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European Investment Bulletin Spring 2009 Prime yield decompression per sector (yoy) CBD offices

Warehouses

Rents in decline in line with business sentiment

Shopping Centres

European average prime office rental growth Business climate indicator (Euro area)

200 175

12%

4

150

9%

3

125

6%

100

3%

2 1

0%

75

-1

-3%

50

-2

-6%

Source: Savills

Q3

Q3

2008 Q1

Q3

2007 Q1

Q3

2006 Q1

2005 Q1

Q3

-4 Q3

-12% 2004 Q1

-3 Q3

-9% 2003 Q1

London

Istanbul

Stockholm

Lisbon

Madrid

Oslo

Warsaw

Milan

Amsterdam

Dublin

Athens

Paris

Frankfurt

Brussels

0

2002 Q1

25

Source: Savills

“Investors are looking for realistically priced deals, especially through distressed sales. Normal investment activity can only recover when the confidence in the banking sector is restored. Under current market conditions good property fundamentals and secure income are key.� Giles Wilcox - European Investment Director

 The Eurozone economy officially fell into recession

 The risk premium for prime CBD offices over the

during the second half of 2008, and latest data and business surveys since then indicate the economy will continue to contract until the second half of 2009.

long term interest rates has risen compared to the height of the capital markets in 2007. However, it is overall still lower compared to the previous slump of investor confidence in 2003.

 The interbank market remains nervous, reflected in

 Property is beginning to look better value especially

the lending rate margin above the Euribor rate. In most markets the spread has more than doubled and LTV rates have dropped compared to a year ago keeping investment activity subdued.

 Following the deterioration of economic fundamentals we expect occupier demand to weaken further. Rental growth should remain negative and more incentives are expected to be offered by landlords.

where re-pricing has been stronger such as in the office markets of London, Paris, Madrid and Dublin. London in particular, due to the exchange rate is even more attractively priced in terms of Euro currency.

 Negative economic outlook and restricted lending should lead to lower capital values especially for secondary assets. The falling trend of base rates and government bond yields, imply that at least prime yield decompression may reach its bottom by the end of 2009.


Overview and market fundamentals European investment market overview 2008 was the year that signalled the end of the strong yield compression trend that the commercial property markets across Europe experienced over the past four years. The economic and financial turmoil that followed the credit crisis in the US has limited the liquidity in the debt markets restricting leveraged investors, who were the driving force in the investment market. The drop in investment demand for commercial property coupled with falling economic and business sentiment has led to falling capital values.

Eurozone GDP growth and ECB interest rates Eurozone GDP growth (% pa)

ECB key interest rates (%)

5.0 4.0 3.0 2.0 1.0 0.0 -1.0

Sources: European Commission, Oxford Economics

European prime property yield curve Prime office yields

Prime warehousing yields

Prime shopping centre yields

9% 8% 7%

6% 5%

Q4

Q3

Q2

Q4

2008 Q1

Q3

Q2

Q4

2007 Q1

Q3

Q2

Q4

2006 Q1

Q3

Q2

Q4

2005 Q1

Q3

Q2

4% 2004 Q1

Although these policies aim to restore confidence in the banking sector, the effect on lending activity has been small until now. The interbank market remains nervous, reflected in the lending rate margin above the Euribor rate. In most markets margins have more than doubled compared to a year ago and they are up to 200 basis points above the Euribor rate. The volume of property investment dropped further in the final quarter of 2008, with debt-backed buyers remaining constrained by liquidity issues and equity buyers looking for true market value. Banks are reluctant to lend and if they do they focus on existing clients. Loan to Value (LTV) rates have dropped from more than 80% last year to 60-65% with the maximum size of loan in the region of â‚Ź50-â‚Ź70m. Investors have reassessed their risk premiums upwards, reflecting the economic uncertainty and the negative impact it has on tenant strength and rental growth. Well located, high quality properties with strong cash-flow, fully let on a long lease to a financially strong tenant are now key prerequisites.

2002 Q1 Q2 Q3 Q4 2003 Q1 Q2 Q3 Q4 2004 Q1 Q2 Q3 Q4 2005 Q1 Q2 Q3 Q4 2006 Q1 Q2 Q3 Q4 2007 Q1 Q2 Q3 Q4 2008 Q1 Q2 Q3 Q4 2009 Q1 Q2 Q3 Q4

-2.0

The Eurozone economy officially fell into recession during the second half of 2008, and latest data and business surveys since then indicate the economy will continue to contract until the second half of 2009. With the recession deepening and inflation falling sharply the European Central Bank (ECB) has significant scope for large cuts in interest rates. The ECB has already brought rates down to 2% from 4.25% in mid2008, but rates remain above those in other major economies. The ECB has indicated that it would be reluctant to cut rates too fast as it wants to retain some room for manoeuvre, yet our economists expect them to fall to 1% by mid-2009.

