Part of the M&G Group

Real Estate Market OutlookContinental Europe

Oct

ober

201

6

2

Consumers continue to spearhead the eurozone’s recovery

In fact, the consumer-led recovery continues. Credit

growth in the eurozone picked up in the first full month

following the UK’s decision to leave the European Union

(EU). According to the European Central Bank (ECB),

annual household credit growth picked up to 3.9%

in July, while bank loans to businesses rose by 1.9%.

This rise in the number of loans suggests the ECB’s

monetary stimulus measures are trickling through to

the real economy, emphasising the broader resilience

of eurozone economic activity post Brexit.

Executive summary• Brexit impact largely confined to the UK economy

as eurozone business sentiment remains stable

• The tight supply environment will see rental

growth opportunities arise in the office sector

• Paris and Frankfurt are the likeliest beneficiaries

of any London financial services job relocations

• The logistics sector to continue benefiting from

the continued growth of e-commerce

The economic repercussions of Brexit have been muted beyond UK borders

Since our last publication, economic and property

market news has focused on the outcome of the UK

Brexit referendum and the potential impact on the

wider European region. So far, the vote does not appear

to have had a marked adverse impact on the eurozone

economy. Indeed, downward revisions to 2017 GDP

forecasts, for example, were mostly confined to the UK,

with Consensus Forecasts reporting a downgrade of

170 basis points (bps), compared to just 50bps in Spain

and Italy and 20bps in Germany and France.

Ireland, Belgium, and the Netherlands have the highest

trade exposure to the UK, as a percentage of GDP.

As a result, these countries may be more vulnerable

to adverse changes in the UK’s economic situation,

particularly if it can’t reach favourable trade agreements

with its counterparts.

Meanwhile, in the peripheral European government

bond markets, things have changed significantly since

ECB President Mario Draghi’s ‘whatever it takes speech’

of July 2012. Looking back to 2012, 10-year government

bonds yields in the periphery appeared uncomfortably

high. Ireland, Portugal, and Greece were in the process

of applying for bailouts, while the Spanish banking

system was dangerously close to collapse. Four years

on, a dramatic drop in peripheral bond yields suggests

that investors are now demanding a much lower

credit premium.

€39.9bn vs €34.3bn Q2 vs Q1 real estate investment

volumes in Europe ex UK

3.9% annual eurozone household credit

growth in post-Brexit July

2021year when first ECB interest

rate hike is expected

Source: Bloomberg.

10 y

ear g

over

nmen

t bon

d yi

elds

(%)

Jul 1

1Oct

11Ja

n 12Apr 1

2Ju

l 12

Jul 1

6

Spain Italy GermanyGreece Portugal

-0.5

4.5

9.5

14.5

19.5

24.5

29.5

34.5

Oct 12

Jan 13

Apr 13

Jul 1

3Oct

13Ja

n 14Apr 1

4Ju

l 14

Oct 14

Jan 15

Apr 15

Jul 1

5Oct

15Ja

n 16Apr 1

6

Fig 1: Selected European ten-year government bonds

“A rise in bank loans to businesses suggests

the ECB’s monetary stimulus measures

are trickling through to the real economy,

emphasising the broader resilience of

eurozone economic activity post Brexit.”

3

More recently, investors have been scrutinising the

amount of bad debt on the books of a number of

European banks and questioning whether the more

fragile parts of the eurozone’s financial systems

can withstand these losses. In August, the results of

European bank stress tests revealed that Italy, the

UK, Germany, and Ireland are home to the greatest

concentration of stress-sensitive banks. However, the

broader conclusion of the tests was that ‘steady-state

monitoring’ was now the order of the day – rather

than emergency recapitalisation.

Meanwhile, the eurozone’s gradual labour market

recovery continues. The number of unemployed people

fell by 37,000 in June, pulling the unemployment rate

down to 10.1% – its lowest level since July 20111.

Headline inflation ticked back up into positive territory

in July, to 0.2%. A pick-up in services inflation pushed

overall core inflation (which excludes food and energy),

up to 0.9%. Further rises in the headline rate lie ahead

as the strong downward pressure from oil and energy

prices seen in the last year starts to fade.

Stimulative monetary policy could have further to run

Even before the Brexit result, the ECB had been operating

a very stimulative monetary policy: quantitative easing

(QE) was extended earlier this year, and interest rates

were cut to zero. In the post-Brexit climate, QE could

be extended again and interest rates could be cut into

negative territory, with the market not expecting the

first rise until as late as 2021 (see Fig 2).

