London: European commercial property prices may fall as much as five per cent in response to last month’s signals that the US Federal Reserve is likely to rein in its support for the economy later this year. For European property markets it will slow what was already a patchy recovery as the sovereign debt crisis continues to depress business sentiment and tenant demand.
“Property is priced for sustained stimulus,” said Jefferies analyst Mike Prew, who downgraded six British property stocks including British Land, Hammerson and Land Securities for this reason. “Ending QE is like passing the baton to the last runner in an Olympic relay race and in this case it will be dropped.”
One result of the Fed curbing its stimulus measures is rising bond yields, which means investors typically demand higher yields to own property, a riskier asset because it is slower and more expensive to buy and sell and risks vacancy.
Bond yields have already risen in Europe in anticipation of QE ending though property yields take longer to follow suit as changes are reliant on valuers, a method based on more subjectivity and backwards-looking deal evidence. Either way, small changes would have a big impact on prices.
An office block with rental income of €5 million (Dh23.5 million) at a yield of five per cent makes the building worth €100 million. At a yield of six per cent, it is only worth €83 million.
At a time when most of Europe’s major economies are either in recession or still struggling to get back to healthier growth, rental prices for offices, shops and warehouses are unlikely to rise any time soon — making a boost for property values from that side unlikely.
Prew forecasts UK property yields will rise 25 basis points, giving an average three per cent fall in prices over the next year if rents stay flat, versus the three per cent rise he forecast at the start of 2013.
Chris Simmons, founder of research company Real Estate Forecasting, expects a similar rise in Europe, which means a five per cent fall based on a five per cent yield and countries with weaker economies and rental demand like Spain and France at most risk, he said.
European commercial rents are lagging other parts of the world. There was no European city in the top 15 locations for annual rises in office occupancy costs, a measure largely driven by rents, in the first quarter of this year, according to data from property consultant CBRE.
With some exceptions like London’s insurance district, companies have tended to stay put rather than move to new offices while the market in malls and high-street shopping units has been hit by the failure of a number of major retailers.
JPMorgan analyst Harm Meijer said his price targets for European property stocks would fall by an average 13 per cent if UK 10-year bond yields rose from the current level of 2.4 per cent to 3.5 per cent in the absence of rental growth.
“The picture is worse in continental Europe than the UK due to lack of rental growth,” Meijer said. “In Holland you still have some cities building malls,” he said, referring to the negative effect of excessive supply on real estate rents.