FURTHER YIELD COMPRESSION CONFIRMS THE POPULARITY OF CORE EUROPEAN MARKETS IN Q3
Some of the most expensive prime office markets in Europe saw further yield compression in Q3 2016, according to the latest information from CBRE.
Prime office yields fell by 10 to 30 bps in some of the major Swiss and German cities1 and in Paris. A 30 bps fall in Munich - where yields were already at just 3.6% in June - contributed appreciably to overall capital growth over the quarter.
These price movements with expensive property becoming more expensive, fit with our view that very low interest rates are continuing to push investors who are looking for fixed-income or near-bond like investments towards prime property. With 10-year German government bond yields still negative and 10-year euro swap rates at just 0.3%, investors see yields on prime offices attractive even if they are sub-4 per cent.
With markets expecting 10-year euro-swaps to still be below 1% in ten years’ time, and market expectations of future German inflation still below 1%, investors see no change in the European interest rate for the foreseeable future, reinforcing their desire to buy prime assets. At the same time, existing owners are generally under no pressure to sell resulting in prices being bid up and yields being pushed down to historic lows in the preferred locations.
Prime property is in demand as the income it produces is seen as resilient in the face of potential future economic shocks. German and Swiss cities are particularly liked because of their past record of economic stability and Paris for the liquidity and market depth that it offers.
In addition to the core German and Swiss cities and Paris, yields are also falling in two other distinct parts of Europe. Amsterdam and Brussels, which are not so keenly priced as some of the other cities have seen yields fall to new lows.
There are also signs of movement in Central Europe. So far in this cycle, we have not seen the rapid convergence of Central and Western European yields that occurred in 2005-7. The market was arguably mispricing risk in the earlier period and is now taking a more cautious approach. Nonetheless, prime office yields in Central Europe have been falling and at 5.4% are back to their end-2007 low in Warsaw and at 5.25% are very close to their 2007 lows in Prague. This still leaves Central European prime yields well above their Western European equivalents, where yields have all fallen to historic lows, and should give scope for further convergence as long as the current low interest rate environment continues.
Taking a slightly longer-term perspective, prime office yields have now fallen in 15 of the top 20 investment markets outside of the UK so far in 2016. The UK is an exception as Brexit-related uncertainty puts prices under pressure. In the majority of non-UK markets however, especially the German cities, the expectation is that yields will continue to compress in the coming months in an ongoing adjustment to the current low interest rate environment. This is not to say that the current cycle will never come to an end but market expectation is that there is still some way to go before the turning point is reached.