Prime office yields in Spain’s capital have closed the spread over Italy’s Milan for just the third time since 1991 and investors are likely to continue favouring Madrid, pushing its yield premium further into negative territory, research house Capital Economics predicts.
Prime offices in Madrid usually trade at a discount to Milan but yields in the Spanish city have fallen around 220bps since 2013 but less than 90bps in Milan, closing the gap and moving slightly in favour of Madrid, the latest Commercial Property Update said.“Given the stark difference in expected economic performance between Italy and Spain, we think that Madrid’s current premium will increase a little further yet.”
In the past two years quarterly GDP growth in Spain has averaged 2.9% y/y while Italy’s has been only 0.5%. Spain’s labour force has risen nearly 1.3m since the start of 2014 while Italy’s job creation has been around half that. The researcher forecasts GDP growth in Spain of 3.1% this year, slowing to 2% in 2017 and 2018 while Italy grows 0.6% this year before stagnating next year and staging a small recovery in 2018. “This should translate into stronger occupier demand in the Spanish capital, supporting higher rental growth than in Milan.”
Yields in Madrid were nearly 120bps over Germany at the start of 2014 while Milan’s premium was 50bps and although these “have narrowed to around 30bps they are well above the minus 100bps gap seen in 2006, suggesting that valuations in Madrid and Milan are not overly stretched in relative terms.” It said “with monetary policy set to be loose for the foreseeable future and yields back towards their 2007 lows, rental growth is likely to become increasingly important for investors.” Madrid does have a high vacancy rate of over 12% but it is closer to 6% in the prime CBD. Political risks could undermine investor confidence, as could EU sanctions if Spain misses its budget deficit targets but “until there is evidence that this might derail the recovery, we think investor perceptions will remain positive.”