EMEA real estate investment volumes have taken a slight breather going into the start of 2018. At $65 billion, volumes were flat in US dollar terms compared to the same period in 2017, however they were down by some 12% in local currency terms. Is the market starting to slow and should we be concerned? Not overly in our view.
Given the record breaking $130 billion final quarter of 2017 we are not surprised to see that the market is flattening a touch. With upward pressure on inflation and the gradual, predictable unwinding of QE, some moderation at this stage in the cycle is arguably a good thing.
We would be more concerned if one sector significantly underperformed, but there appears to be no easily identifiable trend in the retraction. In any case aggregate investment volumes remain almost 20% above the long term average for the first quarter.
Looking ahead to the full-year 2018, we should expect a slight pullback. We doubt that the number of one-off large transactions seen in 2017 is likely to be replicated, especially given the pressure on supply and pricing. A 10% fall in full year volumes, in US$ terms, looks likely to us.
Saying that, though aggregate volumes across the region have flattened out, fundamentals remain solid. European office take-up was up 6% on last year and is a full 23% above the 10-year Q1 average. CEE was notably strong with take-up increasing by 73% in Q1.
When limited supply is combined with this strong demand, vacancy rates always come under pressure. The European office vacancy rate in Q1 2018 tightened by 30 bps last quarter to 7.0%. That’s the lowest level since Q2 2008.
In turn, rental growth continues to beat inflation. In Western Europe, Q1 2018 rental growth reached 4.7% against the year before. In CEE, prime rents were unchanged in Q1 following increases in Prague and Budapest in 2017.
It is this income growth that continues to underpin capital appreciation, which grew by 6.7% from 2017 for prime office assets across 30 major office markets in Europe. Capital growth for prime office assets in 2018 is expected to slow to around 4% for the full year, as rental growth moderates and yields flatten.
So looking through the numbers what trends do we see as we approach the halfway point in the year and what should we look out for through the remainder of 2018?
First, core markets are driving growth. At least for now, UK investors look to have shrugged off Brexit and the negative sale/asking price spread that ran through London in 2017 has now closed. Investment volume growth at 10% in Q1 is in line with Germany at 13%. Though saying that the economic growth profiles of the UK and Germany are very divergent. German GDP growth may moderate slightly to 2.4% in 2018 but at 1.8% the UK continues to trail.
Two, CEE remains very much in favour. One of the strongest performers in the region was Poland in Q1 2018, where volumes rose more than fourfold to US$2.4 billion. This bought total CEE volumes to US$3.8 billion, a 36% increase on last year. Major deals continue to get signed, driven by South Africans and in the retail space.
Third, broadly speaking global capital continues to chase European assets. The Americans, the Chinese, the South Koreans and the South Africans have all upped their investments in the region. Indeed almost 48% of Chinese outbound capital has gone into Europe over the last 12 months, against 16% for the same period last year. South Africa too is on the radar. South African investment in Europe in Q1 this year at $1.2bn is the highest level since Q2 2016 and the second time in two years that the country has made the top ten investor list in Europe.
Fourth, Europe remains awash with liquidity. Preqin reports that capital raised by private real estate funds increased by a third in Q1 2018 against last year and dry powder targeted at Europe now totals $62 billion. Liquidity is also increasingly concentrated in mega funds. Lone Star, Blackstone, AXA, Cromwell, PATRIZIA and TH Real Estate alone have raised over Euro 38 billion since 2013.
Fifth, disruptors are not going away. At $20 billion WeWork’s valuation is bigger than the 2017 GDP of 35 African countries, and roughly the same as Zambia’s. The company is now central London’s largest office occupier having leased more than 240,000m² of office space since 2012, that’s nearly double the amount google has leased. Apple, Alphabet and Facebook’s combined operating income of $107 billion is the same as the combined real estate investment volumes for the UK and CEE in 2017.
Finally, there are major challenges in the retail space with e-commerce continuing to pose questions. However, good assets, in the right location are selling and investors have selectively been expanding their holdings. Poland, for example, set a new record at over $2 billion in retail asset transactions in the first quarter of this year, with the South Africans playing a leading role. Portugal too had a record first quarter over $900 million.