Source: Savills

2008 vs 2007 office take-up (selected markets) 2007 office take-up

2008 office take-up ('000 sqm)

2,800 2,400 2,000 1,600 1,200 800 400

London WE

Madrid

Warsaw

Amsterdam

Athens

Frankfurt

Berlin

0 Paris

The impact on the real economy is gradually reflected in weakening occupational demand and higher tenant default risk. On the other hand higher cost of debt has restricted construction activity, therefore slowing down the development cycle. However, consolidation and rationalisation is leading to lower net absorption rates and rising availability, which gives more negotiation power to the tenants. Total office take up has dropped by around 10% in our survey area (26 markets) in 2008, while the vacancy rate has increased slightly from 7.9% to 8.0%.

Brussels

Market fundamentals

Source: Savills

European Investment Bulletin - Spring 2009

2


Yields

-15.0 -20.0 -25.0 01/01/2009

01/01/2008

01/01/2007

01/01/2006

01/01/2005

01/01/2004

01/01/2003

01/01/2002

01/01/2001

01/01/2000

01/01/1999

-30.0

Source: European Commission

Euribor rate - Prime office yield gap Euribor (12M)

Average prime office yield (%)

8.0

6.0

4.0

2.0

12/12/2008

27/06/2008

08/01/2008

19/07/2007

30/01/2007

15/08/2006

21/02/2006

31/08/2005

20/03/2005

27/09/2004

16/04/2004

19/10/2003

10/05/2003

15/11/2002

31/05/2002

05/12/2001

0.0

Sources: Euribor, Savills

Prime office yield convergence (selected markets) Paris CBD

Milan CBD

Amsterdam CBD

Warsaw CBD

Madrid CBD

London WE

Dublin CBD

Frankfurt CBD

9% 8% 7% 6% 5% 4%

Q4

Q3

Q2

2008 Q1

Q4

Q3

Q2

2007 Q1

Q4

Q3

Q2

2006 Q1

Q4

Q3

Q2

2005 Q1

3% Q4

Over the course of 2008 we have noticed a convergence in European yields. In Q3 2007 the yield gap between the lowest and the highest achievable prime yield across all sectors and markets of our survey area was ranging between 300 and 500 basis points, as the yield compression in some markets was very strong (eg London, Paris, Dublin, Madrid) while now it does not exceed 300 bp. Prime achievable yields (Q4 2008) are above 5.0% across all sectors, with the German markets being the most expensive and Istanbul the cheapest market across all sectors in our survey area. The UK has been one of the first markets to experience a fast and significant yield decompression, being a highly leveraged and transparent market.

-10.0

Q3

The yield decompression that started at the end of 2007 continued in 2008 and yields across all sectors were on average 95 to 115 basis points (bp) higher in Q4 2008 compared to a year before. Yield correction was steeper in the office sector with the achievable average prime yield for our survey area at 6.5% and the average secondary yield at 7.2%. Currently the average prime cap rates for offices are 440 basis points higher than the Euribor rate. This gap had narrowed down to less than 100 bp in 2007, during the time of the strongest yield compression. Historically (since 2000) this spread has been on average around 320 basis points. Currently the Euribor rates are trending downward and we believe that the spread with property rates could narrow again; as long as the confidence in the banking system is restored in order to provide the liquidity that will enable a more active investment market.

0.0 -5.0

20/06/2001

Yields

Retail trade sentiment

5.0

Q2

Following the deterioration of economic fundamentals in recent months and the forecasts for negative economic growth in the major European economies we expect occupier demand to weaken further. Rental growth should remain negative and more incentives are expected to be offered by landlords.

Consumer sentiment 10.0

01/01/2001

Rental growth still remains positive for prime retail properties. However the retail markets are exposed to declining consumer confidence and retail sales, caused by the fear of rising unemployment and falling housing markets. Therefore we expect rents to come under pressure in 2009, especially in markets with higher development pipelines, such as Italy, Portugal, Spain and Istanbul.

Consumer and retail trade sentiment indicators

2004 Q1

In the final quarter of 2008 we saw the first signs of falling rents in the office markets in the countries that were hit more by the economic crisis, such as the UK, Spain and Ireland. The average annual prime office rental growth was -2.6% in Q4 2008 compared to 11.2% in Q4 2007. The average prime warehousing rental growth for last year was almost 0.0% because some markets (eg Poland) still show some positive growth.

