DTZ Foresight Europe Fair Value Q Germany and UK holding firm

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1 Germany and UK holding firm 29 May 2012 Contents Fair value highlights 2 Economic context 3 Market classifications 4 Office market forecasts 5 Retail market forecasts 6 Industrial market forecasts 7 Authors Ben Burston Forecasting & Strategy Research +44 (0) ben.burston@dtz.com Charlie Browne Forecasting & Strategy Research +44 (0) charlie.browne@dtz.com Contacts Matthew Hall Head of European Forecasting +44 (0) matthew.hall@dtz.com Tony McGough Global Head of Forecasting & Strategy Research +44 (0) tony.mcgough@dtz.com Hans Vrensen Global Head of Research +44 (0) hans.vrensen@dtz.com The DTZ Fair Value Index TM score for Europe stood at 46 at end Q1 2012, representing an increase from Q4 when the score stood at 36. The score has increased due to an upward revision to several core markets in response to their more attractive pricing relative to government bond yields which continued to fall during Q1, partly owing to the impact of the ECB s LTRO. The number of HOT markets has increased to 18 this quarter, from only nine markets in Q4. With 72 of the 98 markets in the Index coverage rated HOT or WARM, we consider that prime property is providing investors with a relatively attractive proposition in a troubled economic climate. Our results for this quarter reflect the much wider yield premium offered to property investors in core markets relative to recent experience (Figure 1). Investors fleeing to the safety of government paper in would do well to consider selective investment in prime property, and this widening premium has resulted in upgrades to German, UK and Nordic markets over the past two quarters. The weak European economy is feeding through to our yield forecasts. The subdued growth outlook means that base interest rates will remain low for longer than previously anticipated. This will lower bond yields in the medium term, prolonging the current low interest rate environment that is underpinning below trend yields. As a result we have revised our forecasts this quarter. London is expected to lead the way in terms of rental growth across Europe over the next five years, with London West End, London City and London Midtown all forecast to experience average growth of p.a. or above. Strong rental growth in London is supported by a lack of new supply and more resilient occupier demand than in other European centres, with UK GDP forecast to grow by 0.3% in 2012 while the eurozone sees output fall by 0.. Figure 1 Comparison of selected prime property yields and German bond yield 2% German 5 year bond yield Frankfurt retail Copenhagen retail Helsinki retail 1

2 Fair Value highlights Fair Value Index Q1 overview The DTZ Fair Value Index TM score for Europe stood at 46 at end Q1 2012, representing an increase from Q4 when the score stood at 36 (Table 1). The score has increased due to an upward revision to several core markets in response to their more attractive pricing relative to government bond yields which continued to fall during Q1, partly owing to the impact of the ECB s LTRO. The number of HOT markets has increased to 18 this quarter, from only nine markets in Q4 (Figure 2). With 72 of the 98 markets in the Index coverage rated HOT or WARM, we consider that prime property is providing investors with a relatively attractive proposition in a troubled economic climate. Germany and the UK faring best, while periphery suffers Of the countries covered by our European Index, the UK and Germany are performing best, as indicated by their absence of COLD markets (Figure 2). Several Central and Eastern European and Nordic markets also look attractive, while markets in the troubled Spain and Italy are not offering sufficiently high yields to compensate for the substantial economic risks. Yield premium continues to widen Our results for this quarter reflect the much wider yield premium offered to property investors in core markets relative to recent experience (Figure 3). Investors fleeing to the safety of government paper would do well to consider selective investment in prime property, and this widening premium has resulted in several upgrades to core markets this quarter. With German office markets trading at a yield of around, most regional UK office markets at +, and a similar premium available in several Nordic markets, investors can earn adequate returns even in the absence of future capital appreciation. Table 1 European Fair Value Index scores Q Q Europe all-property Europe office Europe retail Europe industrial Global all-property Asia Pacific all-property US all-property Figure 2 Fair Value Index Q1 ratings by country Figure European index score: Cold Warm Hot Comparison of selected prime property yields and German bond yield % German 5 year bond yield Frankfurt retail 2

