Office yields to keep falling driven by debt and equity availability

The latest outlook for European Commercial Property from research group Capital Economics contains a good piece written by senior property economist Kiran Raichura in a new update, which suggests that widespread availability of debt and equity will keep yields falling across the eurozone over the next few years.

The Capital Economics researchers take the view that additional monetary loosening is on the cards, given the prevailing downgrades to eurozone growth. They forecast euro-zone growth in in 2020 of 0.5% year-on-year, down from their earlier forecasts of 0.8%, with the region avoiding a recession in part due to the resilience of France, Spain and the Netherlands. Even with recovery in 2021, eurozone growth is unlikely to exceed 1% year-on-year. They now believe the ECB will cut its deposit rate by a further 30 bps in 2020, to -0.8% and will increase its asset purchases.

Could these capital market indicators point to further pressure on office yields? Here’s what the researchers have to say, and we quote:

“These indicators show that investors are likely to commit the same amount of capital to real estate in the next 12 months as in the last year. What’s more, there is already a huge swathe of capital committed to real estate that is yet to be invested. Dry powder amongst real estate funds globally sat at $327bn in March, having grown steadily in the last decade.

Debt availability and pricing is also supportive of demand for prime property. In Germany, evidence of strong demand and supply of debt can be seen in the growth in the amount of outstanding debt on commercial property since the end of 2016. Falling swap rates and lower margins have been supportive of debt pricing. As a result, across most major euro-zone markets, there is a 150-250bps buffer between prime office yields and the cost of debt. This is in contrast to early 2011, when, although office yields were higher, 5-year swap rates and lending margins were also far higher. In Spain, the cost of debt was higher than the cited prime office yield.

The combination of high levels of equity continuing to seek exposure to real estate, along with readily available and affordable debt, will be supportive of demand for property over the next few years. While current yields are extremely low by past standards, our own valuation measures suggest that prime property is, on the whole, fairly priced and that office yields could dip another 15-25bps.”