, and real estate demand is following suit.”
One of the strongest endorsements at MIPIM for France’s real estate market came from Zurich Insurance Group, which is eyeing a return to the country following the sale of most of its French business to Italian insurer Generali in 2004.
“For the first time in many years, we are considering the French market,” says Cornel Widmer, Zurich’s head of group real estate. “We did not have the appetite for France before, but we are quite positive about what’s going on there now. The overall economy is improving and has the potential to be picking up quite nicely.”
To mark its re-entry, Zurich is in the middle of the selection process for an asset manager for France and hopes to award a mandate by the end of the first half of the year. The insurer expects to invest $300 million-$400 million of equity by the end of the year, with the goal of building a core and core-plus portfolio in the country before long.
Zurich is far from the only investor seeking to ramp up its exposure in France, however. During the same week as MIPIM, Swiss Life and MAPFRE, the largest multinational insurance company in Latin America, announced plans to launch a real estate vehicle that will invest in the prime office locations in major French cities, with a first size target of up to €150 million of equity.
Caution ahead
But tempering that optimism was a fair amount of caution about the later-stage real estate cycle in Europe, as well as changes to European Central Bank’s monetary policy.
“The biggest concern is the changes and the potential pace with the monetary policy from the European Central Bank,” says Gunnar Herm, UBS Global Asset Management’s head of real estate research and strategy. Quantitative easing by the ECB ended this year, which means that bond rates could rise as soon as the end of 2018.
The impact of a rate increase is potentially worrisome for the prime real estate segment, says Herm. In Berlin, for example, the prime cap rate for a prime office property is currently 2.9 percent. “If interest rates rise and cause cap rates to rise to say, 4 percent, that’s a significant loss in value, and can hardly be compensated by income growth,” he says.
Herm has reason to be concerned, as multiple major European investors are understood to have already been impacted by interest rate increases. Among them is Bayerische Versorgungskammer, Germany’s largest pension fund, which is scaling back on US real estate investing for 2018 because of rising interest rates as well as a dramatic increase in hedging costs.
Over the past two years, BVK’s hedging costs for its US real estate investments have surged from approximately 50-70 basis points to 280bps, according to Rainer Komenda, head of real estate funds at BVK. “If it’s a normal core, core-plus deal that produces a 5 percent cashflow, you end up with a 2.2 percent return,” he says. “It’s too small to support our overall portfolio.”
The rising hedging costs are partly the result of disparity between interest rates in Europe and the US, Komenda notes.
While the US Federal Reserve has raised the target range for the US federal funds rate from 0.75-1 percent to 1.25-1.5 percent over the past year, the ECB’s interest rates have
remained unchanged at zero, 0.25 and -0.40 percent for the past two years.
The increased costs of making a property investment in the US have led BVK to scale back its investment drive in the market. “It’s not to say we’ll completely pull out of the US, but we will slow down,” says Komenda.
Chiming with BVK’s plans are some of Cushman’s projections in this year’s Investment Atlas, which projected the likelihood of “new patterns of risk taking” among investors, as some seek to de-risk portfolios while others seek more growth-driven, rather income-focused, strategies. “Overall therefore, we will see a more dynamic market as investors switch targets between sectors and regions,” the report said.
In other words, it is unlikely to be business as usual for the European real estate market in 2018. While the overall mood at MIPIM is considered an industry barometer every year, what is shifting beneath the surface is also warranting attention.
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