3 Economic context Risk fell during Q1, lowering required returns With the ECB having implemented two tranches of its LTRO in December and again in February, financial markets found a semblance of calm during Q1, as spreads on risk assets fell. Corporate bond spreads certainly fell, with BBB spreads dropping in both Europe and the US (Figure 4). This feeds through to our required return estimates, and in conjunction with a reduction in government bond yields in several countries during Q1 has lowered our required return estimates. Renewed turmoil in recent weeks In recent weeks, however, the impact of the LTRO in calming fears has faded, and we have witnessed a further escalation in the euro crisis following the failure of the recent Greek election to produce a government committed to standing by the bailout agreements stuck earlier in the year. This has exacerbated the divergence between the core and the periphery and driven down bond yields in Sweden, Germany and the UK even further, while lifting yields in Portugal, Italy, Spain and Ireland (Figure 5). This will have a dual impact on our required return estimates going forward, with the bond yield coupled with a likely unwinding of the reduction in risk we saw during Q1. Yields to remain low for longer The weak European economy is feeding through to our property market yield forecasts. The subdued growth outlook means that base interest rates will remain low for longer than previously anticipated. This will lower bond yields in the medium term, prolonging the current low interest rate environment that is underpinning below trend yields. As a result we have revised our forecasts this quarter (Figure 6). This is having a positive impact on our expected return forecasts, and provides an offset to the impact of subdued rental growth on capital values. The impact of this change is largely felt in core markets, whereas we have revised up our yield forecasts for several peripheral markets. Figure 4 Spread of BBB corporate bonds over govt. bonds 3% 2% 1% Eurozone US Figure 5 Change in 5 yr govt. bond yields (percentage points) Change in 5 yr bond yield since end March 2.1% 1.2% 0.7% 0.7% % -0.2% 0. Figure 6 Comparison of yields forecasts Q4 and Q Q4 forecasts of end 2014 yields Latest forecasts 3

4 Market classifications Core market upgrades A reduction in required returns has driven several upgrades this quarter, with many core markets shifting from COLD to WARM and from WARM to HOT (Figure 7). These upgraded markets are spread across Germany, the UK, France, Belgium and the Nordics, and the classifications reflect the yield premium mentioned earlier, along with an uplift in yield of 25bps in Paris La Défense along with several UK regional markets. There were only three markets experiencing downgrades during Q1, including Berlin retail which fell from HOT to WARM due to a fall in yield from 4.9% to 4.7, and Lyon retail where the rental growth outlook was revised down. Pricing mostly stable in Q1 While there were some movements in yield as highlighted above, for the most part yields in the European market have remained steady for the past year (Figure 8). In spite of economic difficulty, prime yields in Spain and Italy have proven sticky, although there were signs in Italy that this has begun to change, with yields in the Milan office market rising by 50bps to 6.3%. Pricing in these markets will bear close watching in coming quarters to see whether this shift is the start of a broader trend. Certainly, on the basis of our Fair Value analysis, yields in the periphery need to rise further to generate adequate returns for investors. Major market rankings Table 2 presents a selection of our Fair Value rankings for major European markets. Helsinki retail heads this listing, supported by an attractive prime retail yield of 5.. The majority of markets are in the WARM category, including the trading hubs of Rotterdam and Antwerp, with the prime retail markets of Munich and Paris offering defensive characteristics. Figure 7 Comparison of market classifications Q1 vs Q4 Q COLD WARM HOT Figure 8 Q COLD WARM HOT Barcelona offices Stockholm offices Rome industrial Budapest offices Madrid offices Lyon retail Helsinki offices Gothenburg industrial Heathrow industrial Paris La Déf. offices Paris CBD retail Hamburg offices Frankfurt offices Stockholm retail Berlin retail Pricing stable but yields shifting out in Italy Copenhagen ind. Hamburg industrial Frankfurt retail Helsinki retail Moscow offices Manchester industrial Copenhagen retail Prague retail 4.2 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Table 2 Frankfurt Milan Copenhagen Paris CBD Madrid Major market pricing relative to Fair Value Q Degree of overpricing (negative is underpriced) Helsinki retail HOT -8% Hamburg industrial HOT - Paris CBD retail WARM - Frankfurt offices WARM -3% Munich retail WARM -3% Rotterdam industrial WARM -2% Antwerp industrial WARM -1% Warsaw industrial COLD Madrid offices COLD 7% Milan offices COLD 12% 4

5 Office market forecasts Strong rental growth expected in London offices Average European office rental growth from has been upgraded this quarter from 1.9% p.a. to 2.2% p.a. We expect average European office rental growth in 2012 to remain unchanged at 1.. London is expected to lead the way in terms of rental growth across Europe over the next five years, where London West End, London City and London Midtown, along with Moscow, are all forecast to experience average growth of p.a. or above (Figure 9). Strong rental growth in London is coupled with a positive economic outlook in the UK compared to its European counterparts. GDP is forecast to grow by 0.3% in 2012 and 1.8% in This is much stronger than the -0. decline in GDP expected in the eurozone in Upward yield pressure in core European markets We expect that there will be a general upward movement in yields in core markets in Europe over the medium term. This upward shift will represent normalising conditions under the base case, where investors will revert away from perceived safe haven markets, and will start to invest in non core markets as they become more robust over the next five years. This upward shift is however expected to be delayed for one or two years, representing the continued uncertainty surrounding the eurozone, and Greece s future within it. Over the medium term, the largest rise in yield is expected in Paris (CBD) of 65 bps, while Dublin and Budapest expect to see a fall in yield of 75 and 35 bps respectively (Figure 10). Moscow expected to show high total returns Moscow is expected to experience relatively high average total returns over the next five years of 16. p.a., an upgrade from 15.8% p.a. last quarter. This is in contrast to Paris (CBD), where total returns will only reach an average of 3. p.a. This is primarily due to a forecast decline in capital values arising from negative yield impact (Figure 11). Italian markets are also expected to show weak total returns in the short term. Milan is likely to see returns of only 0.2% in 2012, while Rome will see negative returns in 2013 and Figure 9 European office average annual rental growth, Figure % 3.2% 3.1% 3.1% % European retail yield forecasts: selected markets 9% 8% 7% 3% Dublin Amsterdam London (City) Paris (CBD) Budapest Frankfurt Figure 11 European office average annual total returns forecast and breakdown, % % 7.8% % 3. Capital growth Income return 5

