Real estate in southern Europe is about so much more than just Rome and Milan, Madrid and Barcelona. Or is it?
As a geographic descriptor, southern Europe stretches from the Atlantic coast of Portugal and Spain in the west to the Aegean Sea of Greece in the east. For our purposes here and for most real estate people who have the term in their job title, southern Europe covers just Italy, Spain and Portugal. Although France and Greece are both in southern Europe and are of topical interest — for wildly different reasons, although both of deep significance for the future of the European Union and the euro zone — those countries are not the subject of this article.
Italy and Spain are both large euro zone economies — after Germany and France, they rank third and fourth for GDP, respectively — that suffered in the global financial crisis and the euro zone sovereign debt crisis that followed, principally through the danger of contagion from Greece’s debt issues but also from economic recession, falls in business activity and sentiment, the imposition of austerity measures, and horrible rises in unemployment levels, especially among the young.
The similarities largely end there, for Spain took action and pulled itself up while Italy remains mired in relative political turmoil, economic sclerosis and financial inaction, seemingly unwilling or unable to dig itself out of the hole it finds itself in. Spain has seen recent years of 3 percent plus annual GDP growth, reductions in unemployment and a return of investor and consumer confidence, and is recovering. Italy has not.
Compelling fundamentals
The IMF’s recent World Economic Outlook report, published in April to coincide with the IMF’s Spring meeting in Washington DC and titled Gaining momentum?, showed that “global economic activity is picking up, with a long-awaited cyclical recovery in investment, manufacturing and trade.” The report said that world growth is expected to rise from 3.1 percent in 2016 to 3.5 percent in 2017 and 3.6 percent in 2018.
Those numbers, higher than the IMF’s last report, are global averages and mask the range — China, for example, is on course for GDP growth this year of 6.5 percent.
In Europe, the growth picture is not so upbeat — but it has been worse and evidence is now emerging that the euro zone has also started, finally, on a period of economic growth that augurs well for the fundamentals that real estate investors look out for. Although the latest inflation statistics from Eurostat show that euro zone inflation fell to 1.5 percent in March, from 2.0 percent in February, no euro zone members are now in a deflationary environment, which brings its own dangers.
Estimated final GDP growth numbers give a euro zone outturn for 2016 of 1.7 percent — the numbers for Italy and Spain point to the different situations in those two countries, with Spain seeing growth of 3.0 percent last year and Italy only 1.0 percent; Portugal, at 2.0 percent, straddled the other two countries. (The highest GDP growth in the European Union last year was in Romania, with 4.8 percent; bizarrely, Romania also had the lowest inflation in March, of 0.4 percent.)
Eurostat’s GDP per capita numbers also tell an interesting story. Whereas in 2015 — the last year for which full data is available — GDP per capita across the EU was €28,900, in Italy it was €27,100 and in Spain €23,200, showing that the two countries were lag- ging behind. On a purchasing power basis, the three numbers were €28,900, €27,800 and €25,900, respectively, throwing up some interesting questions but still showing the two countries as being behind the EU average.
In common with most countries, the major cities have a higher GDP per capita than the country as a whole — Italy’s northwest region, covering Milan, for instance, has €34,200 and in Spain Madrid has €35,400.
Nevertheless, the combination of a return to normal levels of inflation — an oxymoron, perhaps, but preferred to deflation or near-zero inflation as it pushes the buttons that encourage other activity — and sustained economic growth is helping bring about a self-fulfilling situation of higher levels of business activity, reduced unemployment, uplifts in retail spending and improved consumer and business confidence across the euro zone, and Italy and Spain as locked-in and mutually beneficent members of the euro zone should soon see the rewards.
Part of the investment mix
Domestic investment activity is one thing but cross-border activity is better as it is taken as an effective barometer of investor interest in a real estate market; these are people who want to invest in a foreign market and have found a reason to do so. According to BNP Paribas Real Estate, commercial real estate investment volume across Europe last year was €230 billion, a fall of 10 percent on 2015. €109.8 billion of that was cross-border investment.
