A broad-based expansion in European real estate is finally getting what it has lacked for years—a tailwind of accelerating economic activity following a prolonged period of anaemic growth. Second-quarter 2017 EU-wide gross domestic product (GDP) growth reached its highest level in more than six years. Pointing to continued strong growth, the European Commission’s economic sentiment indicator for the 19 countries that make up the Eurozone stands at a post-crisis high amid rising optimism across all sectors of the economy. This optimism flows from the following key factors:
- Improving jobs market- After years of trailing the U.S., Europe now leads in job creation. EU unemployment has dropped nearly a full point in the past year to 9.1%, down from 12% four years ago. More people at work fosters greater household formation and consumer spending. Yet there is still considerable room for improvement in the employment situation.
- Favourable monetary conditions- Monetary policy should also continue to stimulate growth. Bond yields remain near historic lows, and inflationary pressures are still largely absent in Europe but moving up from a low base which should be a positive for inflation linked rental contracts.
- Improved Business Models: For most European countries, REITs are still relatively new. The REIT structure has only been available in the U.K. and Germany for about 10 years, and in Ireland and Spain for about five years. Like we have seen in the U.S., which has had the REIT structure for more than 50 years, European and U.K. REITs have increasingly adopted significant reforms that have improved environmental, social and governance (ESG) standards and increased shareholder returns.
Attractive real estate opportunities can be found today across Europe among companies operating in a variety of sectors.
Berlin Ist der Ort (Berlin is the place): Germany, the economic gravitational centre of the EU, is enjoying strong economic, population and job growth largely thanks to a vibrant exports sector and attractive migration policies. German household formations are running at the highest levels since the boom years in the early 1990s following reunification. Nowhere is this more evident than in Berlin, which has attracted both German nationals and immigrants with its low costs of living and doing business.
Although residential supply is increasing in Germany, it has not been nearly enough to meet demand, especially in Berlin. It is estimated that 20,000 new housing units are needed each year to meet new and pent-up demand in the city. Yet the market has supplied only half that amount annually in recent years (Exhibit 1), which is helping to drive rents higher. Quality office space in Berlin is also scarce, with strong job growth driving low vacancy rates and rising rents amid the creation of limited new supply. Berlin office take-up has set records in each of the last several years, but supply has met only a quarter of that demand.
Spain is heating up: Spain was among the countries hardest hit following the 2007–08 financial crisis and subsequent sovereign debt crisis. Its housing market collapsed, triggering a deep recession and essentially bankrupting the country’s banking sector. But unlike Italy or Greece, which experienced similar issues, Spain tackled its problems early on and is now seeing advantageous results. Structural labour reforms, surging exports, a revitalised service sector and a tourism boom have helped put the country on pace for its third consecutive year of economic growth of around 3%—the fastest of any large economy in the euro area.
Improved business models: European and U.K. REITs have increasingly adopted significant reforms that have improved environmental, social and governance (ESG) standards and increased shareholder returns. Based on our observations, companies that have been successful in these efforts have often seen an improved cost of capital, giving them a competitive advantage versus the private market. Some “new kids on the block” have used these principles from the start and have seen solid total returns, with what we believe is still a bright long-term outlook. Also, more recently some established names and structural benchmark laggards have upped their game and initiated shareholder friendly strategies, which we welcome.
Healthy economies throughout Europe are driving demand for commercial real estate at a time when supply is generally limited (largely as a result of the Great Financial Crisis) and credit conditions remain supportive. In addition, we believe valuations for real estate securities are attractive on an absolute basis and relative to global equities & especially compared to bonds. Real estate typically offers high & stable income compared to most fixed income categories—and we believe that income will rise with at least inflation over time, protecting against rising interest rates.
Rogier Quirijns is senior vice president and portfolio manager of Cohen & Steers