Study shows investors expecting further drop in returns

The latest investment climate study by German fund manager Union Investment shows that investors are increasingly reconciled to lower real estate return expectations, with less than half of those surveyed now believing they will achieve their yield targets over the next three years.

With interest rates at such historically low levels, professional property investors are finding it increasingly difficult to achieve adequate, low-risk, investment returns. Hencing the lowering of return expectations – with respondents only marginally more optimistic when asked the same question about the next FIVE years.

The latest edition of the twice-yearly survey was carried out among 164 institutional property investors in Germany, France and the UK in November and December 2014 by market research institute Ipsos, on behalf of Union Investment. The index is based on four indicators: market structure, the general environment, location factors and expectations, each with a weighting of 25%.

According to Olaf Janssen, head of real estate research at the Hamburg-based Union Investment, “The latest ECB decision has further increased the pressure to revisit real estate investment strategies. Falling acquisition yields are having an increasingly adverse impact on investment outcomes. In order to ensure that their investments continue to perform, the more risk-averse investors are being forced to make a raft of adjustments.”

The study highlights how European investors have nonetheless remained cautious in terms of strategy. There is still no sign of the anticipated shift towards investments that carry significantly higher risk in an effort to escape low returns. Only a relatively small group of investors are considering boosting their exposure to non-European investments; the same applies to a move into the hotel and logistics segments with their higher returns.

The proportion of professional investors who are prepared to take on greater risk due to price pressure in European investment markets remains at 37 per cent, the same as in the last survey in summer 2014. At 52 per cent, the majority of investors are not seeking to avoid this highly competitive environment or willing to invest in other risk classes.

“The core segment remains a safe harbour and despite the current high prices investors still expect it to deliver stable performance,” continued Olaf Janßen. “The letting markets in most core European countries are in relatively good shape at the moment. Companies are doing well. As long as the investment conditions are right – in terms of the lease and the income potential of the location – investors see no reason to change their investment style or diversify into different regions or sectors.”

Compared to last year's survey, professional investors are now more willing to accept shorter lease periods when acquiring properties and to seek slightly higher returns via development projects, while also accepting lower pre-letting rates in such cases. A good half of the surveyed investors are aiming to shore up their performance by increasing the proportion of secondary cities in their portfolio and focusing investment on European core markets.

High global demand for real estate has also resulted in portfolio holders taking a much closer interest in market opportunities for property disposals than was the case half a year ago. Interestingly, for 76%of German investors, 79% of British investors and 51% of French investors, the main priority over the next twelve months is to exploit market opportunities in order to streamline their portfolios or take profits.

“The turnover rate in European portfolios is set to increase because international capital is currently more willing to take significantly greater risks in Europe than local capital,” commented Janßen.

Compared with summer 2014, the real estate investment climate is now bleaker in all three of the regions surveyed. Due to a decline in the “expectation” indicator, the Investment Climate Index fell by 1.8 points in Germany and stands at 68.1 out of a possible 100 points. The mood among French investors deteriorated more significantly – the index for the country fell by 2.9 points to 66.4. The UK index, meanwhile, confirmed the optimistic sentiment seen in the British investment market. The index softened by just 0.3 points and thus recorded the highest level of all three European countries at 70.3 points.