Market recovery sets in across Europe…

Volumes will Increase in 2010

€24.6 billion of commercial real estate was transacted in Q4 2009, more than double the €11.6 billion in Q1 2009 and 50% more than the turnover in Q4 2008. A strong final quarter of the year is typical as investors try to place capital before year end—although this had not been seen for the last two years when volumes declined for seven consecutive quarters between Q2 2007 and Q1 2009. Volumes for the whole year were down around 38% on 2008 figures at €69.2 billion, just below levels last seen in 2001.

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Jones Lang LaSalle’s outlook for 2010 is for volumes to increase by between 20% and 30% on 2009 taking the market to around €85-90 billion. This will be fuelled by an improvement in the availability of debt, the recognition that pricing has probably hit or even passed its floor, slightly more appetite for risk taking and more assets coming to the market particularly from banks.
If in 2010, the market does reach these levels it would still be a low number in historical terms—roughly 2002 levels. The reason for volumes recording a gradual rather than abrupt recovery will, we think, be the continued focus by investors on a narrow band of core, income producing prime assets in all but a minority of cases. A weak economic outlook sets the backdrop for difficult occupier markets almost everywhere, and despite some markets seeing some recovery in prime rents, caution and risk aversion will remain key themes in the market in 2010 for investors and occupiers.

Yields Fall and Capital Values Move Up

Although volumes remain at historically low levels, a concentrated wall of capital chasing a limited number of investment opportunities has led to yield compression in several prime markets. The UK has seen the bulk of this movement with yields compressing in almost all markets and across all sectors; yields in London West End offices have moved in 125bps since their ceiling in Q1 2009, and have consistently outperformed forecasts. Although the UK has largely been driven by international investment, German offices have shown that yield compression can also be driven by domestic investment, although to a lesser extent: yields compressed in Frankfurt (-15bps) and Hamburg (-15bps) in Q4 2009.

Compressing yields in some markets combined with rents which are approaching the bottom of the market in others, resulted in upward movements in all of Jones Lang LaSalle’s Capital Value Indices in the final quarter of 2009. The European Office Index moved up 1.1% on the quarter, high street retail +4.8% and distribution warehousing +1.0%. Our expectation is for prime rents to remain under pressure in 2010 (although some markets may buck the trend), but broader yield compression will mean capital values will record minor positive year-on-year growth.

Larger Lot Sizes Will Continue to Increase During 2010

As well as increasing volumes, the second half of 2009 also saw an increase in larger deals driven by a combination of an increase in the availability of debt for these transactions and more creative deal making, including club deals and joint ventures. Some investors who are able to transact at larger volumes had been taking advantage of less competitive bidding and discounts for larger lot sizes—however, the price premium for smaller lots sizes is already starting to narrow. In London City, for example, the yield spread between the largest and smallest lot sizes has narrowed from 75bps a year ago to zero today. More recently several large, equity rich investors, including institutions and international wealth capital, are again valuing the ability to place large volumes of capital in a single transaction.

Deals over €50 million have seen a steady increase since Q1 2009, driven higher in Q3 by the two €1 billion deals. Of the almost 100 deals over €100 million completed in 2009 almost 75 were closed in the second half of the year and 40 in the final quarter. The second half of the year also saw the return of the €1 billion plus deal with two significant transactions: the sale and leaseback of a portfolio of bank branches in Spain and the sale of a 50% share in the Broadgate Estate in the UK. Both transactions highlight the complexity of putting together deals of this size in today’s market. We see a continued improvement in deal making and the availability of debt which ill translate into more large deals in 2010. Banks in particular will look at innovative ways to extract value from their distressed loan books which could be a source of larger deals in 2010.

International Capital Remains Concentrated but its Focus is Expanding

During 2009 domestic investors increased their share of total investment activity for the second year in a row, although inter-regional investors, those who invest from outside the EMEA region saw their share grow. Total cross border investment now makes up less than 50% of total transaction activity down from a high of 63% in 2007. Moreover, cross border investment typically involved foreign vendors selling to domestic purchasers. For example, cross border activity represented 52% of deals in Italy, yet 74% of purchasers were domestic. Across the region in 2009, just 37% of deals involved a foreign purchaser, compared with 47% in 2008 and 57% in 2007.

The decline in cross border investment masked a concentration of international capital in a small number of markets. The UK which attracted over 50% of all inward cross border investment flows saw purchasers from over 50 nationalities make up 54% of the purchasing activity; cross border investment flows picked up rapidly in France towards the end of the year, focussed on Paris, with cross border volumes increasing almost 100% on Q3 and 350% on Q1 levels—albeit from low levels; a small number of large, opportunistic deals also ensured Spain remained a cross border destination; and CEE markets continued to attract a significant share of foreign investors and in total attracted the fourth largest share of cross border capital. The focus of international capital will widen in 2010 driven by increased confidence in the recovery and movements in relative pricing.

German Funds and Global Capital Dominate Cross Border Capital Flows

The most active cross border investors across the continent were those who source equity from global indirect investors (and was responsible for the two largest deals of the year) followed by German investors. German investors continued to be the most diversified group buying assets in 19 countries across Europe compared with investors who source their capital globally who concentrated 80% of their investment volumes in the UK and Spain—two of the markets where pricing had moved out the most. Although German and globally sourced capital combined represented almost 55% of inward cross border activity, a long tail of over 50 other nationalities demonstrates the continued geographical diversity of interest in the sector. Into 2010 we expect more investor groups to become more wide ranging in their focus and for countries to begin to attract a more diversified purchaser base than in 2009.

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