Spain is one of the larger western European countries with a population of 44 million. Furthermore, its population growth during the period between 2005 and 2010 is expected to be around 1.2%, well ahead of the European average of 0.4%, suggesting a better than average increase in demand for commercial floorspace.
The country has enjoyed a strong economic growth rate since accession to the EU in 1986. The average annual rate of economic growth has been 3.3% per annum compared to an EU average of 2.7%. Although the Spanish economic growth rate is forecast to moderate over the next 5 years it is expected to remain above the EU average.
The institutional market is dominated by investment in the office and retail markets which make up 40% and 44% of the Spanish IPD index, respectively. Institutional exposure to the residential and industrial/logistics markets is relatively minor.
Because the market remains dominated by owner-occupiers, the average institutional lot size is quite large. Within the Spanish IPD Index, for example, the average retail and industrial (logistics) investment is around €20 million, while the average office investment is over €35 million. This characteristic will tend to limit the direct accessibility to smaller investors who prefer to take their exposure by way of co-mingled funds.
The country has become increasingly important for pan-European property investors. Though the market remains dominated by owner-occupiers, institutional ownership (both domestic and foreign) is increasing and in the context of a pan-European institutional investment universe, Spain makes up around 2.1%.
Whilst accessibility to the market is not as good as that in say the UK or France, the real estate market is becoming increasingly transparent and therefore attractive to foreign investors.
The strong economic performance of the country is reflected in the performance of investment property which has, for the last 5 years (the period covered by IPD), consistently outperformed European all property returns (as defined by IPD pan-European Index). Furthermore, the degree of outperformance has been impressive with a 5- year average total return of 10.9% p.a. compared to the European all property average return of 8.5% p.a.
While Spanish property yields fell faster than the European average in the early 1990s as the market matured - and in the process generated very attractive returns for investors - the recent outperformance has been the result of superior rental growth.
Prime unit shops, as measured by Jones Lang LaSalle, have risen faster in Madrid and Barcelona than any other major European retail location. Rental growth has also been above the average in the office markets.
Real negative interest rates and the wealth effect of a strong housing market have driven private rates of consumption growth that have been consistently ahead of the euro zone average. As in the rest of Europe, the growth in values in the housing market is expected to slow down and combined with rising interest rates will reduce the rate of growth in private consumption.
However a dynamic employment market which has seen a steady improvement in participation levels is expected to maintain consumption growth comfortably above the EU average. This should continue to underpin demand for retail floorspace.
Retail returns in the Spanish market have been excellent, averaging over 13% p.a. over the last 5 years. The outlook for future returns also looks attractive.
Spanish retail rents still have some way to go to match the rentals paid in more mature markets. Prime rents in Paris for example are twice as high as those in Madrid and Barcelona. Rents are generally indexed to the consumer price index and store turnover. Given an optimistic outlook for the retail trade and an inflation rate of 3.4% p.a., retail rental value growth in Spain is expected to be amongst the strongest in Europe over the next 5 years.
As in much of the rest of Europe, there is a significant shopping centre pipeline.
The Spanish office market was one of the first European office markets to show signs of recovery after a period when high vacancy rates depressed rental values. The vacancy rate is now falling, partly as a result of improving demand but also because there has been a trend toward converting some older office buildings into residential and hotel use particularly those located in city centres.
The topography of the main office centres of Madrid and Barcelona limits the extent of new development in the central areas. This is particularly acute in Barcelona which is hemmed in by the sea on one side and the mountains on the other. In Madrid, the area regarded as the CBD is slowly spreading northward. Rental growth in these central locations is running at around 5% per year and we expect this to accelerate further.
However, there is a marked difference in the outlook for offices in the central area and those on the periphery where the market remains significantly oversupplied and where there is no immediate prospect for any rental growth.
In common with other European investment markets, yields have been driven down by investors in recent years. Prime yields now stand at around 4.1% for offices and 5.1% for retail. Robust rates of rental growth from retail property have ensured that yields have reduced to the greatest extent in the retail sector over the last three or four years. As the outlook for rental growth remains positive and real rates of interest remain very modest: it is possible to borrow to invest in property at rates around 5% whilst inflation is currently running at 3.4%. It is likely that retail yields will decline further at least in the short term.
However, we would expect even greater capital appreciation in the office sector in anticipation of stronger rates of rental growth in the sector.
For the Pan-European investor, Spain offers the opportunity to enjoy returns from a market in the forefront of the European office market. Spanish retail property is also expected to be amongst the best performing markets in this sector in Europe.
With these investment characteristics, the prudent pan-European investor and especially those looking for growth will have a meaningful allocation to Spanish commercial property.
Ian Whittock is ING's managing director for research and strategy Europe