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Yield Compression – falling returns, rising purchase prices: Where are we headed?

Tom Leahy
Director of Market Analysis at Real Capital Analytics

We are definitely at a really interesting point in the cycle. After such a strong year in 2015, when more than 320 billion Euro was spent on European real estate, we have seen a slowing in the first three quarters of 2016. Clearly some of this was related to the build-up to and outcome of the Brexit vote, but we are also at a mature stage in the cycle now. Prices are high, economic growth in Europe could be starting to falter, and there are political, economic and financial risks aplenty, both at home and abroad.

However, investment returns are being driven by central bank activity and the extended period of low rates and QE, and in this low rate environment property’s trump card is the positive income return it provides. So, in a world where there is 13.4 trillion US dollars of negative yielding bonds outstanding, income-returns of 3-6 percent from European real estate look very attractive. In a relative world property looks relatively good, notwithstanding the fact that it is historically expensive in many markets. This is why investors are still allocating to European real estate and why demand will remain high.

Buyers though are being much pickier than they were during the peak of the last cycle in terms of location and quality of property, therefore we aren’t seeing a big expansion into secondary and tertiary properties and markets. This might change as the pressure to deploy capital grows, but for now this will limit transactions volumes to below that peak level we saw last year.

In the UK, the uncertainty from the Brexit vote has probably brought forward the end of the cycle, but the full impact from the vote, whatever it might be (in the UK and the rest of Europe), will only be seen over the long term, when the political settlement has been agreed and enacted. In the rest of Europe, a period of consolidation is likely in the core markets, with growth in volumes more likely in less mature like Italy, Benelux and some central and eastern Europe markets. In terms of segments of the market likely to do well, student accommodation, private-rented housing and logistics all look well set.

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