Source: Savills

European Investment Bulletin - Spring 2009

3


Outlook

100

120

Paris CBD

90

190

160

Madrid CBD

80

160

180

Frankfurt CBD

80

200

120

Brussels CBD**

180

260

170

Milan CBD

110

220

140

Amsterdam CBD

220

310

160

Stockholm CBD

90

200

160

Dublin CBD

30

130

170

Sources: Savills, European Commission *2003 for most markets **for 3/6/9 year leases

Current and long term average prime office yield Current prime office CBD yield

10 year average prime office yield

7.0% 6.5% 6.0% 5.5% 5.0% 4.5% 4.0% 3.5%

Dublin

Stockholm

Amsterdam

Milan

3.0% Brussels

These conditions are expected to have a negative impact on the occupational markets, which should be led by consolidation and rationalisation, thus leading to lower net absorption rates. Although new developments are being put on hold, the development pipeline in the office and retail sectors in particular, should put some further pressure on rents. Following the decompression of yields during the course of 2008, property is beginning to look better value relative to the peak of the capital markets cycle, especially where re-pricing has been stronger such as in the office markets of London, Paris, Madrid and Dublin. London in particular, due to the exchange rate is even more attractively priced in terms of Euro currency.

0

Frankfurt

The outlook for the real economy and the impact on the fundamentals of the property market on the one hand and the future of the banking sector and the impact on lending activity and market liquidity on the other will be the main determinants for the European property investment market for 2009. Following a difficult second half of 2008, our economists expect all major European economies to continue to contract significantly until the second half of 2009. UK, Germany, Italy and Spain are likely to see GDP fall by 2%, with France only a little better, contracting by 1.6%. Job losses will be widespread, pushing Eurozone unemployment towards 10%. Central and Eastern European economies are also going to experience subdued growth.

London West End

Madrid

Outlook

10 year Last Current average highest risk risk risk premium premium premium*

(in basis points)

Paris

When we compare current achievable prime office yields with the 10 year historic averages, we notice that Amsterdam and Brussels CBD yields are still below the historic average, which could imply that these markets may still experience some further yield softening, while London WE, Madrid and Paris are above their respective long term averages, which reflects investor concerns for the exposure of these markets to the financial crisis.

Risk premium over long term interest rates for prime office properties

London WE

Currently the risk premium for prime CBD offices over the long term interest rates in the office markets shown in the table on the right has risen to 150bp compared to 50bp at the height of the capital markets in 2007. However, it is still lower compared to the previous slump of investor confidence in 2003, when the risk premium had risen to an average of 210bp for these markets. The current economic outlook is worse than in 2003, when the major economies of the world avoided recession and recovered quite quickly. Under the current conditions investors may continue to apply a higher risk premium until the first signs of economic recovery become apparent. The only markets where the risk premium for prime offices has exceeded the last high level are London West End, Dublin and Madrid implying that yield decompression in these markets may be closer to an end.

Source: Savills

European Investment Bulletin - Spring-2009

4


Outlook In order to assess the current pricing levels we should also take into consideration the local market fundamentals, as these cities’ economies are likely to suffer more during the downturn. According to Oxford Economics economic activity in the international financial centres is driven by a mixture of domestic demand and the impact of world credit and investment cycles on financial services activity. As both are expected to contract sharply in 2009, most major cities, including Frankfurt, London, Madrid and Stockholm, are expected to see sharper than average contractions in GDP. However, experience of past recessions suggests Europe’s largest cities should recover strongly over the medium to long term, supported by a favourable industrial mix, highly skilled workforce and strong connectivity to global markets.

Eurozone GDP growth and employment growth

The other major driver of the property investment market is the cost and availability of capital. The latest ECB survey shows that credit conditions have been tightened by euro-zone lenders during the course of 2008 and the majority expects to tighten them further. Less available debt should keep the investment markets subdued and lead to lower capital values as potential buyers will have to use higher levels of equity. Opportunities may arise from distressed or highly leveraged investors and developers who acquired assets at the top of the market. Tighter financing conditions may also lead to some sale and leaseback deals. Although some forced sales may be inevitable under the current circumstances, it is apparent that in many cases the banks are renegotiating the terms of their loans with property owners, especially those clients with a good track record. By doing this they avoid taking back properties they have no desire to manage and forced sales are thereby avoided. This is especially the case with large unwieldy portfolios.

