European property investment market

So far, the impact of the credit crunch has been most severe on some mortgage companies and the lower-rated bond market. The effects on Continental Europe has been less than in the UK and US. In the real estate market the impact has been most apparent on secondary assets where there is a greater reliance on debt funding.

Economic uncertainty, has led to a fundamental change in the investment environment. Over the last 25 years or so investment markets have enjoyed very favourable conditions as the yield on long bonds around the world have steadily declined. However, it looks increasingly likely that this period of declining long bond yields is now over. In fact, rising inflation risks over the medium term are likely to put some upward pressure on bond yields. This will moderate the degree of yield compression in the majority of European markets and in some markets will result in a rise in property investment yields. It is important to acknowledge that this will affect all asset classes, not only property, but also bonds and equities. In the future, investment returns are likely to be lower than those enjoyed by investors over the last 25 years, a period that has been marked by what was, in effect, an excess return to investors. The recent fall in government bond yields is short term and caused by a flight to safety during a period of great uncertainty in investment markets. Over the medium term bond yields are expected to rise.

Future returns are likely to be primarily driven by rental growth rates and income return, whereas in recent years the property market in particular has been primarily driven by capital appreciation arising from a fall in investment yields. The current crisis in financial markets is expected to be relatively short lived, as the issue appears to be one of confidence rather than solvency within the wider corporate world. Furthermore, as the bank reporting season gets underway, there should be greater clarity with regard to the extent and location of bad loans, which should gradually improve confidence. The view that the financial crisis is likely to be short lived is supported by the fact that interest rates are still moderate although higher than they were. There is still a global savings glut and corporates remain in sound financial health. Nevertheless and not withstanding downward pressure on base rates, the cost of debt has risen and more particularly the availability of debt has declined and this will have an impact particularly on secondary property investment markets which rely heavily on debt financed buyers.