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European market this year expected to mirror 2003 Back  
The market in Europe is expected to stabilise this year although there may still be some downside on rents. But with vacancy rates peaking there will be no shortage of money seeking a home in property writes John Moran.
LLeasing activity in the European commercial property market is expected to stabilise during 2004 and vacancy rates will peak, according to the latest European Capital Markets Bulletin from Jones Lang LaSalle.

The pan-European research predicts that prime rental levels will continue to fall this year but the weight of capital currently in the property market will continue to outstrip the amount of good quality, available investment opportunities.

Jones Lang LaSalle expects investment volumes to be similar to the €80.6 billion invested in European property in 2003, which was only 8 per cent down on the record level reached in 2002.

Although subdued by global uncertainties during the first half of 2003, investors returned to the market strongly in the second half of the year, driven by the same factors as in 2002 - low interest rates, strong capital inflows to real estate funds, and good risk-adjusted returns and high income yields.

The UK remained by the far the largest investment market (50 per cent) but the Nordic region of Sweden, Denmark and Finland (12 per cent) overtook France (10 per cent) in second place, thanks to strong interest by foreign investors in Sweden. Investment volumes in Central and Eastern Europe rose for the fourth consecutive year with foreign investors dominating the market.

Cross-border investment activity as a proportion of all investment rose sharply in 2003, accounting for €38.4 billion or 48 per cent of the total, compared to 40 per cent in 2002. Among the reasons for the increase were the desire for economic and real estate diversification, the search for higher yields, and the search for a larger stock of more varied product than was available domestically.

Over the past few years the office sector has accounted for a progressively smaller share of investment as investors sought better returns in retail (value growth prospects) and distribution warehouses (high income). This continued in 2003 with the office share remaining below 50 per cent. Strong interest in retail was maintained throughout the year, especially for shopping centres and, increasingly, retail warehouses, although transaction volumes were held back by limited product availability.

Over the past three years European real estate has been characterised by a growing weight of investment capital, which has led to an interesting trend in pricing across the region. During the period 1990 to 1994, weighted average prime office yields rose from 5.1 per cent to a peak of 6.3 per cent (+120 bps) in response to both the prospect and reality of widespread rental declines. In the current rental downturn there has been only a limited outward shift in yields (just +40 bps to 6.0 per cent), despite the fact that rents have fallen by almost as much as during the early 1990s.

German open-ended funds (GOEFs) received more than €14 billion of capital inflows and invested equity of at least €10 billion into real estate in 2003, frequently out-bidding debt-driven and institutional investors for some of the largest lot sizes traded in 2003.

Debt-driven investors were a large source of capital in 2003, especially private property companies, individuals and syndicates that took advantage of low borrowing rates to compete for large, well-let assets and, increasingly, value-added opportunities. A domestic example was the Warren & Partners purchase of the AIB Building in the IFSC for €78 million in a sale-and-leaseback transaction.

There was also more interest and activity from Irish and Middle Eastern private investors in Belgium, Hungary, Italy and the Netherlands. Investment activity from institutions (predominantly UK pension funds) was up sharply in the second half of 2003, boosting their annual share of total investment from 12 per cent to 15 per cent. It is expected that many of the same factors will apply in 2004. Even if an improvement in equity markets leads to lower inflows to German open-ended funds and private equity funds, there is sufficient capital available in the market to sustain a high rate of investment activity. Pension funds are up-weighting real estate in their portfolios and this will give them greater freedom to be net purchasers of property in 2004. In addition, tax efficient investments vehicles, introduced in France last September and expected in the UK next year, will add to market dynamism.

The office sector is expected to continue to be weak, although investors will seek opportunities in markets showing a potential to bottom-out over the short to medium term. Strong interest will continue in retail but investment volumes will be pegged back where owners are unwilling to sell and there is little development. Investment volumes are likely to increase in the distribution/warehousing sector, attracted by high income yields as market fundamentals improve. Jones Lang LaSalle believes that the outlook for Europe’s real estate markets remains positive, that investment volumes in 2004 will match those of 2003, and that property remains attractive relative to other markets.

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