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Urban LandInstitute$

2006

Real Estate®

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EmergingTrends

Real Estate®

Europe

Emerging Trends in Real Estate® Europe 2006

A joint venture of:


Underwritten in part by:

Executive Summary

Chapter 1 A Liquidity HurricaneMore Buyers Than Sellers by a Very Fat MarginInflation: Shifting to Lower VolatilityA Repositioned Asset ClassGrowth Is Picking Up—But Not by MuchReturns Still Attractive Relative to Other Asset ClassesPan-European Investment: the Flexible FriendIndirect Investment Gets Growing PainsYou Can Get It if You Really Want—but at What Price?Development Is Back on the MenuThe Universe Is Expanding—Even Core Investors Are Going NicheMixed Use Moves Up the AgendaWanted: Corporate and Government Assets Infrastructure Gets a New Fan ClubSustainability Issues Barely SurfaceGoing East for Opportunity

Chapter 2 Real Estate Capital FlowsCapital Trends: Equity Capital Trends: Debt

Chapter 3 Markets to WatchThe Top Ten MarketsThe Middle-Ranked MarketsChallenging Markets

Chapter 4 Property Types in Perspective Retail HotelsIndustrial Residential Office

Interview Participants

Contents1

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2006Real Estate®

EmergingTrendsin

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ii Emerging Trends in Real Estate® Europe 2006

Editorial Leadership TeamEmerging Trends in Real Estate® Europe 2006 ChairsRichard M. Rosan, Urban Land InstitutePatrick R. Leardo, PricewaterhouseCoopers

Principal Authors and Senior AdvisersKate Gimblett, Urban Land Institute ConsultantSteve Laposa, PricewaterhouseCoopersAndrea Carpenter, Urban Land Institute

Editor and Senior AdviserDean Schwanke, Urban Land Institute

Senior Adviser and PublisherRachelle L. Levitt, Urban Land Institute

Senior Adviser and Contributing ResearcherStephen Blank, Urban Land Institute

Senior AdvisersWilliam Croteau, PricewaterhouseCoopersJohn Forbes, PricewaterhouseCoopersPeter F. Korpacz, PricewaterhouseCoopersHenrik Steinbrecher, PricewaterhouseCoopersFrank van Zelst, PricewaterhouseCoopers

ULI Editorial and Production Staff Nancy H. Stewart, Managing EditorDavid James Rose, Manuscript EditorByron Holly, Senior Graphic DesignerCraig Chapman, Director of Publishing Operations Jason Scully, Senior Research AssociateClara Meesarapu, Administrative AssistantKarrie Underwood, Administrative Assistant

PricewaterhouseCoopers Contributing ResearchersAustria Dirk KadelBelgium Alain FisetCzech Republic Hans van Capelleveen, Glen Lonie,

Michal AdamovskyFrance Yvan Gril, Laurian DouinGermany Jochen Brücken, Helmut Trappmann,

Thomas Veith Greece Constantin Pechlivanidis,

Theo SmyrniotisHungary Paul GrocottItaly Margherita BiancheriNetherlands Wileke Ong, Jeroen Elink SchuurmanNordic Jorgen Sigvardsson, Robert FonovichPoland Malgorzata Cieslak, Tomasz TrzosloPortugal Patricia Reis, Cidalia Santos,

Antonio Rodrigues, Goncalo Silva AdriaoRomania Edwin Warmerdam, Richard GrotendorstRussia Brian Arnold, Marina Kharitidi,

Steven SnaithSpain Guillermo Masso, Angel Bravo OlacireguiSwitzerland Kurt RitzTurkey Adnan Nas, Ozlem Guc Alioglu,

Ersun BayraktarogluUnited Kingdom Mark Charlton, Sandra Dowling

Emerging Trends in Real Estate® is a registered trademark ofPricewaterhouseCoopers LLP.

© January 2006 by ULI–the Urban Land Institute andPricewaterhouseCoopers LLP.

Printed in the United States of America. All rights reserved. No part of this book may be reproduced in any form or by anymeans, electronic or mechanical, including photocopying andrecording, or by any information storage and retrieval system,without written permission of the publisher.

Recommended bibliographic listing:ULI–the Urban Land Institute and PricewaterhouseCoopers LLP.Emerging Trends in Real Estate® Europe 2006. Washington, D.C.: ULI–the Urban Land Institute.

ULI Catalog Number: E24ISBN: 978-0-87420-949-5

PrefaceA joint undertaking of the Urban Land Institute (ULI) andPricewaterhouseCoopers, Emerging Trends in Real Estate® Europeis a trends and forecast publication now in its third edition. Thereport provides an outlook on European real estate investment anddevelopment trends, real estate finance and capital markets, prop-erty sectors, metropolitan areas, and other real estate issues.

