Low level demand continues

The European real estate market has slowed, but it is well positioned for a recovery.

First quarter data for European office markets was better than expected. In some cities rents rose and rates of take-up were excellent. But is too soon to start hanging out the flags. Undoubtedly, rents have increased in certain areas, mostly notably central Brussels. Here, relatively fixed supply coupled with increasing demands for space from the EU as it heads for expansion in 2004 saw prime rents rise by 10 per cent year-on-year. And take-up was up in several locations, albeit from a weak base. Central Paris even showed an unexpected fall in vacancy rates.

However, to an extent, the relative strength of the first quarter merely reflects occupancy decisions postponed from 2002. Real estate recoveries generally lag macroeconomic recoveries and, in Europe at least, the latter looks further away than ever. Although the slowdown in growth is much less pronounced than the “short sharp shock” recession of the early 1990s, the extended period of below-trend growth this time around now looks set to last longer than anyone expected two years ago. Although for many markets a protracted period of below-trend growth may ultimately produce the same result as a brief recession (in terms of unemployment, for example), this is not true of real estate markets, where supply has a chance to react during a prolonged slowdown. This is exactly what has happened, with the new office supply pipeline in Europe in retreat every quarter since summer 2001. This in itself is not enough to generate a turnaround while demand remains weak; but once demand does start to recover, it means that European office markets will be in a better position to respond than they were after the last downturn in the early 1990s. Investment inflows Nevertheless, it remains the case that real estate investors will continue to rely on strong capital inflows rather than occupier markets to see them through the period of weaker economic growth. Investment in real estate hit a record high in 2002 as investors fled from equities, pushing down income yields and keeping capital values flat despite weak occupier markets. As a result real estate was the best-performing major asset class across Europe last year. Turnaround hits Although there have been hints in early 2003 of a stock market turnaround, inflows to real estate remain in good shape. For example, German open-ended funds received €8.8bn of new cash to invest in the first four months of 2003 alone. Going into 2004, we would expect to see the first rental recoveries in office markets. These are likely to be concentrated in cyclical markets such as Stockholm, and those where supply is constrained such as central Paris or Lisbon. However, it will not be until 2005 that European occupier markets in aggregate start to show enough rental growth to generate buoyant returns without the support of new investor money. A critical question is therefore whether the new-found enthusiasm for real estate can last long enough to keep the asset class afloat while occupier markets adjust. It could be a close call. Nick Tyrrell is head of real estate research Europe at DB Real Estate

The above is condensed from the introduction to DB Real Estate’s bi-annual report “European Real Estate 2003/I”, which will be published in mid-June. For a free copy email nick.tyrrell@db.com or visit www.dbrealestate.com

'The extended period of below-trend growths this time around now looks set to last longer than anyone expected two years ago'
Nick Tyrell, DB Real Estate