While that portion represented a higher fall of 19 percent on the year before, Etienne Prongue, head of the International Investment Group at BNP Paribas Real Estate, points out that “one of the strengths of the European commercial real estate market has been the amount of capital moving in between markets and flowing into Europe.” After peaking in 2015, the share of cross-border investment dropped to 48 percent of the total in 2016, says Prongue, “but, at nearly €110 billion, it is still the third highest amount in the last 10 years.”
While Europe’s three main markets — France, Germany and the United Kingdom — predictably attracted the largest shares of foreign investor activity, both Italy and Spain saw 5 percent shares, or €5.5 billion each. That’s a healthy measure of foreign investor interest.
Implementation brings benefits
Economic growth is always a magnet for real estate investors. Although Spain’s has come from a low base, its economic growth of recent years has been followed by investors, initially of the opportunistic kind and more recently of the more mainstream kind. “Spain has always been of interest to non-European investors,” says Nathalie Charles, head of asset management and transactions, south- ern Europe, at AXA Investment Managers – Real Assets. “Sometimes that interest has been purely theoretical, depending on the point in the cycle, and sometimes — like now — that interest is real.”
“It’s a great time to be here,” says Brian Betel, head of Spain for ActivumSG. “There are tremendous opportunities. We have been helped by the return of financing departments, and that has been underpinning transactions, supported by the return of the capital markets.”
“It helps,” says Marta Cladera de Codina, head of Spain at TH Real Estate, “that Spain is experiencing high GDP growth, higher last year than Germany, the United Kingdom, France or Italy. And the government expects this to be maintained. We are on the right track.”
“A lot of it is in the eye of the beholder,” says John Thompson, director at Rockspring Iberia. “Clearly, the fundamental reason why there are so many investors of all shapes and sizes in Spain already, with new investors coming in seemingly every week, is that they see something that is attractive to them.”
“We were one of the few countries in the EU to implement the necessary measures to stabilise the country,” Cladera de Codina continues. “We cleaned the banking sector, something that other countries — like Italy, for example — still have not done. And we brought unemployment down. It’s still high at 18 percent but it’s coming down. There is trust in the economy, in the country, because we implemented the measures,” says Cladera de Codina.
A good spread
In Spain, the recovery has seen that real estate investment interest move from the normal activity in the two main office markets of Madrid and Barcelona to High Street retail, retail park and shopping centre activity in regional cities across the country and logistics facilities serving those centres and the slow-burning e-commerce market. Increasingly, too, investors are focusing on alternative real estate like student housing and hotels.
“Spain is one of the most dynamic economies in continental Europe,” says François Rispe, managing director at Prologis and regional direc- tor for southern Europe, “and that has been the case for the past two or three years. We often talk about central Europe being the backyard of Germany for manufacturing but I think that Spain is also the backyard of Europe for the same reason. It is Europe’s fifth-largest economy with commensurate consumption and affordable labour, factors that drive favourable risk-adjusted returns in real estate and manufacturing.”
“Certainly,” adds Thompson, “in the 22 years that I have been here I have never known a market with such a breadth and depth of investment capital looking for a home in Iberian real estate as now.”
“We often talk about improving market conditions in Hungary, Slovakia or the Czech Republic,” Rispe continues, “but actually Spain is in the same spot. It probably has more potential because its economy is stronger. Spain is one of the largest exporters in Europe and the growth rate of exports out of Spain has been quite significant over the past few years. This generates real estate demand, not only in the office and retail sectors but also in logistics. All the ingredients are there for a good story for real estate investors.”
The potential for rental growth is recognised. “We have still not got to where rents were pre-crisis,” Cladera de Codina points out. “We manage 1,000 leases, across more than 300,000 square metres of shopping centre space, and we see the sales figures. Sales are increasing every month and so there is the potential to increase rents.” “Five years ago, Spain was at a 10-year low in investment volume terms,” says Antonio Roncero, head of transactions for Spain and Portugal at CBRE Global Investors. “After the strong recovery over the past five years, we are at about the same level as we were at the peak in 2007.
“The attractiveness of the market is clear,” Roncero adds. “There is political stability now in Spain and the economy is resilient, with an ability to overcome difficult situations. As for investment in offices, I would rather concentrate on the big cities; that is an asset class that is more driven by the city itself and its economic strength rather than by anything else.”