Emerging Trends in Real Estate® Europe represents a consensusoutlook for the future and reflects the views of more than 300individuals who completed surveys and/or were interviewed as apart of the research process for this report. Interviewees and sur-vey participants represent a wide range of industry experts—investors, developers, property companies, lenders, brokers, andconsultants. ULI and PricewaterhouseCoopers researchers per-sonally interviewed over 150 individuals, and survey responseswere received from 157 individuals whose company affiliationsare broken down as follows:

Real Estate Service Firm 29%Private Property Company 19%Developer 15%Publicly Listed Property Company 12%Institutional Investor 11%Investment Bank 6%Commercial Bank 5%Other 2%

A list of the interview participants in this year’s study appears at the end of this report. To all who helped, the Urban LandInstitute and PricewaterhouseCoopers extend sincere thanks forsharing valuable time and expertise. Without the involvement ofthese many individuals, this report would not have been possible.

Emerging Trends in Real Estate® Europe 2006 1

n Market opinion is both divided and undecided as to whetherwe are in a period of structural change in the equilibrium valueof real estate or in the thrall of “irrational exuberance.” Themajor challenge in 2006 is to negotiate the imbalance betweeninvestable funds and available assets without moving pricing toa dangerously unsustainable level.

n Sentiment is hugely weighted to the “buy” side. Even the lowest-ranked city markets have much higher “hold” recommendationsthan “sell.” A vocal minority of those surveyed believe this isindicative of a market nearing its peak. However, there are a fewwho firmly believe that we are in a market bubble that will burstin the next 12 months.

n There is an increasing consensus that real estate has beenrepositioned as an asset class. This contention is supported bythe continuing increase in strategic institutional target weight-ings in real estate. Private equity, venture capital, and hedgefunds that invest in real estate–related assets are all now therecipients of increasing percentages of institutional allocationsin addition to core investments.

n The German open-ended funds are in deep trouble and will bethe only source of equity not expanding in 2006. According toofficial figures, they experienced €3.43 billion outflows in 2005,€3.05 billion of these in December alone as fear left investorsrunning for the exit doors following the freezing of one of thelargest funds. A general loss of confidence has taken hold and thefunds currently face potential regulatory changes from bothwithin the industry and from the German federal government.The only ray of light is the timely explosion of internationalinterest in German real estate that could bolster the value of thefunds’ holdings. The increase in cross-border traffic hunting forGerman assets is one of the most significant changes highlightedby our survey and interviews since a year ago.

n The nonlisted vehicles sector is experiencing growing pains.The number of investors now wishing to get into funds has cre-ated waiting lists for some funds. In addition, many large insti-tutions are questioning the utility of investing in closed-endfunds when the biggest problem they face is reinvestment risk.The new “flavour du jour” is the institutional open-ended fund,which has no expiration date. Despite the current problems,indirect investment is still deemed the most efficient route tocross-border investment for the majority of investors.

n Listed real estate in Europe will receive continued firm sup-port in 2006. There is growth in global investor interest andEuropean institutions have huge sums to put into the listed realestate sector if more tax-transparent REIT vehicles become avail-able. French SIICs will expand markedly in 2006 as more corpo-rates sell their property assets into the sector. REIT legislationhas been proposed in the U.K. that would come into effect inJanuary 2007, but crucial details have yet to be disclosed. TheGerman government has also committed itself to introducing aG-REIT, but the vehicle may not be tax transparent.

n The past year saw the emergence of a real estate derivativesmarket in the U.K. The range of potential transaction types isalready on the rise because established derivatives professionalswho are familiar with how quickly these markets can grow arekeen to develop the market. The world’s largest interdealer bro-ker has expressed intent and another major international inter-

dealer broker has partnered with an international real estateadvisory group to create over-the-counter (OTC) property deriv-atives for both U.K. and continental commercial property. Inaddition, at least three major international banks have commit-ted themselves to the market.

n Growing numbers of investors are now prepared to take devel-opment risk. Even speculative development is making a come-back. A significant number of investors are looking to team upwith developers to get product for their portfolios.

n The shortage of conventional real estate is forcing investors tolook at a much broader range of assets than ever before. A hugearray of investors are interested in gaining exposure to new areassuch as nursing homes, retirement communities, student hous-ing, self-storage, car parking facilities, pubs, recreational facili-ties, spas, resorts, entertainment complexes, condo-hotels,schools, hospitals, airports, and other infrastructure assets.

