Building Opportunities
Key Messages
Lisbon, Milan and Barcelona logistics post the best total return in Southern Europe above 6.5%, followed by Madrid logistics and office segments
The strongest capital growth comes from Lisbon logistics at 3.1% due to further 10bps yield compression
Strongest prime rental growth may occur in Madrid and Barcelona offices, close to 3%
Southern Europe continues to be of interest to investors seeking opportunities that are harder to find in northern European markets. Supporting this will be a strong occupational market exhibiting sustained activity with take-up above the long –term average over the forecast period.
Vacancy may reach its lowest levels in 2020 in most Southern European markets. Madrid and Milan vacancy will only bottom out at the end of the forecast. Overall, the compression of vacancy rates in Spain and Portugal may take them down to their pre-2007 levels. It may put upwards pressure on average and prime rents, particularly in Madrid and Barcelona with growth of between 1.5% to 2% over 2020-2024. In contrast, Italy can expect 1% over the same period.
Robust prime total returns of over 6% in 2020 come from better capital growth (through rent effect) for Madrid, Barcelona and Rome and better income return in Rome. Returns are front loaded in all markets although Lisbon may see the most consistent prime total return at slightly above 4%. Milan, with limited prime rental growth, will end 2024 at the bottom with 1.1%. Yield compression may end by 2023 and all office sub markets in the region will witness decompression by an average by 5-10 bps by 2024.
The prime total returns attained their maximum in Barcelona (15.7%) and Madrid (13.7%) in 2019. Returns are now set to slow in the region and go down around 5% on average over the horizon. Lisbon may achieve more due to higher capital growth where compression of net initial yields in 2020 is greater and there is slightly better rental growth.
Prime yields in 2019 range from 4.9% in Madrid and Barcelona to 5.3% in Milan and 6.2% in Lisbon, Aside from Lisbon all other markets will see stability across the front part of the forecast before decompression from 2022 onwards. Limited supply is likely to result in consistent rent increases of between 1.2% and 1.8% for all markets over 2020-2024 except for Madrid where rental growth may flatten to 0% from 2022 to 2024.
Milan continues to be a best in class for prime total return in high-street retail segment that is the focus of our forecast. The prime total return is likely to be 11.6% for 2020 far above Rome at 4.8%, Madrid (4.0%) and Barcelona (2.2%).
Total returns though decrease sharply for Milan to 2.1% in 2021 and stay near that level for the remainder of the forecast. Rome may end the forecast with the strongest return at 5.0% in 2024
The strength of return in Milan is attributable to yield compression expected in 2020 to be 10bps. The good dynamics of retail sales are linked to government policies (minimum wage increases in Spain) and better domestic demand.
These are helping to protect high street retail in Southern Europe where rental growth is likely to stay positive at 1.4% for Rome and around 2.4% for Milan.
Madrid and Barcelona have lower growth, which reflects the greater role the internet plays in retail. Investor caution on shopping centres, more directly affected by e-commerce, is common across Southern Europe.
Risk to the Forecast
Political risks remain the primary concern for investors in Southern Europe. In both Spain and Italy, the survival of government alliances is an ongoing issue with the difficulty in forming coalitions that are vulnerable to tiny majorities.
In Spain, there is a remote risk of the resurgence of independence. More relevant is the Spanish government revamp of the REIT regime putting more pressure on income distribution that might present stress for some investors.
Xavier Zoutu