City dynamics overcome perceptions
“There are differences between Italy and Spain,” says Mario Pello, head of Italy at TH Real Estate, “but there are also some similarities.” Pello points to the rental growth perspective. “Italy’s potential for rental growth is higher than average,” he says, “and there is also a premium on yield, a higher income return.” Pello concedes that Italy’s political uncertainty and less robust economic development are reasons for the yield premium.
Pello also points to the rationale for city investing. “It is quite clear to everyone that investing in Milan does not mean investing in Italy;” Milan’s GDP per capita is almost double that of Italy’s, he says.
Italy has a renowned north-south issue and many investors will not venture south of Rome. “But in retail many shopping centres in southern Italy perform better than those in northern Italy,” says Pello. “There is a lower concentration of shopping centres in some regions and the spending habits of inhabitants of southern Italy are very strong, so shopping centres there are outperforming.”
“Italy requires you to be selective more than other countries,” Rispe comments. “Italy is not easy to understand. The market is less transparent, so you need people on the ground to understand how things work and where to put your money. You need to be a bit more careful than in an average European country.
“Once the above is taken care of, there are good opportunities in Italy as it is still the third- largest economy in continental Europe. You don’t see the same micro dynamics as in Spain but you still have catch-up potential,” Rispe adds.
Charles points out that the Italian market differs from the Spanish market as a large proportion is not institutional, being dominated by private mid-sized companies that have their own real estate investment entities. “Italy and Spain are very different,” says Charles. “Spain is more global, more institutional and more attractive to investors, while Italy requires more local knowledge.”
For Francesco Coviello, head of southern Europe at LaSalle Investment Management, it is the resilience of the major cities that attracts investors. “If you look at the real estate fundamentals in the cities that we are targeting, cities like Milan, Rome, Barcelona and a few others, they are very resilient despite the economy of the country. Their economies have always worked. Sometimes the perception is more negative than the actual economy.”
Coviello says that investor types have also changed through the cycle. Core investors stepped back a bit when things were bad, core-plus and value-add investors then became more active but core investors are now being attracted again by the improvements in economic fortunes and spend- ing patterns. Coviello agrees that office investment in Italy is Rome and Milan — “more Milan than Rome” — but there is significant interest in retail, and that interest goes across regional cities. “Retail is a different story,” he says.
LaSalle recently purchased a logistics facility in Milan that was its first buy in Italy for 10 years. Why now? “It was a good deal and we have a couple of European funds that are targeting Italy. On top of this, there’s a strong recovery in the logistics sector,” says Coviello. “An investment in Madrid or Barcelona, Milan or Rome, given investor appetite and the cities’ historic fundamentals, in the long term is never a bad investment,” he adds.
Portugal, also with twin-city syndrome in the shape of Lisbon and Porto, isn’t getting much of a look-in here. “It’s a small market and in poor shape compared to Spain,” Cladera de Codina points out, “but if you look at retail it’s better than anywhere else in southern Europe or even France. Portugal has probably two or three of the best retail or shopping centres in southern Europe, including France. You need to explain properly to investors why investing in Portugal can work; investors would be amazed about how well certain shopping centres in Portugal are trading.”
Always on the radar
David Jackson, director of fund management at M&G Real Estate, explains that funds with a pan- European focus will always have southern European countries on their radar. “We have a set tactical allocation strategy. We had virtually no exposure to southern Europe through the global financial crisis and were heavily overweight in northern Europe. As the cycle has evolved, we shifted that tactical position as we began to see recovery in the southern European markets, prin- cipally Italy and Spain, and began to increase our weight in those markets. A balanced fund has a broadly diversified exposure as one of the key objectives.
“One of the reasons we have come back into Spain and Italy, in particular, is because of where they are in the cycle,” says Jackson. “In Madrid, Barcelona, Milan and Rome we are now seeing recovery and rental growth, particularly in the Spanish markets. We’re sticking to core, prime, liquid markets where rental growth is most in evidence, and we’re looking to take advantage of good rental growth over the next four to five years.”
“It sounds obvious,” Thompson adds. “Investors can be as sophisticated and clever as they like with underwriting, cashflows and assumptions, but the lion’s share of successful property invest- ing is basically getting your timing broadly right and being sensible about your pricing relative to the yardstick of comparison, to historic pricing.”
It’s all about fundamentals, see?
Source: IRE Europe