n There will be a substantial increase in the availability of debtfinance from all sources. Rising competition has sent margins ona downward trajectory and no one expects any relief this year.The investment banks engaged in securitisation are frequentlycited as the major force behind increasingly aggressive pricing.

n Substantial further growth in CMBS issuance is expected for2006. This will be driven by rising numbers of conduit pro-grammes, expanding appetite for CMBS on the part of a widen-ing pool of investors from all over the world, and the fact thatthis is the cheapest form of real estate finance for many borrow-ers. B-note issuance will also grow because it enables CMBSarrangers to achieve better pricing on the senior or A-note of asecuritisation. There is also a considerably expanded pool of ded-icated mezzanine investors looking for B-notes.

n The top markets for solid risk-adjusted returns will be Paris,London, Helsinki, Madrid, and Barcelona, in that order. Parisand London were in the top five last year, but Helsinki has risenfrom fifth place while last year’s number two, Milan, has fallenwell down the rankings. All the favoured markets have goodprospects for rental growth.

n The sustained downward shift in yields has sent manyinvestors seeking higher returns out to new markets—most ofthem to the east. A surprisingly diverse set of investors is nowlooking at Romania and other nascent central and easternEuropean markets. However, the big movers are heading to theFar East and India because they offer investment opportunitiesin larger scale.

n Istanbul and Moscow retain the top rankings for develop-ment prospects for the same reasons cited in last year’s report.These are fast-growing economies with a shortage of modernhigh-quality assets, but the risks have to be carefully mitigatedin any project.

n The best sectors in which to invest will again be retail parksand shopping centres, but there are increasing concerns about anumber of markets, so investors must be discerning. Hotels riseto third place from sixth in last year’s survey, pointing to theirincreasing acceptance as a mainstream sector. In addition, theyare beneficiaries of improving cyclical factors as well as the secu-lar increase in intra-European leisure travel.

Executive Summary

A Liquidity

A Liquidity


Deals that might have attractedtwo or three bids in the past are now

attracting 30 or 50 or even more.

c h a p t e r 1

HurricaneEurope’s real estate markets enter 2006 at levels where

investors are going to have to make some toughjudgement calls. Are we in a period of fundamental

change in the equilibrium value of real estate due to a “struc-tural change in demand for the entire asset class”—or are wein the thrall of “irrational exuberance” that will “ultimatelylead to overshooting” and “end in a train wreck”? The 2006survey and interviews for Emerging Trends show that marketopinion is both divided and undecided. But, if actions speaklouder than words, then the escalating appetite for Europeanreal estate assets appears to show that the path of least resist-ance for now is to keep buying.

More Buyers Than Sellers bya Very Fat Margin“The market has gone white-hot.” “We’re having to take onmore and more risk for less and less return.” “People are pre-pared to pay what would have been considered crazy yieldsonly a year ago.” These comments are heard across almost all

of the major markets. Deals that might have attracted two orthree bids in the past are now attracting 30 or 50 or evenmore. One investor said, “We lost an asset in Warsaw. If youadded up the bids for that asset, it was more than the totalinvested in Poland in 2004.” This type of bidding war accel-erated yield compression in the final quarter of 2005, accord-ing to those interviewed, and the acceleration came on top ofheady yield compression already documented in most of themajor markets during the first three quarters of the year.“Has pricing gone too far?” “How do you price risk and whatis an acceptable rate of return?” These are the questions inmany investors’ minds.

The presence of debt-driven buyers particularly challengesseasoned European real estate professionals. Bidding warsover prime assets—and even secondary assets—are so com-petitive that many investors who were formerly able to takeout an asset when they really wanted it have been beaten by awide margin in the past year, often to a debt-backed playerwith leverage in excess of 90 percent or even 95 percent. It isnot uncommon to hear: “We bid on something and it wentfor a price that was our year-three exit value.” The sceptics

confined to particular pockets of the markets with thestrongest economies rather than across the board. Moreover,most of the mainstream data do not reflect incentives such asrent-free periods and thus overstate yields. Nevertheless, thereis some optimism that the worst may be over.

A look at our survey statistics on city markets reveals thatin each city and major sector, sentiment is hugely weighted to the “buy” side. Even the lowest-ranked city markets havemuch higher “hold” recommendations than “sell,” while thevast majority of recommendations on even middle-rankedmarkets are unequivocally “buy.” This is not a market that isgoing to correct anytime soon in the judgement of most ofour interviewees and those surveyed. However, a minoritybelieve this is indicative of a market nearing its peak. Thosewho are most sceptical of current market conditions say thatthis is “just another cycle” and cap rates could correct as soonas the second half of 2006. They point in particular to thedebt-driven buyers who “will disappear as soon as the arbi-trage between borrowing rates and yields disappears.” The

The decline in yields has to stop at some point, but few of those we interviewed believe that it is going to stop in 2006.