Source: European Commission

1%

0%

-1%

2010

2009

2008

2007

2006

2005

2004

-2%

Forecasts for selected European cities 2012 - 2020 GDP growth City

GDP growth National

4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5%

Stockholm

Amsterdam

Milan

Brussels

Frankfurt

Madrid

Paris

London WE

0.0%

Source: Oxford Economics

IPD average annual office returns (5 year) Capital value growth

Income return

London WE

Stockholm

Madrid

Amsterdam

Milan

Dublin

Berlin

Frankfurt

10.0% 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% -1.0% -2.0% -3.0% -4.0% -5.0% Paris CBD

The negative economic outlook and the uncertainty in the interbank market keep the investment market inactive indicting that yields can soften further in 2009 especially for secondary assets with shorter leases. Based on the falling trend of base rates and government bond yields, which can be used as the main indicators of the direction that property yields can go, we can anticipate at least prime yield decompression to reach its bottom by the end of 2009, especially in markets that are ahead in the cycle, such as the office markets in the UK and France.

Employment growth

2%

Brussels

Opportunity funds, national institutional investors, private investors for small lot sizes and selective german open ended and spezial funds, are expected to be the main types of buyers in 2009. National investors account for an increasing share of transactions over cross-border investors. High quality assets, in terms of location, tenant covenant and lease terms, at attractive pricing are the main targets, at the expense of secondary properties and locations. Secure, long term defensive income is key in the current market conditions. According to the IPD data even for the past five years that the markets experienced a strong yield compression, the main component of total returns in the European markets was income return.

GDP growth 3%

Sources: Experian, IPD

European Investment Bulletin - Spring 2009

5


Summary table (Q4 2008) City

Prime CBD offices Yield Rental growth 5.75% -1.3% 7.0% 0.0% 6.0% -5.6% 6.0% -3.4% 6.0% -19.7% 5.3% 5.5% 7.75% 0.0% 6.5% 0.0% 6.75% -27.6% 5.75% -27.8% 6.0% -9.5% 5.85% 8.7% 4.5% 3.6% 6.75% -8.8% 5.75% -6.4% 6.0% 0.0% 5.5% 0.0% 5.75% -14.3%

Amsterdam Athens Barcelona Brussels Dublin Frankfurt Istanbul Lisbon London, City London, West End Madrid Milan Munich Oslo Paris Rome Stockholm Warsaw

Prime warehouses Yield Rental growth 7.5% 0.0% 8.25% 0.0% 7.25% -2.9% 6.5% 0.0% 7.0% 0.0% 6.8% 0.0% 8.25% -2.7% 7.75% -0.8% N/A N/A N/A N/A 7.25% N/A 6.7% 3.3% N/A N/A 7.6% 0.0% 8.0% -1.9% 7.25% -20.0% 7.0% 0.0% 7.5% 6.5%

Prime shopping centres Yield Rental growth 6.5% 0.0% 6.75% -12.0% 6.5% 0.0% 6.0% 0.0% N/A N/A 5.6% N/A 7.5% -25.0% 6.0% 0.0% 7.0% 0.0% 7.0% 0.0% 6.5% 0.0% 6.0% 0.0% 5.0% N/A 7.2% -11.2% 5.25% 0.0% 6.75% 0.0% 5.5% 2.2% 6.75% -14.3%

Note 1: All costs are in â‚Ź/sqm/year Note 2: Prime offices refer to modern, minimum 1,000sqm, fully let, standard leased building Note 3: Prime warehouses refer to modern properties, minimum 10,000sqm Note 4: Prime shopping centre rental growth refers to a standard unit in a prime regional shopping centre Note 5: Athens, Dublin, London and Stockholm yields are quoted ‘Net’

For further information please contact

Giles Wilcox European Investment +44 20 7409 8864 gwilcox@savills.com

Lydia Brissy European Research +44 20 7016 3776 lbrissy@savills.com

Eri Mitsostergiou European Research +30 210 6996311 emitso@savills.com

Savills plc is a leading international property services company with a full listing on the London Stock Exchange. The company has undergone dynamic growth in recent years establishing itself as a powerful player on the international stage with offices and associates throughout the UK, Europe, Asia Pacific and Africa. In addition, Savills is the trading name for the property service subsidiaries of Savills plc which advise on commercial, rural, residential and leisure property. Other services include corporate finance advice, property and venture capital funding and a range of property related financial services. This bulletin is for general informative purposes only. Whilst every effort has been made to ensure its accuracy, Savills accepts no liability whatsoever for any direct or consequential loss arising from its use. The bulletin is strictly copyright and reproduction of the whole or part of it in any form is prohibited without written permission from Savills Research. (c) Savills Ltd February 2009

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