How investors play the markets
With the dire performance of equities over the last few years universally-acknowledged, is it time to consider alternative assets more carefully? This article briefly examines the composition of European property markets, the returns delivered by these investments, and investors’ recent allocation decisions within the property sector. It concludes with a look at one of the more interesting stories of relative performance in 2002 – the superiority of provincial office returns to those achieved on capital city properties.
This year, IPD published indices on 11 European property markets, outlining their performance to the end of 2002. Details of the size of these markets, and the extent to which they are covered by IPD, are given in Table 1.
Institutional investors across Europe have differing tastes, and Table 2 illustrates the composition of the 11 markets. In seven markets, including France and Germany, the office sector accounts for the majority of holdings, and for more than a quarter of the market in the remaining four countries. The retail sector is also well-represented, but accounts for a larger proportion of the market than the office sector in just two countries, Portugal and the UK. Institutional investors generally have limited exposure to the residential sector, though notable exceptions include France and the Netherlands. Significant investment in the industrial sector is largely confined to the Irish and UK markets.
It should be noted that the composition of investment markets is continually changing as investors’ preferences for certain types of property varies, a subject that is addressed later in this article.
Figure 1 compares the property, equity and bond returns in 2002 in the European markets covered by IPD. With equity markets tumbling across the continent, ranging from -22.3% in the UK to -43.9% in Germany, it was bonds that provided property with competition in terms of performance last year. Bond returns exceeded those on property in 2002 in nine of the 11 countries covered by IPD, the exceptions being Denmark and Portugal,
IPD has performance data stretching back five years or more on seven European property markets, as illustrated in Figure 2. Over this time-period, equity returns still generally trail those on other assets – Finland is the only country to see the traditional one-two-three of equities-property-bonds, thanks to the stellar performance of its stock market in 1998 and 1999. In the remaining six markets, equity returns run last, with property out-performing bonds everywhere except Germany.
Investor trends in Europe
Table 2 describes the composition by sector of various European property markets at the end of 2002. Table 3 illustrates how investors changed their sector allocations through net investment in seven European countries in 2002.
Overall, investment in property in the seven markets listed below was muted in 2002, in spite of property’s superior performance relative to equities. However within the property market itself there was a clear shift of money out of the residential sector and into retails and offices.
In the four European markets where residentials make up a significant proportion of the investment market – France, Germany, Netherlands and Sweden – institutional investors were net sellers of residentials, to the tune of E2.4bn. This dis-investment comes despite the out-performance of the residential sector relative to the commercial sectors, and betrays investors’ preferences for large, easy-to-manage schemes like shopping centres or office parks. In the UK over the last five years, for example, the average capital value of properties held in the databank has more than doubled, as investors have sold off large numbers of smaller investments and switched into larger lot-sized holdings.
While investors in the smaller markets of Denmark, Ireland and Sweden withdrew from the retail sector, the four largest European markets – France, Germany, Netherlands and the UK – saw net investment in the retail sector totalling E2bn in 2002. Investors have recently perceived retails as a safe port in a storm. With consumer spending proving resilient throughout 2002, even in the face of prolonged economic slowdown and the threat of terrorism, tenant demand remained robust in the retail sector, offering investors the chance to benefit from growth in rental values.
The office sector was popular with continental European investors. Net investment in offices in France, Germany and the Netherlands totalled E2.6 bn. The UK ran counter to this trend, with investors withdrawing E1.1bn from the sector in 2002. This enthusiasm for offices runs counter to returns achieved in 2002, when offices were the worst-performing sector in all European markets. However, this generalisation masks an interesting subtlety; namely, that while poor returns are being achieved in capital cities, the performance of provincial markets demonstrates considerable resilience. Figure 3 illustrates the variation in returns achieved in 2002 by nine European capital cities, compared with their provincial benchmark.
Figure 3 shows that, with the exception of Lisbon, capital cities clearly under-performed provincial markets in 2002, with the margin of under-performance ranging from 1-4 percentage points in France and Germany to 11 percentage points in Spain and the UK.
Capital city office markets suffered in 2002 as their tenant-base – stacked with large financial institutions and in particular investment banks – came under increasing pressure as the global economic slowdown continued to bite. While demand for space dried up in Europe’s premier cities, with rents and capital values falling accordingly, there was little impact on provincial office markets, as their more parochial client base was less affected by world economic events. Accordingly, returns on provincial office markets – in any case less dependent on rental growth thanks to the protection afforded them by their higher yield rating – out-shone those achieved by their more illustrious neighbours.
Dominic Smith is a researcher at Investment Property Databank in London