Continental carry trade
The big takeaway from the interim results season is the recovery in continental property markets. It’s been a decade since the listed sector in Europe signalled such a positive outlook in spite of some mixed performances in retail. Offices and logistics/industrial in all countries, and residential in almost all, would appear strong or in recovering phase, and with limited new supply. Combined with low interest rates and strong investment markets, this trend is partly reflected in share price performances, with the EPRA/NAREIT Index for the Eurozone showing an 8% TR in euros YTD, or 15% in sterling.
Colonial in Spain takes the prize as the most positive, particularly on the Barcelona office market, but perhaps the biggest change in sentiment this year is in Paris offices where Gecina, Icade, Unibail and Colonial are signalled good momentum. And it would appear the ‘Macron effect’ has been positive for the regional market with Foncierre des Regions and Icade both reporting improved take-up and rental growth in the larger cities. Meanwhile the Nordic markets continue to show good growth and limited supply, as reported by Entra, Wihlborg and Fabege; and the German office markets outlook remains positive (Alstria). Supply is coming through in Dublin, and Paris has the potential for higher supply, but at the moment Europe is not showing the same supply-side threats as we are seeing in the US (a key feature of the US REIT reporting season). Even the Dutch office market feels better!
Retail in Europe is more variable, with Unibail and Klepierre delivering good NRI growth (3.4% and 2.7% respectively), but the retail sales picture overall is challenging: Unibail showing +1.8% in France compared to Klepierre -0.4%, and Hammerson -3.1%. Both Unibail and Klepierre have taken great strides to sell smaller malls in order to concentrate on regional and super-regional retail and leisure assets, but one can’t help feeling that even the best malls with ongoing investment are at risk of going ex-growth. Unibail presented very clearly on why Europe represents such a different retail property dynamic compared to the US, but the bottom line is that Amazon is coming to Europe in size and sooner than you think! Ironically, both Simon Property Group and General Growth, the leading US mall REITs, delivered robust results for H1 and clear strategies on how they are managing the internet threat. Meanwhile Spain (LAR retail sales +3%) and the Nordics (Unibail +4.4%) showed the best retail sales growth in Europe.
UK consumer concerns
In the UK both Intu and Hammerson reported declining retail sales (-2.1% and -3.9%), not helped by a slowing economy and almost daily warnings of consumer indebtedness. So not only do we face structural changes in the face of e-commerce, but we now face cyclical weakness. Without compelling dividend yields it’s going to be hard for UK mall REITs to provide an adequate return for equity investors. The pressures on cost control and M&A will only intensify.
The UK consumer woes are highlighted in the weakness of the London second-hand homes market – Foxtons showing sales down 29%, EBITDA down 46% and profits down 64%. This is in contrast to the health of the regional new-build market where Taylor Wimpey delivered upgrades to its guidance; however 45% of its sales are financed via Help to Buy and so a review of this policy could have implications for the UK homebuilders in spite of the on-going housing shortages.
In contrast, Segro delivered a strong set of interims, confirming the structural change in both consumer and business demand towards logistics, both big box and last mile. Segro now has its largest ever development programme, 12 projects in the UK and 28 in Continental Europe, totalling one million square metres and substantially pre-let with good ongoing tenant demand. ProLogis, the US logistics giant with operations worldwide, confirmed logistics demand is particularly strong in Europe, although they commented that growth in the UK has slowed in Q2. ProLogis also outlined why healthcare could be the next big structural driver of logistics demand.
London still in business
The surprise this summer has been the strength of the London office leasing market, in spite of numerous announcements from investment banks of impending investment in Frankfurt, Paris, Amsterdam and Dublin ahead of the 2019 Brexit deadline. The improved momentum in Q2 was evident from the CBRE London office update, with Q2 take-up of over 3msf and perhaps more importantly 3.5msf under offer (albeit including the exceptional growth in serviced offices which count only as take-up in the stats). With speculative schemes continuing to be deferred, CBRE forecast peaks in vacancy rates of <8% in the City (2019) and <6% in the West End (2018). And record H1 lettings from Derwent London continue to demonstrate the strength of tenant demand for state-of-the-art space at mid-market rents. Meanwhile, overseas interest in trophy London office investment remains voracious!
Contrasting capital markets
So while British Land and Landsec announced returns of capital following the recent sales to Asian investors of the Cheesegrater and Walkie Talkie respectively, the UK stock market has been raising capital for smaller newcomers offering investors income security and yield, with modest growth (ironically a similar equity story to the UK majors stuck on discounts!). I am slightly surprised at the success of the new social housing REITs, as this is a market which historically has been a victim of over-regulation, but clearly there is a demonstrable need for new investment into UK housing and for these listings to be successful. The two commercial newcomers which caught my eye are LXi (offering an alternative to Secure Income REIT) and Pacific Industrial & Logistics (last mile logistics, and of Beckwith pedigree).
MiFID II
But who is going to research these smaller stocks? For years key investors and intermediaries have been advocating fewer and larger UK stocks with liquidity and yield, but instead of M&A we have a plethora of smallcap IPOs (and yes I’ve done my share over the years!). With MiFID II just a few months away, sell-side research faces another challenge to its business model. For the few quality independent equity research houses, such as Lazarus, it could accelerate the opportunity.