Mo

nth

s

Feb

09Ju

n 09

Oct

09

Feb

10Ju

n 10

Jun

16

Feb

16

0

10

20

30

40

50

60

70

Oct

10

Feb

11Ju

n 11

Oct

11

Feb

12Ju

n 12

Oct

12

Feb

13Ju

n 13

Oct

13

Feb

14Ju

n 14

Oct

14

Feb

15

Oct

15

Jun

15

USUK EU

Source: Bloomberg.

Fig 2: First interest rate hike expectations

Interestingly, Google Trends suggests that people from

the US and UK have been more worried about a

European recession than Europeans themselves over

the past two years. The vast majority of searches for

‘Europe recession’ come from the US or UK. In Germany

and Italy there are on average seven and five searches

per month, respectively, for ‘Europa Rezession’ and

‘recessione Europa’ (see Fig 3).

There has been little change in economic sentiment

in core, Southern and Nordic European countries. Even

in Spain, where two general elections in six months

generated heightened uncertainty, the country

produced a quarter-on-quarter GDP growth rate of 0.7%,

well above the eurozone average of 0.3%. On balance,

both business and economic confidence indicators

across the region continue to point to eurozone GDP

growth of 1.5% in 2016, in line with 2015 figures,

suggesting that the contagion effect from the UK’s

Brexit vote could be quite limited (see Fig 4).

European sentiment stays stable

Greece

Ave

rag

e s

ea

rch

es

pe

r m

on

th

UKUSA Ireland

0

50

100

150

200

250

Germany Spain Italy

Source: Google Analytics.

Fig 3: Average number of searches per month for ‘Europe recession’ between July 2014 and June 2016

Bu

sin

ess

co

nfi

de

nce

an

d e

coo

mic

se

nti

me

nt

Jan

09

Jan

10

Jun

10

Jun

16

Jan

16

Economic sentiment: Core (Weighted Average France, Germany)

Economic sentiment: Southern Europe (Weighted Average Spain, Italy, Portugal)

Economic sentiment: Nordics (Weighted Average Sweden, Finland)

Business services confidence: Eurozone

90

110

130

150

170

190

Jun

09

Jan

11

Jun

11

Jan

12

Jun

12

Jan

13

Jun

13

Jun

14

Jan

14

Jun

15

Jan

15

Fig 4: Eurozone business confidence and economic sentiment

Source: Bloomberg.

1 Capital Economics, June 2016

4

The Paris Central Business District (CBD) also showed

healthy growth over the same period, with a 34%

increase in take-up2.

This pick-up in demand was seen particularly in small

and medium-sized spaces, which are experiencing falls

in  incentives. Indeed, incentives are higher for spaces

over 5,000sqm (24%), but more moderate for medium-

sized spaces between 1,000sqm and 5,000sqm (18%)

and small spaces under 1,000sqm (13%)3. The gradual

shift of the CBD market from the west of Paris to

the centre and east of the city is now an evident

trend, driven by the arrival of companies from the

co-working sector, which have made areas like Opéra

their neighbourhood of choice.

In the wake of Brexit, much speculation has been

dedicated to identifying the next office centres

that could stand to gain from the redistribution of

London-based financial services. The biannual Global

Financial Centres Index (GFCI), which measures a city’s

competitiveness, indicates that the gap between the

perceived attractiveness of London and other European

financial centres is now beginning to close.

Eurozone occupier markets led by Paris prime retail shop market

Downward revisions to the consensus eurozone GDP

forecasts suggest that the region’s occupier markets

could now be in a period of slower rental value

growth than previously expected, reflecting a weaker

overall growth environment. However, the European

recovery remains underpinned by improving consumer

confidence, which continues to boost rental growth

performance – particularly in the retail sector.

The Paris prime retail shop market has experienced

the strongest growth, expanding over 20% since the

start of 2016. Moreover, given that UK-based retailers

don’t represent a dominant source of demand in

Europe, we believe the continued physical expansion

of international retailers on prime European pitches

will be  unaffected by the Brexit referendum result

(see  Fig  5). With three-year average rental growth of

2.7% pa forecast, retail shops and shopping sectors

lead our latest European sector projections.

