Real estate will continue to look relatively attractive compared to other asset classes but are at the end of the upward cycle
The European economy enjoys strong growth, but investment real estate markets have advanced in the cycle and it is becoming more and more difficult for investors to find value, says the online property-magazine.eu.
According to forecasts, if the region continues to grow at the current pace, it will probably reach full economic capacity by the end of 2018. Until then, inflation has to remain subdued in order for the European Central Bank (ECB) to normalize monetary policy.
Real estate will continue to look relatively attractive compared to other asset classes, which will lead to further investment activity. By the end of 2018 or early 2019, however, the ECB is likely to increase interest rates from its current historically low levels.
"Given that we are at a later stage in the investment cycle, investors have to follow several correct rules: focus on assets in places that will enjoy sustainable demand and avoid property in structurally weaker to look for cities with a diverse local economy, healthy demographics and a high share of intensive employment that should remain relatively sustainable against the background of automation growth, "said Aviva Investors.
The report summarizes three forecasts and key trends that will shape European real estate markets next year.
The first is that rent growth will continue. Retail sales are strong and industrial output is increasing. The PMI index in the euro area rose to 60 points in November 2017 - the highest level for more than 17 years. These trends are likely to stimulate the rising demand for tenants in 2018.
At the same time, there is an increasing shortage in supply. The proportion of vacant office space is down to almost pre-crisis levels.
Expectations are that rent growth will moderate after 2019 due to the projected increase in supply at that time.
The second forecast is related to investor profits - this year it will probably be the last one with such record profits, as Aviva Investors' five-year outlook shows. According to the forecast, the total return on investment in commercial properties this year will reach 6.7%, but the average annual return will be much lower between 2018-2022 - 2.6%.
It would be sensible for investors to consider selling weaker assets in the next 12 months, especially assets that are in markets that are likely to be weaker in the next round of the cycle.
Investors should avoid high-risk properties as well as curb the use of debt as declining returns on capital and rising borrowing costs will reduce return on investment over the medium term.
Property debt, however, is likely to offer better risk-adjusted returns than capital investment, as it will protect investors from the impact of the downturn.
Top-class commercial and industrial properties are expected to perform better than offices. The selected markets will offer value to investors with medium-term investment horizons in 2018. The main industrial assets in Belgium, France and the Netherlands remain attractive on the basis of the adjusted risk.
Improvements in production, coupled with structural trends such as the growth of e-commerce, lead to solid and sustainable demand for high-quality logistics space by tenants. The sector also offers relatively high returns.
Of course, there are risks to the outlook. The first is linked to the possibility of a stronger growth in yields on bonds. This will erode the relative attractiveness of real estate and cause investors to turn to other classes of assets.
The other risk is related to the rapid increase in supply. The future supply of offices in the period 2018-2022, for example, exceeds the average long-term on a number of markets.
At relatively high capital values and declining supply, investment in projects in the property sector appears to be favorable. Data shows that banks are more likely to take a higher risk and lend to builders and investors. This, however, pushes fast construction and may have a negative impact on rental growth.