The following Article is published in the Korean property magazine “Noble Asset”, issue 66, March 2009

Europe

A property investment opportunity?

Europe is often seen by foreigners as a small continent of just a view smaller, but economic powerful countries that introduced their “European Union”, the common currency (“EURO”), standardizing and unifying laws and allowed tax free trading between their countries.

Does that mean, all European markets – including the industrial property market – are unique all over Europe?

Obviously not! The European continent of about 50 countries and 700 Million inhabitants is not congruent to the 27 countries of the European Union and even inside the European Union, the property rules and regulations are different; the major differences can be recognized in the laws and regulations comparing European Union nations and the former communistic countries of Eastern Europe. That means the property markets within Europe are national markets, influenced by the political status and history of the nation, the country’s economic strength and the geographic and climatic facts.


The Central European market
The “Central European market” is the most vibrant European property market and accommodates the most powerful countries of the European Union (primarily Germany, United Kingdom, Netherlands, Belgium, France, Spain, Austria). These countries benefit beside the political stability and the economic power from long time proofed reliable property rules. This strength and reliability established a property market which attracts investors from all over the world.

Within these countries there is no limitation for any foreign investor to transfer the investment money into the country and to acquire all kind of properties without the need of finding a local joint venture partner. Buying a property in these countries also means to achieve unlimited freehold rights (not only land use rights!!) for the property bought.

The health of the economy and the predictability of the national politics has major impact on the attractiveness for the national appeal for property investors; so Germany for example benefits from a straight forward and - for a long time now - more conservative government and it’s role as an pushing outrider of the European Union. In contrary for example Italy suffers from frequently changing governments; their changing views on rights of property and other property related rules and regulations limit the comfort international investors look for in a foreign market.

Another famous property market within this Central European market must not be missed: England, often seen as the cradle of the modern property business and still the home of the most respected property schools is a major target of international investors. Long leases of 25 years, but even leases up to 99 years are still common and - to the benefit of the landlord - the lease transfers the entire property maintenance liability (including repair of core and shell) to the tenant, what is very exceptional to any other Country in Europe. This transfer of liability does not even harm the rental income as it is common term.
Potentially caused by the limited land on the British island and the continuous increase in demand of space, the British economy is strongly relying on a constantly increase in property values. This peaks in property prices and rents (especially in London) which are hard to calculate economically using regular measures, but makes the market easily vulnerable in times of crunches.

The investor’s demand, independently of national or international investors, is mostly concentrated on the main cities; dependant from the country, they show interest in several cities per country (the top 10 cities in Germany) or just in the capital city as in Austria (City of Vienna).

Prime locations within these cities are strongly sought after: obviously 5-star Hotel investors, but also specifically big shopping malls, who avoided the high costs of city centre premises 10 years ago and built the shopping arcades on “Greenfield locations” 10 km outside the cities are coming back in town.
Caused by the dramatic increase of gasoline prices, the inner city land and property prices increased again as office buildings are requested to be within the inner perimeter of the cities as well.

As foreign investors, property investment funds or Reits try to avoid any development risk, new developments are primarily undertaken by local developers who depend on financing by bank credit until the construction is completed and the property is taken over by the foreign or institutional investors.
Similar to this demand investors are not prepared to refurbish older premises or to put effort in managing their property. This means only offices or other industrial properties with long term leases signed by AAA-ranked tenants are attractive for investors.


Niches
As the above mentioned criteria narrow the market and reduce the returns for the investor some most attractive niches beside this mainstream can be identified that have proven their profitability: The Central Europe economy is driven mostly by small entrepreneurial and middle sized businesses. They need flexibility in size of their rented space, flexible terms and - especially the smaller businesses - low pre-investment costs. This means business parks providing small flexible units and additional services like easy to connect telephone switches, a smiling receptionist at the front desk and other supportive installations are mostly welcome for smaller companies; they are prepared to pay some extra rent for this flexibility and additional service. Providing these services and taking the role of a “Property Manager” serious, will fill the property with tenants and provide additional profit by higher rents and income from the services.
It is also not necessary for this kind of business parks to be located in the inner city centre or in one of the top 10 cities; under return of investment perspective some B-locations in cities of about 100.000 inhabitants have proofed to be very attractive and profitable.

