Outlook 2017 - Property
Outlook 2017: European commercial real estate
Individual cities, rather than countries, should be the focus for commercial real estate investing in 2017.
- Continental markets should see rents rise
- Cities with diverse economies can thrive regardless of politics
- Brexit poses uncertainties for London but also opportunities
The last year has been dominated by two political events: the UK’s vote to leave the EU and Donald Trump’s election as US president. Both results reflect a growing concern that the majority of people are failing to benefit from free trade, globalisation, immigration and government austerity.
Moreover, populist parties are gaining ground in Europe, and while they may not win next year’s elections in France, Germany and the Netherlands, some of their policies are likely to influence mainstream parties.
What does this shift to isolationism mean for commercial real estate across Europe and real restate strategies?
London faces some opportunities as well as uncertainty
Starting with Brexit, the uncertainty over the UK’s future trading arrangements with the EU and free movement of people raises a question mark over London’s role as a centre for international business. On a positive note, several big US technology companies have re-affirmed their commitment to London, citing the city’s large pool of creative people with skills in IT and digital media.
Likewise, London is developing into a major hub for life sciences, helped by the UK’s leading role in stem cell research and by the recent opening of the Francis Crick Institute and Imperial College London’s new campus at White City. These factors, along with the talent pool, legal systems, time zone and established markets, continue to provide the UK with real competitive advantages.
However, on the downside, there is a real risk that some banks and other financial services based in London will lose guaranteed access to the EU and that some activities (e.g. trading in euro-denominated securities) will be switched to the continent.
If that were to happen, then the lawyers and other professionals who work with the banks would probably follow and the loss of highly paid jobs would affect London’s office market as well as retail, residential and industrial assets.
The risk of this may be heightened if negotiations with the EU were to stumble and the UK then faces the prospect of losing its privileged access to the single market – a so-called hard Brexit.
Continental cities will do well, but limited Brexit boost
The impact of the above is that Brexit could boost the demand for space in Amsterdam, Dublin, Frankfurt, Paris and other European cities. However, we expect the impact to be limited. In part this is because the investment banks will take a long hard look at their current operations in London and close those that are marginally profitable.
This arguably would have occurred without Brexit. Also, in part it is because financial services are likely to invest more in software robots and automated trading.
Trade wars and politics are potential risks
So what are the consequences of Donald Trump’s victory and the growth of populist parties across Europe? One outside risk is a damaging trade war between the US and China, with Europe caught in the middle. The US accounts for 15% and 22% of eurozone and UK exports, respectively.
A second potential risk is a political shock, such as a National Front win in France, which then leads to a jump in bond and real estate yields. Schroders’ central outlook is that long-dated bond yields in Europe will rise modestly by 0.5-0.75% over the next couple of years.
Neither the European Central Bank, nor the Bank of England is in a hurry to raise interest rates and probably most of the increase will be due to higher bond yields in the US (assuming Donald Trump keeps to his election promise to cut taxes and simultaneously increase infrastructure investment).
Under this scenario, we expect that European real estate values (and yields) will be broadly flat over the next couple of years. This is because the current gap over bond yields at 4% is well above its long-term average of 2%. Also, most continental markets should see an increase in rents, assuming the eurozone economy continues to grow.
Focus on “winning” cities with diverse economies
How should real estate investors proceed? One response might to be to adopt a national model and avoid countries where populist parties are likely to take power. However, the difficulty with this is that it is a blunt approach. Opinion polls can be unreliable and investors might be left with a very small set of markets (e.g. Germany, Ireland).
An alternative strategy, which we favour, is to focus on those cities which have diverse economies, strong universities and good infrastructure. These cities are likely to continue to attract businesses, almost regardless of politics. They are centres where people wish to live and work.
In the UK, we prefer office and industrial assets in Brighton, Bristol, Cambridge, Leeds, Manchester, Oxford, Milton Keynes and Reading. We also continue to monitor the London office market and are ready to invest in a small number of specific locations. On the continent, we favour Amsterdam, Berlin, Brussels, Hamburg, Lyon, Madrid, Munich, Paris, Stockholm and Stuttgart.
The opinions contained herein are those of the author and do not necessarily represent the house view. This document is intended to be for information purposes only. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Cazenove Capital Management does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. This does not exclude or restrict any duty or liability that Cazenove Capital Management has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Cazenove Capital Management is a trading name of Schroder & Co. Limited 12 Moorgate, London, EC2R 6DA. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. For your security, communications may be taped and monitored.