Investment volume declined q/q by 12%

Investment volumes in Europe are following the economic development more than ever before. In 2Q11, transaction volumes in the European investment market declined by 12% q/q to EUR 25bn. Also, in a yearly comparison, the investment turnover is down by 3% from EUR 25.7bn in 2Q10. The annual prime yield compression continued in 2Q11, with the cities of Moscow, St. Petersburg, Bucharest and Kiev showing the strongest decline in CEE.

Investment volumes in the CEE property investment market reached EUR 6.9bn by mid-August 2011, which is 20% higher than the full-year figure of 2010, accounted for by roughly 120 transactions. The majority of investment turnover continued to be concentrated on the markets Poland and Russia, which account for more than 70% of total CEE investment. The Czech Republic is the third largest market in terms of property investments in the region and already reported volume growth of 50% until mid-August compared to the FY10 figure.In the office segment, investment turnover amounted to EUR 2.2bn in 1H11, mainly driven by transactions in Russia and Poland, which accounted for 75% of total volume. Even though there is still more than 50% of the turnover coming from local investors, cross-border activity is on the rise.

Retail segment with strongest rise in capital values

Among the three segments (residential, retail and office), retail properties observed the strongest growth in 2Q11 with 0.8% q/q and 3.5% y/y. The fast growing economies like Germany, Russia, Poland and the Nordics have witnessed increased turnover in the retail segment, while Southern European countries have seen only limited activity. Investors remain more cautious and are concerned about economic growth and the impact of austerity measures on consumer spending.

While capital values for industrial properties declined, the office segment reported a decrease of 0.3% q/q, but an increase of 2% y/y. Looking at the geographical level, the strongest sequential increase in capital values was recorded in the CEE region with +0.9% q/q (+3.5 y/y), followed by the Nordic region with +0.6% q/q (+4.4% y/y).

Office completion in the CEE capital cities reached a new low at a meager 460,000 sqm in 1H11 (vs. 2.1mn sqm for FY10), out of which more than half of the space was covered by Moscow. To estimate the future supply of office space, a look at the pipelines under construction provides a good indication. The capital cities in the CE region have seen a pick-up in new projects.

Regarding prime rents, the previous stabilization trend seems to be holding on in the European property markets. This is confirmed when looking at the EU15 Office Rent Index, which remained flat q/q in 2Q11 (+2.1% y/y), while the EU15 Industrial Rent Index showed only a minor decline of 0.5% (-0.1% y/y). The respective retail index even managed to increase by 1.7% q/q (+2.6% y/y), which was mainly due to rising rental levels in various cities in Germany, France, the UK, Finland and Sweden.

Outlook

Most real estate companies cannot take advantage of the persistently low interest rate environment, as they are hedged at higher levels. Both factors are still stumbling blocks to an improvement in ROE. “Reaching the pre-crisis levels of 10% ROE and P/BV parity seems unlikely to us, as these numbers were based on a strongly positive leverage effect and included high revaluation gains as well. We expect a bit higher revaluation gains at companies with fresh assets in good locations. Based on our new reduced estimates, a regression analysis of ROE vs. P/BV shows 15% upside potential until year-end and 25% until the end of 2012 (in addition to the dividend distributions)”, stated Martina Valenta, Real Estate Analyst at Erste Group. In Erste Group’s regression analysis of ROE vs. P/BV, real estate companies would have to reach ROE of 11% to reach P/BV parity. The average forecast ROE is 3.7% for the Austrian real estate companies and 1.9% for CEE developers for 2012. The 25% upside until year-end 2012 would translate into an average P/BV 2013e multiple of 0.6x at this point of time.