Stockholm, Barcelona and Paris drive growth in office sector markets

Reflecting recent buoyancy in office-based employment,

office sector markets achieved year-to-date rental

growth of up to 11.5% in Stockholm, 5.0% in Barcelona

and 4.8% in Paris. At 10.3%, the office vacancy rate

in Madrid remains among the highest across the

eurozone, but continues to trend down: take-up was up

by 25% in the four quarters leading up to the second

quarter of 2016.

Nu

mb

er

of

ne

w e

ntr

an

ts

LondonParis Barcelona0

10

20

30

40

50

Amsterdam Milan Berlin

AsiaOther N.America UK Cont. Europe

Source: PMA Spring 2016.

Fig 5: International retailer arrivals, 2013-15

“The gradual shift of the CBD market from

the west of Paris to the centre and east

of the city is being driven by the arrival

of companies from the co-working sector

that have made areas like Opéra their

neighbourhood of choice.”

“The European recovery remains underpinned

by improving consumer confidence,

which continues to boost rental growth

performance – particularly in the retail sector.”

GFC

I1G

FCI2

GFC

I3G

FCI4

GFC

I5

GFC

I19

Luxembourg Geneva FrankfurtLondon Zurich

550

600

650

700

750

800

850

GFC

I6G

FCI7

GFC

I8G

FCI9

GFC

I10

GFC

I11

GFC

I12

GFC

I13

GFC

I14

GFC

I15

GFC

I16

GFC

I17

GFC

I18

Source: Z/YEN Group, April 2016.

Fig 6: Global Financial Centres Index

2 Source: JLL Q2 2016.3 Source: BNP Paribas, July 2016.

5

In the industrial sector, rental growth was generally flat

in  the second quarter, with some notable exceptions.

The healthy economic environment in Spain, for

example, is evident in occupier demand for industrial

property, generating a year-to-date rental growth of

5.3% in Madrid. Take-up in both Madrid and Barcelona

has been supported by a high availability of stock

and low rental values. Headline rents in both cities

fell by around one-third following the global financial

crisis, and therefore have greater scope to recover.

So far in 2016, Amsterdam (2.9% year to date) and

Lyon (2.2% year to date) also benefited from positive

rental growth4.

Following the Brexit vote, demand for logistics space is

most likely to suffer in markets with strong goods trade

ties with the UK. In Europe, the most resilient logistics

locations will be those on established distribution

networks such as the ‘dorsale’ (backbone) area in

France, stretching from Lille to Marseille through the

Paris region. Further east, Poznan and Lodz are among

the major regional industrial hubs in Poland. Leasing

activity here has been driven by low labour and property

costs, expansion of e-commerce, and proximity to

major European distribution networks. In the long

term, Brexit could prompt a rethink of European cross-

border supply chains. We expect the European industrial

sector to generate 1.1% pa average rental growth over

the next three years.

Despite the high but cautious, demand environment,

investment volumes in Europe excluding the UK

rose to €39.9 billion in the second quarter – up from

€34.3 billion in the first quarter. All-property investments

increased by up to 110% in Sweden, while the largest

fall – in Benelux – was more restrained (-27%  in the

Netherlands). The return to safe haven and liquid

core markets is evident, with particularly significant

quarterly  year-on-year increases in volumes in France

(+68%) and Sweden (+74%).

Selected European cities defy broadly flat rental growth in Q2

Offi

ce n

et

ad

dit

ion

s (%

sto

ck)

0

1.0

0.5

2.0

3.0

1.5

2.5

3.5

Historic average '95-'15 (LHS) Forecast average '16-'20 (LHS)

Rom

e

CopenhagenM

ilan

Munich

Paris

Berlin

Vienna

Helsinki

Cologne

Hamburg

Amst

erdam

Frankf

urt

Dusseld

orfLy

on

Lisbon

Stuttg

art

Barcelo

na

Bruss

els

Madrid

Luxe

mbourg

Stock

holm

Source: PMA Spring 2016, M&G Real Estate.

Fig 8: Office net additions (% stock)

Based on financial services take-up, Paris and Frankfurt

have been cited as the most likely beneficiaries of potential

London job relocations, having attracted the largest

shares of demand over the last ten years (see Fig 7).