4 Emerging Trends in Real Estate® Europe 2006

are faced with a dilemma. Do they adjust their target returnsdownward or do they sit and wait for a correction that maynot come? There are some—but not many—who are selling.“These things run in cycles. There’s going to be disappoint-ment in a few years because things like replacement costeventually do matter.” “We’ve lost sight of residual values atthese levels.” “People understand risk and return—but not atthe same time. We won’t have lower returns forever.”

The decline in yields has to stop at some point, but few ofthose we interviewed believe that it is going to stop in 2006.The majority believe that there is simply too much moneypouring into European real estate relative to the near-term sup-ply of assets. “This is a liquidity hurricane.” “Capital is comingout of every orifice.” “New investors are popping up everyday—U.S. investment banks, Middle Eastern petro dollars,Australian REITs, hedge funds, and deep pockets of privatemoney from the Far East.” At the same time, “It’s a totallyproduct-starved market and people who are potential sellersonly do so because they think they can get an unbelievablygood price.” And of course, many of those who do sell thenhave the dilemma of getting the money back in the market.

The shortage of product has meant that turnover has notincreased as much as it might have done in the past year andthere are lots of disappointed buyers with cash awaitingdeployment. Nevertheless, profits in 2005 were good and ourcurrent survey anticipates even better profit growth in 2006(see Exhibit 1-1). Much of this optimism is based on the sheerweight of money coming into real estate, but there is somefundamental comfort, too. Occupier markets have stabilisedin many major markets, vacancy has ceased its vertiginousincreases, and in a few markets headline prime rents have evenstarted to rise. However, for now the recovery is patchy. It is

Exhibit 1-1 Real Estate Firm Profitability Prospects

2005 2006

7.16.79

Source: Emerging Trends in Real Estate Europe 2006 survey.

Note: 6 = modestly good, 7 = good, 8 = very good.

Exhibit 1-2 Survey Responses by Geographic Scope of Firm


European Firm with aPan-European Strategy

26.14%

Other 13.73%

European FirmFocussed Primarilyon One Country35.95%

Global Firm with a Global Strategy

24.18%

Exhibit 1-3 Survey Responses by Country


United Kingdom23.57%

Sweden 1.91%

Portugal12.10%

Spain11.46%

France 10.83%

Germany 8.92%

Italy 6.37%

Turkey 3.82%Russia 3.18%

Netherlands 3.18%Poland 2.55%Belgium 1.91%

Greece 1.91%Hungary 1.91% Other Europe

6.37%

funding rates for these players are determined by market-driven bond yields and swap rates that have been highlycyclical in the past. “Bond yields look dangerously low and areversal in the fixed-income markets would send real estatepricing into a tailspin.”

Inflation: Shifting to LowerVolatilityThere are plenty of players in the real estate markets whowould like nothing better than a nasty surprise increase ininterest rates and bond yields just big enough to “get rid of the debt-driven buyers who are mucking up pricing.”However, our interviews indicate that the majority of partici-pants expect only marginal increases in Eurozone interestrates in 2006. Moreover, for the U.K., most expect anothermodest reduction in interest rates.

The fixed-income markets clearly back the real estate mar-ket’s judgement. The swap and bond yield curves are indicat-ing that the fixed-income markets expect both low inflationand a low volatility of inflation. As a result, they also expectlow volatility in interest rates. They are certainly not dis-counting a big cyclical swing at present. The bottom line forreal estate is that the current financial conditions driving realestate pricing are not expected to disappear anytime soon.

There is also an important trend in the “big picture” forbond markets that is influencing fixed-income pricing and, inturn, the pricing of real estate finance. The growing percent-age of populations nearing retirement in most developedcountries has increased the need for assets that will generatelow-risk, long-term cash flows to fund pensions. As a result,the demand for long-maturity investment-grade bonds hasincreased dramatically. This has caused the yield differentialsbetween medium-term bonds and riskier long-term bonds to diminish or, in some cases, to disappear entirely. At theextreme, there are markets such as the U.K. where the riskiestgovernment bonds, the 30- and 50-year gilts, yield less thantwo-year gilts. If this sounds strangely familiar to real estateplayers, it is because their markets are being influenced by the same “big picture” trends. It also explains why long-termfinance for real estate is so cheap.

