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Macro outlook

Think European cities Q3 2019 outlook

Stefan Wundrak
Head of Research, Real Estate, Europe
Town view
Given the weakness of markets and confidence in H2 2018, the return of relatively solid economic expansion across Europe in Q1 2019 provides welcome relief. With Europe's four largest economies recording expansion, European Union (EU) member states, in aggregate, grew by 0.5% in the first quarter. That said, political risks are never far away in Europe and given the persistence of potential external shocks, growth estimates for 2019 and 2020 remain muted at just 1.3% and 1.5% respectively. 

The eurozone economy remains dominated by a wide divergence between healthy activity in services and a struggling manufacturing sector which is still reeling from the impact of several transitory shocks and a sharp deterioration in the external environment. A weakening fixed investment and export outlook reflects the soft economic sentiment, although positives can be taken from unemployment falling to a decade low. Fiscal policy should also be the most accommodative since 2010, providing some additional boost to growth this year.

The benign economic and inflation outlook means that the European Central Bank (ECB) will remain very cautious about withdrawing monetary support. Our view that the ECB will not raise interest rates until 2020 and that the normalization path will stay very slow, has been consistent. The marked retreat in U.S. 10-year treasuries from 3.3% to 2.4% since mid Q4 2018, and an accompanying more dovish tone, echoes this mantra. Meanwhile in the United Kingdom, the direction of the Bank of England will depend on any final agreement reached (or not) with the EU. Unable to come to an agreement on the terms of Brexit in the U.K., the EU has accepted a further extension of the Article 50 deadline to the end of October 2019.

It is still our assumption that some agreement is penned with the EU. However, our revised lower long-term economic rates are also a reflection of changing demographic and productivity trends indicative across many developed economies. These are shaping future long-term borrowing rates and, consequently, capital flows across asset classes. A demand-led shock, amplified by technological or structural change, is the biggest concern for real estate investors as the traditional causes of corrections, namely excessive debt or a supply glut, are currently not present.


Table: Economic dashboard - market recovery in H1 2019

Office sector overview 
  • Many European economies are performing well domestically, despite the negative external environment. 
  • Leasing markets have softened slightly in many cities in Q1 2019, but the underlying momentum is very healthy. 
  • Slower leasing in some cases reflects very low vacancy and a lack of options for tenants.
  •  Positive short-term growth outlook.
  • Nominal rents are relatively high in many cities, but with supply relatively disciplined and inflation subdued.
  •  Financial shock is likely to be the key disruptor to the otherwise rosy outlook.

Retail sector overview 
  • Retail sales remain solid across the European economy.
  • Contraction is taking hold in the investment market ahead of the occupier market.
  • Online retail sales are eroding in-store sales across the market, but most of the region is some way from the U.K.'s tipping point.
  • Food-led retail offers more reliable growth.
  • The window is still open to dispose of non-core assets before pricing worsens.

Logistics sector overview 
  • Strong value increases since mid 2017, due to significant yield compression and rental growth.
  • Unexpected development activity has met strong structural and cyclical demand for modern space.
  • Rental growth has picked up, although remains more modest than widely assumed.
  • Trade disputes and economic weakening has cast a shadow over the demand side, but currently the structural demand factors outstrip cyclical issues. 
  • The economic slowdown has had little impact on logistics occupier markets.

Housing sector overview 
  • In all its guises, the housing sector appeals to investors who are attracted by past performance and projected resilience.
  • Challenges include achieving scale and operator efficiencies.
  • Pricing reflects that European markets are at different levels of sophistication and maturity.
  • There is an under-supply of purpose-built build-to-rent, student housing and healthcare assets across Europe.
  •  Pricing is keen but value-add returns are achievable through forward funding and build-to-core strategies.


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