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European commercial property offers better value, index shows

The index, which measures the attractiveness of commercial real estate markets around the world, currently stands at 41 for Europe, which is an increase from 32 in the first quarter of the year. All sectors gained with offices increasing to 28 from 17 and retail and industrial both increasing to 52 from 40 and 48 respectively.

The index score increased despite the worsened economic outlook caused by the renewed uncertainty over the Eurozone debt crisis. The rise in the score follows two consecutive quarters of declining scores and largely reflects the fall in bond yields in core markets witnessed over recent months.
With government bond yields compressing in many countries, significantly in Germany and France, prime property is now relatively more attractive. It offers higher income yields and a broadly stable capital value outlook going forward.

The number of HOT markets in Europe increased from 10 in the first quarter to 11 and 18 markets were upgraded from COLD to WARM. The number of COLD markets decreased from 46 to 28. The majority of HOT markets are Central and Eastern European office and retail markets, such as Moscow office and retail, and Bucharest and Prague retail. These markets are expected to enjoy strong capital value growth in the medium term, stemming from yield compression and strong rental growth, which more than compensates for their higher risk.

Most of the markets that were upgraded were in France, Germany and the UK. Several German markets, including Berlin and Frankfurt offices and Munich retail were upgraded from COLD to WARM, even though they became more expensive in the second quarter as yields compressed. However, the shift was not sufficient to offset the positive impact from the inward German government bond yield movement.
In France, Paris CBD yields compressed further to 4.5%. This market remains COLD as it is considered overpriced and an outward yield shift is expected. Paris La Defense provides higher yields but poor quality stock and high service charges are dampening rental growth as investors prefer other areas close to the CBD. On the upside, improved rental growth outlook led to the upgrade of Lyon retail and Marseille offices from COLD to WARM.

The Nordic markets have a relatively low ranking in the DTZ Fair Value Index TM due to their aggressive pricing. For example, yields moved in from 5.5% in the first quarter to 5% in the second quarter in Oslo and are at a low 4.85% in Stockholm.

‘Our latest index shows that core European markets now offer better value to investors than they did earlier this year. This is partly explained by the higher income returns property now offers relative to government bonds in core markets,’ said Magali Marton, head of CEMEA Research at DTZ.

‘Although occupier demand is likely to be affected by the turmoil in the economy, the lack of supply at the prime end of the market is expected to keep rents broadly stable, with growth prospects in some markets. For example, a lack of supply in the office and retail markets of Milan and Rome is supporting price stability in spite of subdued occupier demand,’ she added.

According to Tony McGough, global head of Forecasting and Strategy Research, the outlook for property returns in European markets remains largely unchanged, and is characterized by solid income returns but weak rental growth in most markets. ‘However, these income returns look increasingly attractive in the current climate of increased equity market volatility and very low fixed income returns,’ he added.