European Fair Value Index

FORESIGHT
Real estate to enjoy longer
low interest rate regime
European Fair Value Index™ Q4 2015
9/2/2016
Contents
Overview
2
Drivers of Fair Value Index
3
Market in Focus: Warsaw
Retail
3
Cushman & Wakefield Fair
Value™ Methodology
4

Cushman & Wakefield's European Fair Value Index™ was 55 in Q4, down from
the Q3 published figure of 62 (Figure 1).

The number of attractive investment opportunities in European commercial
property has receded as yields have fallen and more markets have become fully
priced. Just 38 of the 117 markets included in our index were classified as
underpriced for Q4, with industrial continuing to be the most attractive sector.

Of the larger markets, Paris industrial, Madrid office and Frankfurt industrial show
as underpriced. On the basis of pricing alone, the five most attractive markets are
Riga industrial, Vilnius industrial, Riga retail, Antwerp industrial and Vilnius retail.

With Eurozone interest rates unlikely to rise until 2018 at the earliest we do not
expect any rises in prime property yields in core Eurozone markets until 2017/18.
Rather, we think yields will continue to edge lower in the near term in some
markets and that attractive investment opportunities will diminish further.

We expect the fair value index to level off around 50 and not to show the
precipitous decline that it did during the financial crisis. This is because we expect
reasonable growth in most economies to filter through to rent rises, rather than
the falls in rents brought about by the recession in the financial crisis.

This report reflects the position as at Q4 2015. Since then, though, the oil price
has hit decade lows, stock markets have fallen sharply, and worries about the
global economy abound.

Mario Draghi has signalled more monetary easing to come in the Eurozone in
March, which would be supportive of real estate investment. However, although
not our base case, the danger for property is that financial market turmoil is
followed by weaker growth in the economy and rental and income growth are hit.
Figure 1
Cushman & Wakefield European Fair Value Index™, Q4 2015
Author
Matteo Vaglio Gralin
Associate Director, Research
+44 (0) 20 3296 2308
[email protected]
100
More underpriced
markets
75
Contacts
Fergus Hicks
Global Head of Forecasting
+44 (0) 20 3296 2307
[email protected]
Magali Marton
Head of EMEA Research
+33 (0) 1 4964 4954
[email protected]
50
Q3 2017
25
0
2000
More fully priced
markets
2002
2004
2006
2008
2010
2012
2014
Q4 2016
2016
2018
2020
Source: Cushman & Wakefield Research
cushmanwakefield.com
FORESIGHT
1
European Fair Value Index™ Q4 2015
Overview
The all-property European Fair Value Index™ score for Europe
was 55 in Q4, down from Q3's published figure of 62. The
index measures the attractiveness of European property
markets on a relative pricing basis compared to government
bonds. It assumes a five-year hold period (a score of 100
indicates that all markets are underpriced for investors and
zero that all markets are fully priced, Table 1).
Industrial remained the most attractive sector in Q4, with an
index score of 77 and 57% of markets classified as
underpriced (Figure 2). Retail was the second most attractive
sector, with a score of 55, and 30% of markets classified as
underpriced. The office index score fell further to 40, well below
the 50 mark, and with only 16% of markets classified as
underpriced.
We expect the European Fair Value Index™ to decrease in the
short term as investor demand continues to push property
yields lower and attractive investment opportunities diminish.
The office and retail indices are both expected to bottom out
this year, while we expect industrial to reach its low only at the
end of the forecasting period. In several European markets we
expect yields to start to move out from 2017/18.
Of the 117 markets included in our European Fair Value
Index™, 38 were classified as underpriced for Q4, 53 as fairly
priced and 26 as fully priced. Compared to Q3, 19 markets
have been downgraded, just two markets upgraded, while the
majority of markets (95) saw no change in their Fair Value
categories.
Baltics, CEE and Eurozone Periphery regions have the highest
share of underpriced markets (Figure 3). Germany has the
majority of its markets classified as fairly priced, while the UK
still has 19 fairly priced markets, and is further ahead in the
cycle.
The two markets classified as fairly priced in the ‘other’
category are Moscow and Kyiv offices, both of which have high
return forecasts due to double-digit yields. However, downside
risks for these two markets are clearly high, particularly given
the drop in the oil price, and our fair value model may be overly
flattering them. Swiss markets continue to look unattractive due
to their very low property yields (between 3.0-3.5%) and weak
rental growth prospects.
Of the larger markets, Paris industrial, Madrid office and
Frankfurt industrial show as underpriced. In terms of pricing
alone, three of the top five most attractive markets for Q4 are
industrial; Riga, Vilnius and Antwerp. The other two are the
retail markets of Riga and Vilnius. According to our fair value
analysis, the top three markets are underpriced by 19% and
more, with Riga industrial the most attractive, being 23% below
fair value. However, the size of these markets would limit the
deployment of large amounts of capital to them.
cushmanwakefield.com
Table 1
Fair Value IndexTM scores
GEOGRAPHY/SECTOR
Q3 2015
Q4 2015
Europe all-property
62
55
Europe offices
46
40
Europe retail
62
55
Europe industrial
84
77
Source: Cushman & Wakefield Research
Note: Q3 scores refer to those published in the Q3 report; charts show revised
index scores, which may differ due to changes in property forecasts.
Figure 2
Cushman & Wakefield European Fair Value Index™
Office
100
Retail
Industrial
More underpriced
markets
75
50
25
More fully priced
markets
0
2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020
Source: Cushman & Wakefield Research
Figure 3
Number of markets in each category by region/country
1
1
2
3
2
38
5
5
19
10
8
8
4
4
12
Fully priced
10
6
53
5
4
4
1
Fairly priced
1
2
26
Underpriced
Source: Cushman & Wakefield Research
*Other includes six markets from Turkey, Ukraine, Russia and Switzerland.
Kyiv office has been added to the index this quarter, while Moscow retail has
been removed.
FORESIGHT
2
European Fair Value Index™ Q4 2015
Figure 4
Drivers of Fair Value Index
5-year government bond yield cycle
Fair total returns
25%
Fair/required total returns rose for some European markets this
quarter, driven by a higher illiquidity and risk premium
component that offset the fall in bond yields. The illiquidity and
risk premium in part depends on the spread between corporate
and 5-year bond yields, and is a proxy for tenant risk.
20%
European 5-year bond yields remain at very low levels,
supported by solid demand, boosted in the Eurozone by the
ECB’s QE programme (Figure 4). The length of the programme
was extended in December as inflation remains way below
target. Bond yields dropped in Q4 in several markets, with
Russia, Turkey, Italy and Spain seeing the biggest falls.
5%
The other two components of the fair total return in the model
(transaction and depreciation costs) are stable throughout time.
Forecast returns
2015 was a record year for European commercial real estate
activity and volumes surpassed 2007 levels. Yields fell in Q4 in
37 of the 117 markets covered in our European Fair Value
Index™. For those markets in which yields fell, the average
decline over the quarter was 22 bps.
We expect prime property yields to further compress this year
in several European markets, supported by strong investor
demand, a shortage of stock and the low interest rate
environment. From 2017-18, dependent on market, we expect
yields to move out gradually due to less favourable investment
conditions.
Reasonable growth in most European economies is forecast to
filter through to modest rent rises. For all the European
markets we cover in our Fair Value analysis, we expect rents to
rise by 1.5% p.a. over the next five years. Growth is pretty
similar across all three sectors (Figure 5).
min
max
Q4 2015
15%
10%
Swiss
Spain
France
Germany
Finland
Romania
Netherl
UK
Belgium
Sweden
Italy
Norway
Denmark
CZ Rep
Russia
Hungary
Ireland
Poland
Turkey
0%
-5%
Source: Bloomberg
Min-Max refers to Q1 2000 - Q4 2015 period
Figure 5
Prime rental growth (five years from Q4 2015, p.a.)
Simple Average
Min-Max
8%
4%
0%
Edinburgh
The Hague
Office
Retail
Industrial
Source: Cushman & Wakefield Research
Figure 6