Another very attractive opportunity beside the mainstream is to invest in countries where the property market is undervalued. Austria for example is seen by many investors as a small country (~ 8 Million inhabitants) located in the valleys of the Alps, without major industries and not worth looking more detailed at the real (estate) figures. In fact Austria is providing the benefits of it’s strong economy within the European Union, but also being historically connected to Hungary, Slovakia and other Eastern European countries, it is the perfect gateway to the Eastern European countries seeking to become full member of the European Union. These issues are mostly not respected and so the entire Austrian market is not in the focus and assets undervalued.


Eastern European market
The question might be asked, whether the Eastern European property market might be an alternative to escape the disadvantages of the mainstream demand; about 5 – 7 years ago, this definitely would have been a lucrative alternative. The eastern European countries were very attractive for the western European businesses who moved their factories and many call centers over there as the salaries were very low, the education of the people reasonable good and land was very cheap. Even properties at top locations within the centers of the capital cities (like Prague, Warsaw, Budapest) were affordable and the necessary refurbishments were cheap through to low labour costs.
Today nearly all of these benefits are gone: the labour costs increased so the factories were displaced to Asia and – to the disadvantage primarily of the new shopping malls - the purchase power of the locals didn’t increase any longer. Also the top locations in the capital city centers are in the ownership of the “early bird” investors who wouldn’t sell it for reasonable prices.

In addition to this in some countries the ownership structure of the land is not always 100% clarified, what extends the transaction period and leaves a certain amount of risk in any deal.
So at the moment the Eastern European market can not be recommended to investors searching a safe haven for their investment or expect a high return on their investment.


The current crisis’ impact
The European property market can not be described without a short overview on the impact of the current crisis.
Without blaming the banks for all that slows the market at the moment, the disinclination of the banks to finance any property deals stops the entire market. No one really expects the banks to provide up to 95% depth to any deals as they did not even 2 years ago, but if the buyer would be prepared to bring 30 to 40% equity in, the banks should lend the rest to make the deal happen. Unfortunately they don’t and so many transaction or new developments are blocked.

The current crisis and the lack of potential buyers reduced the value of the properties and all portfolio holders and institutional investors had to correct the value of their assets in the balance sheets. Especially Great Britain, where the entire economy is strongly based on increasing property prices, suffers dramatically from this downgrade and has also major impact on the residential property market, consequently on the purchasing power of the people and the entire British economy. Not as dramatic, but quite similar is the situation in Spain and Portugal where also many holiday homes came on the market as well.

Who ever can afford it will not bring his properties on the market at the moment; this would be seen as if the company would be in major financial trouble.
As a consequence there are two kinds of properties coming on the market:
Firstly real estate that is still on a price level as it was appropriate 1 year ago providing an initial yield of 6 - 8 %. These sellers want to show that they are not in urgent need to sell and want to run business “as usual”. There is nearly no market for these offers as banks wouldn’t finance these prices and even if they would do, they do it at conditions, where no attractive leverage would justify the deal.
On the other hand there are portfolio holders who need to sell the properties even at drastic reduced prices (~12% initial yield). As they don’t want to be recognized as being in trouble, these properties will not be advertised on the market and the deal will be completed “off market”.
There are bargain hunters with sufficient equity on the market who buy these opportunities and increase their portfolio, but as it happens “off market” no realistic market price can be achieved. So these deals can’t help to create new confidence in a stabilization of the market.


Summary
It’s hard to summarize the European property market as it is very much diversified and every country is differently respected and valuated. Therefore it is nearly impossible for a foreigner to investigate the entire European market and to take the right investment decision. Support by an European company understanding the foreign investor’s needs and providing a good network to local inside knowledge is essential to prepare a successful property investment in Europe.
There are bargains at the moment and undervalued locations and market niches that provide good returns even at current market condition, but cash (equity) is king.