The all-sector European Fair Value Index score was 75 in Q3, up from the Q2 figure of 61 (Figure 10). Commercial real estate valuations generally improved on a relative adjusted basis as an increasing number of prime market yields over the last two quarters started to move upwards (reducing the future negative impact from outward yield shift), with the majority from the retail sector.
Over the last three months the economic outlook has marginally improved for 2020 but deteriorated for 2021. Economic data covering the summer and early autumn period paints a better recovery picture than expected in June 2020, but as infection rates increased over recent months restrictions were reintroduced, which will slow the pace of recovery over the winter.
Prime headline rents for European office’s fell by 2.2% in Q3 versus -0.7% in Q2. Some office markets across Europe have started to correct strongly reporting an increase in vacancy, particularly tenant released space, and falling rents. In contrast, the European logistics sector bounced back strongly in Q3 as demand outpaced supply creating upward pressure on rents. As such, prime headline rents grew by 1.0% in Q3, in line with the quarterly growth rates seen in 2019 (pre-pandemic). The High Street retail sector continues to suffer with a further 7.0% contraction in prime headline rents in Q3 following a 7.3% fall in Q2. More locations across Europe are reporting softening rents as the effects of Covid-19 restrictions and online competition continue to impact the sector.
Looking ahead, European all sector* prime rents are forecast to increase by 0.3% p.a. over the next five years with logistics showing faster growth than office and retail underperforming.
Capital Markets Overview
The Covid-19 pandemic continued to impact the European property investment market over Q3 2020. Despite the broad easing of lockdown restrictions, low activity appears to reflect that investors have taken a wait and see approach and that there continues a mismatch in pricing expectations between buyers and sellers. That said, demand for prime assets continue to hold up in many markets, with little evidence of office and logistics repricing, suggesting that buyers still appear willing to pay pre-pandemic prices for the best assets.
Government bonds performed well as sentiment toward the region improved markedly after the EU announced a €750 billion pandemic recovery fund. The most notable development was a decline in the Italian 5-year bond yield of 38 basis points to 0.2%.
*123 European markets: 49 office, 41 high street retail and 33 logistics
About the European Fair Value Index
The index was launched in August 2010 and covers 123 markets across Europe.
Fair value is the value at which an investor is indifferent between a risk-free return and the forecast return from holding property, taking into account the extra risk of investing in the property asset class.
When a property price is at fair value, an investor is being adequately compensated for the risk taken in choosing to purchase real estate; similarly, when the property price is below the fair value price, an investor is being more than compensated for the risk taken in choosing to purchase real estate. When buying at or below fair value, an investor does not necessarily buy at the bottom of the market.
Our fair value analysis focuses on prime assets and a five-year investment horizon and hold for the market overall; individual transactions may provide opportunities and risks beyond the average market view. In the report, we compare results for the current quarter with the previous quarter, which may differ from those published in the previous quarter’s report; this is due to the forward-looking methodology. As such, when our forecasts change so too does the Fair Value Index.