Warsaw retail: fair and forecast returns



IndexTM
Ranked
overall in our Fair Value
for Q4,
Warsaw retail shows as underpriced by 7%.
The Polish economy expanded 3.6% in 2015 and is
expected to expand by 3.3% p.a. over the next five years.
Fair returns remained around 5.5% in Q4, in line with
previous quarter. A fall in the 5-year bond yield was almost
offset by a higher illiquidity & risk premium component.
Expectations for further yield falls this year and moderate
rental growth lead us to forecast prime total returns of
around 7.4% p.a. over the next five years, which outpaces
fair returns by a margin (Figure 6).
Berlin, Rome
-4%
Market in Focus: Warsaw Retail
31st
Dublin
Dublin
Madrid
15%
Fair return
Forecast
return
10%
5%
0%
Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
2011
2012
5 Year bond yield
Transaction costs
2013
2014
2015
Depreciation cost
Illiquidity & risk
Source: Cushman & Wakefield Research
cushmanwakefield.com
FORESIGHT
3
Figure 7
European office market Fair Value™ classifications, Q4 2015
Source: Cushman & Wakefield Research
Cushman & Wakefield Fair Value™ Methodology
The Cushman & Wakefield Fair Value Index™ was launched in August 2010 and covers 228 markets globally.
Fair value is the value at which an investor is indifferent between a risk free return and the forecast return from holding property,
taking into account the extra risk of investing in the property asset class.
When a property price is at fair value, an investor is being adequately compensated for the risk taken in choosing to purchase real
estate; similarly, when the property price is below the fair value price, an investor is being more than compensated for the risk taken
in choosing to purchase real estate.
When buying at or below fair value, an investor does not necessarily buy at the bottom of the market.
Our Fair Value analysis focuses on prime assets and a five-year investment horizon, and hold for the market overall; individual
transactions may provide opportunities and risks beyond the average market view.
In the report we compare results for the current quarter with those published in the previous quarter’s report, though the history of
the Fair Value Index does change as our forecasts change.
For more information please contact Matteo Vaglio Gralin: [email protected]
cushmanwakefield.com
FORESIGHT
4
EMEA
John Forrester
Chief Executive
+44 (0)20 3296 2002
[email protected]
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