Lower government bond yields have been the influential driver of office yield compression across Europe’s markets, which has had a huge impact on the lending community across Europe, according to Savills latest research. Lending rates to CBD offices have dipped below 1.5% per annum on most of Europe’s core cities, with c. 60% loan to value (LTV) ratios on offer for investors. As a result, €69.4bn of global equity was raised in 2018 for non-listed European real estate, according to INREV. This is the highest number recorded over the last seven years.
Nick Harris, Head of European Cross Border Valuation, Savills, said: “Back in 2013, 10-year German bonds were yielding 1.6%. We have since witnessed a steady decline in bond yields to 0.4% at end 2018 and these lodged into negative territory in H2 2019. During this time, annual European real estate investment rose from €173bn to €297bn, as multi-asset class investors shifted their focus from fixed income to real estate. There remains a substantial weight of capital – both in equity and debt form – still to be invested in European property.”
The sectors which have seen the strongest increase in investment on the previous five years are those where long-term ‘bond type’ income is generally more common, including within the hotel sector (+132% on previous five years), industrial sector (+142%) and the alternative sector, which, amongst others, includes multifamily, senior living and student accommodation (+143%), according to Savills (see Chart 3).
Mike Barnes, Associate, European Research, Savills, said: “We expect traditionally ‘alternative‘ sectors such as multifamily, senior living and purpose-built student accommodation to come to the mainstream as investors increasingly search for a long, secure income. The weight of money targeting European real estate will keep yields low for the foreseeable future and we feel that the underlying risk of holding property ahead of bonds has not materially changed, which will continue to keep the yield spread with bonds stable. Rental growth, rather than capital growth, will be the main driver of returns in 2020.”
Drazenko Grahovac, Head of Valuation Europe and Managing Director Savills Germany, commented: “Given negative government bond yields, multi-asset managers will increasingly consider the property risk premium against holding cash, rather than government bonds. With debt so comparatively cheap across Europe and office occupational markets remaining tight, we believe there is an opportunity for property companies willing to take on development risk to secure long income and sell on to institutional landlords. We do not expect an interest rate rise in the short-time, especially given how interest rate swaps have recently developed.”
Savills forecasts office yields to move in over the next 12 months in Belgium, Czech Republic, France, Greece, Italy, Romania, and Sweden due to resilient investor interest. This has been supported by strong rental growth forecasts of 3.8% for the full year across Europe’s CBD offices, although some softening of yields is expected in the UK and Portuguese office markets.