6 Retail market forecasts Retail sector shows strongest average rental growth in the medium term Average retail rental growth across Europe in 2012 is forecast to reach only 0.2%. However, this figure is anticipated to rise in the latter years of the forecast period, making average medium term retail rental growth in Europe 1.9% p.a., which is the strongest rental growth expected of any sector. The volume of retail trade in the eurozone rose by 0.3% in March compared to February. On the other hand, retail sales in Spain fell by 0., which is coupled by retail rental growth in Madrid forecast to average p.a. over the next five years (Figure 12). Investors preferences to shift in the medium term Alongside offices, the retail sector is expected to show an upward shift in yields in core markets over the medium term. Lyon retail is expected to experience the largest rise in yields of any retail market over the forecast period of 45 bps. We also expect to see a rise in yields in core markets such as Frankfurt, Berlin and London (WE). Alternatively, distressed or underdeveloped markets are expected to see a fall in yields in the medium term. For example, over the next five years, Moscow yields are expected to fall by 50 bps and Madrid by 40 bps (Figure 13). This represents normalising conditions under the base case, where economic growth in the medium term will see investors more willing to buy properties in currently underperforming markets as they begin to recover. Bucharest retail shows strongest total return of any retail sector Bucharest is forecast to see the highest average total returns of any European retail market in the medium term of 14. p.a. Lyon, on the other hand is expected to see comparatively weak returns over the medium term, averaging only 4.3% p.a. The current low interest rate environment has persisted longer than expected, and as such we have adjusted downward our yield forecasts in the medium term. This, in turn has increased overall capital growth and hence total returns this quarter compared to last (Figure 14). Figure 12 European retail average rental growth (Top 5 bottom 5), % Figure % 2.9% 1.9% 0.8% Top 5 Bottom 5 European retail yield forecasts, selected markets 9% 8% 7% 3% Frankfurt Berlin London (WE) Lyon Madrid Figure 14 Average forecast total returns : Q and Q forecasts, (% p.a.) Average total returns forecast, Q Average total returns forecast, Q

7 Industrial market forecasts 2012 rental growth is weak compared to medium term average Average industrial rental growth across Europe in 2012 is expected to be 0.3%. This will increase slightly in the latter years of the forecast period, bringing average medium term rental growth in Europe to 1. p.a. Barcelona is expected to see rental growth of 3% p.a. over the next five years, which is a downgrade from 3. p.a. last quarter. Other rental growth downgrades include Prague, Paris (IDF) and Marseille. On the other hand, a number of German and UK markets had their rental growth upgraded this quarter, including Berlin, Frankfurt, London (Heathrow) and Manchester (Figure 15) Non core markets to experience yield compression in the medium term Again, as with the office and retail sectors, we expect a rise in yields in core industrial markets and a fall in yields in distressed or underdeveloped markets over the medium term. Furthermore, we expect these movements to be delayed in most markets for one to two years, until the eurozone finds a more concrete path. Over the next five years, we expect yields in Paris (IDF) to rise by 35 bps, while Barcelona yields are expected to fall by 25 bps (Figure 16). Industrial sector to show strongest total returns in Europe In 2012, Brussels industrial is expected to show comparatively high total returns of 11.3%. In contrast to this, Madrid industrial is expected to show total returns of only 3.1 this year. These weak returns are matched with an expectation that GDP growth will be negative in Spain in 2012 and In the medium term however, Budapest industrial is expected to show reasonably strong total returns of 10. p.a., while on the other hand, Amsterdam is expected to show quite weak returns of 7% p.a. Over the next five years, the industrial sector is expected to lead the way in terms of total returns across Europe, averaging 8. p.a., while office is second at 7.3% p.a. and retail is third at 7% p.a. (Figure 17). Figure 15 Average rental growth: selected markets, : Q and Q forecasts (%p.a.) 3% 2% 1% Figure 16 Average rental growth forecast, Q Average rental growth forecast, Q Industrial yield forecasts, selected markets 12% 11% 1 9% 8% 7% Figure 17 Frankfurt Dublin Barcelona Marseille Paris (IDF) Average annual total returns by sector and period (% p.a.) Office Retail Industrial 7

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