For companies in sectors such as legal services and TMT,

Paris, Munich or Berlin are perhaps an obvious choice of

location. Given the importance of the ‘fintech’ sector,

cities like Amsterdam and Dublin may also be well

placed to benefit from staff relocations. While it is too

early to gauge the impact of the UK’s future passporting

rights, we believe the risk to our rental growth forecasts

in these cities is to the upside.

European office sector to generate average rental growth of 2.3% pa over next three years

Besides improving labour markets, the performance of

the European office sector will be further underpinned

by tight pipelines compared to history. Most European

centres – apart from Stockholm – currently benefit from

lower-than-historic average supply under construction

over the next five years (see Fig 8). Swedish GDP

forecasts look relatively healthy, giving developers the

confidence to meet future demand requirements with

new building starts. Overall, we expect the European

office sector to generate average rental growth of 2.3%

pa over the next three years.

Financial Services Take Up

Index 100 = London, Last 10 years

Milan

Munich

Paris

Vienna

Cologne

Hamburg

Amsterdam

Moscow

Frankfurt

Warsaw

Dublin

Barcelona

Brussels

Madrid

Luxembourg

0 5 10 15 20 25 30 35 40 45 50

Source: PMA Spring 2016.

Fig 7: Financial services take-up, selected European office centres

“In Europe, the most resilient logistics

locations will be those on established

distribution networks such as the ‘dorsale’

(backbone) area in France, stretching from

Lille to Marseille through the Paris region.”

4 Source: JLL.

6

Property market yields move out in the UK, but keep trending down in Europe

UK property markets have experienced the first

outward  yield movements, but the downward yield

trend  in Europe has continued. The office sector saw

inward movements of up to 50bps over the second

quarter in Brussels and Prague and up to 75bps year

on year in Warsaw. Retail shops experienced the most

stabilisation over the quarter, with the exception of

Madrid (25bps year on year) and Barcelona (50bps

year on year). Among industrial markets, where

yields have further scope to compress compared

with historic  averages, Madrid and Barcelona saw

the most significant inward movements quarter on

quarter (65bps,) while Paris and Lyon also experienced

significant movements year on year (70bps).

Going forward, the uncertainty created by Brexit

negotiations and the upcoming US elections (and

French and German elections next year) are likely

to affect overall investment activity levels. A retreat

to core in what will remain a moderate growth, low

supply, low interest rate environment will continue to

see prime values hold up in major European markets.

While the market faces a continuation of cautious

demand focused on core areas, the steady expansion

of interest towards other, more emerging markets may

slow. Higher yield premiums will also be demanded. As

a result, the prime-to-secondary yield gap may widen.

“Overall investment activity is likely to be

affected by uncertainty created by ongoing

Brexit negotiations and the upcoming

elections in the US, France and Germany.”

We believe the long-term impact of the Brexit result is

likely to be limited, but this evolving situation will need

to be closely monitored for some time to come. While

economic sentiment may be a little more subdued,

growth is set to continue, and the adverse impact on

rental growth is likely to be modest. Furthermore, a

positive yield impact on European property, underpinned

by very low bond yields, will support the return outlook.

As a result, real estate in the region is set to remain

an attractive proposition for many investors, from all

corners of the globe.

ConclusionQ

2 1

5 t

o Q

21

6 €

M i

nve

stm

en

t vo

lum

es

% c

ha

ng

e

Spai

n

Nor

way

Port

ugal

Finl

and

UK

Ger

man

yN

ethe

rland

s

Aus

tria

Ital

y

Den

mar

k

Belg

ium

Fran

ce

Swed

en

-80

-60

-40

-20

0

20

40

60

80

Source: CBRE, M&G Real Estate.

Fig 9: Year-on-year quarterly investment volumes by country

Vanessa MuscaràSenior Research Analyst Tel: +44 (0) 20 7548 6714vanessa.muscara@mandg.com

Richard GwilliamHead of Property Research

Tel: +44 (0) 20 7548 6863richard.gwilliam@mandg.com

Christopher Andrews, CFA Head of Client Relationships

and Marketing

Tel: +65 6436 5331chris.j.andrews@mandg.com

Lucy Williams Director of Institutional Business,

Real Estate, UK and Europe

Tel: +44 (0) 20 7548 6585lucy.williams@mandg.com

Stefan Cornelissen Director of Institutional Business,

Benelux, Nordics, and Switzerland

Tel: +31 (0) 20 799 7680stefan.cornelissen@mandg.co.uk

www.mandgrealestate.com

Contacts

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