Dutch real estate returns drop off
At the end of 2003, the IPD Databank for the Netherlands comprised 6,243 properties, valued at €38bn – representing around 80 % of property assets owned by institutions and quoted property companies in the Netherlands. 2003 saw a further gradual deterioration in the performance of the Netherlands property market. All property returns slipped to 7.1% in 2003 from 8.8% in 2002. This decline came as rental value growth slowed from 2.7% in 2002 to 1.6% in 2003 and yields remained static for the second year in succession.
After a poor year in 2002, when returns fell to -32.8%, equities rallied to achieve an annual return of 9.2% in 2003. Meanwhile bonds, the top-performing asset in 2002, saw returns more than half0 to 4.1%.
However, over the medium term, property has delivered superior returns in the Netherlands, as shown in Figure 1. Over the last nine years, property has achieved total returns of 11.9% per year, against equity returns of 9.5% per year and bond returns of 7.9%.
The commercial property market in the Netherlands is made up largely of three sectors. At the end of 2003 the residential sector accounted for around 45% by value of the total investment market. Retails and offices each made up around 25%, with the remaining 5% or so held in industrials and mixed use properties.
Residentials have been the star performer of the Netherlands property market over the last nine years, delivering total returns of 12.9%. Offices and retails trail on 11.0% and 10.6% per year respectively. The driver of this out-performance has been the strong reduction in yields seen in the residential sector in the last nine years – the reversionary yield has fallen by 2.6 percentage points, adding 4.5% per year to capital values.
Given this strong performance history – residentials have delivered top returns in six out of the nine years of the IPD record – it might be expected that investors would have moved to increase their exposure to the sector. But in fact, the reverse is true, as the chart shows.
The chart unbundles the changes in portfolio weights since 1996 into 'active' changes resulting from investors’ deliberate asset allocation decisions (termed net investment shift) and 'passive' changes caused by variations in the rate of capital growth across segments. At a sector level the analysis reveals that investors have sought to decrease their exposure to residentials by almost 14 percentage points over the last eight years, but that this has been moderated to a degree by the more rapid rise in residential capital values over the period. Conversely, the attempt to increase exposure to the retail and office sectors by 9.3 and 3.3 percentage points respectively has been frustrated due to inferior capital growth.
At first glance then, one might consider that Dutch property investors have been “biting the hand that feeds them”, by shifting money from strong to weak performing sectors. However there are strong historical and fundamental motives behind this pattern. Much of the residential stock held in Dutch investment portfolios was built in the post-war period when institutions were encouraged by the government to assist the post-war reconstruction effort by supplying capital to build new housing projects. As this stock has aged, institutions have become increasingly eager to offload it rather than commit to costly refurbishment expenditure. In 1994, half of the residential property in the IPD was built prior to 1979, but by the end of 2003 this figure had fallen to under a third.
But aside from this desire to renew their portfolios, investors have also been anxious to sell in order to realise gains in capital values. The steep fall in yields that has driven the surge in capital values in the residential sector has come as demand from private investors has soared.
House prices – measured as a percentage of average income – have increased by more than 50% since 1995, although more recently this increase has stalled. Thus, institutional disinvestment from the residential sector in recent years may also have resulted from investors seeking to take advantage of what they consider to be unsustainably high prices in advance of an anticipated correction in the next few years.
As part of the move to shift capital away from older residentials and into newer office stock, the Amsterdam Southaxis district around Schipol Airport has seen considerable institutional net investment over the past nine years. At the end of 2003, Amsterdam Southaxis accounted for 12.3% of the total office portfolio, against 6.0% at the end of 1995. The area is dominated by the ICT sector and enjoyed a very strong run of returns from 1998 to 2001 as occupier demand pushed rental values up at a rate of over 7% per year, compared with an annualised rise of 5.2% in the office sector as a whole. However, the recent malaise in the technology sector has seen returns tail off, with rental values falling by -5.4% in 2003, against the all office average of -1.0%.
Overall, Amsterdam Southaxis total returns, at 11.3% per year, have marginally out-performed the all office average of 11.0% over the last nine years. However, this is still some way short of the returns on residentials, at 12.9% per year. Furthermore, Southaxis office returns have been far more volatile, with a standard deviation in returns of 6.0%, against 3.7% for residentials. Given that the shift of capital away from residentials looks set to be a feature of the Netherlands investment market for a few years to come, it remains to be seen whether the positive gap in performance seen over the last nine years between property and equities and bonds is sustainable.
Dominic Smith is a senior researcher at Investment Property Databank (IPD). E-mail: firstname.lastname@example.org