by Alice Breheny*
Europe’s diverse retail property markets present excellent opportunities for institutional investors looking for stability, diversification, income and resilience, but not all locations and assets are equal, according to TH Real Estate.
Investors in commercial real estate (CRE) are usually seeking capital stability, diversification, income and resilience in the face of economic shocks. Retail property in Europe can provide all four of these, but stands out for its ability to provide diversification through geography, sub-sector and risk profile.
High street versus malls
Investors who are focusing on core retail properties, for instance, have three broad choices. They may look for shops that are located on prime streets in major cities. The risks are low, but rental yields are correspondingly reduced – and may be below 3 per cent in some prime locations. The opportunities come from situations where entire blocks of shops can be acquired and where there are opportunities for repositioning through tenant engineering.
Alternatively, investors can look for shopping centres. The consensus is that this sub-sector will outperform the European CRE market over the next five years. Centres offer better scope for asset management – and rental growth – than unit shops. Larger, dominant shopping centres that are well anchored are expected to achieve superior increases in rent and should provide stable yields.
Over the short-to-medium term, we expect that shopping centres in the Nordic region will perform well, thanks to the sound economic fundamentals. However, attractive opportunities – which should be considered on a case-by-case basis – can be found in all European markets.
In addition, investors can look for ‘super prime’ regional centres. These tend to offer relatively low net income yields (NIY) of about 4.5 per cent – but compensate for this with stronger rental growth prospects and bigger potential for asset management initiatives.
Sometimes, it is possible for an investor to become a joint-venture partner in a ‘super prime’ regional centre, as existing investors and developers are looking to reduce a part of their exposure. We think that ‘super prime’ shopping centres in Italy and Spain may still be available at better prices than in other markets, however the margin is being eroded as investor appetite for these countries increases.
Looking outside core retail
There are two sub-sectors which are outside the core retail universe but which offer interesting opportunities. One of these sub-sectors is outlet malls. These are purpose-built centres where a range of manufacturers and retailers offer stock at discounted prices. Usually the landlords require that the tenants offer discounts of at least 30 per cent. Both shoppers and retailers benefit from the managed environments and the economies of scale.
Retail warehouse parks are the other sub-sector. Retail warehouse parks were hard hit by the downturn in the housing markets, and have not recovered to the extent that other shopping centres have. Both sub-sectors are less well understood than the three core sub-sectors and, as a consequence, offer attractive values to buyers.
Some national markets are coming back into vogue. Italy and Spain are enjoying economic recoveries. We think that Portugal will follow suit. However, structural problems in Greece mean that that economy should not be seen as an imminent recovery play. There are also good returns to be made from the less established markets in Central and Eastern Europe. However, there are significant risks in terms of market size and liquidity.
Finally, there is an absence of a development pipeline. This means that CRE investors in Europe could do well to include a proportion of developments within their overall strategy, and ahead of the next development cycle. Exposures could include refurbishment of existing stock, or the development of new schemes that are fully consented and that have a high proportion of pre-lets.
Flexible approach required
In short, we do not think that CRE investors who are interested in the opportunities from European retail property should invest indiscriminately – or indeed evenly – across the market. Significant local and regional disparities in occupier market and pricing will emerge as the market matures. Larger investors should be able to achieve lower volatility through greater diversification, and superior performance thanks to the ability to pick stock from a larger pool.
Although most European markets are generally experiencing greater liquidity, the supply of good quality ‘interesting’ stock remains tight. It is therefore important that any investment strategy is flexible enough to ensure that it has the greatest chance of meeting its investment objectives.
TH Real Estate’s report ‘THINK Europe: Retail’ provides an overview of the European retail property market and the opportunities it presents. Download here
*Alice Breheny is global co-head of research at TH Real Estate