A Repositioned Asset ClassWhile it is hard to find anyone who is not wary of pricinggoing forward, there are few—even among the sceptics—whofirmly believe that we are in a market bubble that will burstin the next 12 months. “A pending disappointment” or “aslow deflation back to realistic levels after 2006” are morecommon expectations. For others, “current market levelspotentially represent a new mean for values.” What tempers

pessimistic opinions and underpins the beliefs of the opti-mists is the increasing consensus that real estate has beenrepositioned as an asset class. This contention is supported by the continuing increase in strategic (i.e., long-term) insti-tutional weightings in real estate.

“The pension funds are back because they ‘lost the ranch’in equities” is the sceptical view of the current institutionalenthusiasm for real estate. While there is a kernel of truthhere, it ignores demographic trends and the changes in theway pension fund liabilities are accounted for in corporatebalance sheets, which are the major drivers of renewedappetite for cash-generating assets. The principal force behindthe twin shift to higher fixed-income and real estate weight-ings in institutional portfolios is the ageing populations inthe majority of European countries and the need to fundtheir pensions with long-duration, low-volatility assets thatgenerate reliable cash flows. Real estate now “fits the bill” in a way it could not even a mere five years ago.

Until recently, the absence of reliable statistical informa-tion on most real estate markets handicapped the entire assetclass as far as institutional investors were concerned. The lackof robust long-term statistics on performance and the result-ing inability to analyse the risk-return characteristics of realestate with confidence meant one could not do meaningfulcomparisons with equities and bonds. This is all changingwith the increase in the number of reliable indices and therising turnover in real estate assets. “The tool kit is now get-ting there for real estate in the way it has been there for otherasset classes.” The institutions and their consultants are get-ting more of the information they need to justify higherexposure, and the improvement is set to continue in 2006.Moreover, this information gap is declining in tandem with a rise in liquidity. Since portfolio theory—which underpinsinstitutional investment models—dictates that increasinginformation and liquidity will drive down risk premiums, atleast some of the reduction in yields we are witnessing makesperfect sense. “The new equilibrium value for the market—whatever it turns out to be—will be higher than it was whenliquidity was low and markets were opaque.”

Growth Is Picking Up—ButNot by MuchEconomic growth forecasts for the Eurozone in 2006 areactually being revised upward at the time of writing, which isa welcome contrast to what was happening a year ago. Whileno one is expecting to see strong gross domestic product(GDP) growth in the Eurozone, the anticipated increase to

that it is going to stop in 2006.


around 1.7 percent or perhaps even a bit higher for the areaas a whole provides some much-needed underpinning foroccupier markets.

Germany in particular has seen some surprisingly positivesurveys on business confidence and business conditions. Asthe largest economy in the Eurozone, a somewhat healthiergrowth rate in Germany bodes well for the rest of the region.However, almost all of Germany’s growth is export led,thanks to a weaker euro exchange rate and strong GDPgrowth outside of Europe. This is feeding healthier corporateprofits—but so are negotiated wage cuts, outsourcing, andmass redundancies. As a result, consumer spending remainsweak and employment growth is not evident, so the pictureis hardly one of unalloyed cheer. Although consumer confi-dence and retail sales started to rise in the autumn of 2005,they were still below their year-earlier levels. Also, the retailsales pick-up may have been due to fears that the new coali-tion government in Germany would raise the value-added tax(VAT) rate this year. In the end, the government postponedthe VAT rise until 2007 and this will push forward some wel-come consumer spending into 2006. But, it also holds thedanger that 2007 will see recovery go into reverse before itreally gathers momentum.

Nevertheless, there is currently an explosion of interna-tional interest in German real estate based on the assumptionthat the bottom of the cycle has been reached. This is one ofthe biggest changes highlighted by our survey and interviewssince a year ago. Investors from all over the world are comb-ing Germany for assets. At the same time, German investorsare focussed on diversifying out of their home market andhappy to sell if a fat price can be achieved. This sudden stam-pede into what is, ironically, one of the most opaque andfragmented markets in Europe has prevented the distressedselling that many had anticipated. On the contrary, competi-tion for assets has been fierce and information is so patchythat “pricing is all over the place.” One thwarted investorobserved, “We have occasionally been beaten by 10 or 15percent in other countries, but in Germany we were beatenby a 100 percent in several situations!” In fact, “The onlycommon denominator on Germany is total confusion.”

Elsewhere in the Eurozone, France and Italy are also seeingstronger data for both the business and consumer sectors andguarded optimism is mounting for 2006. The pick-up inFrance is expected to be modest and will take growth to theEurozone average, while Italy has glimmerings of hope that itwill overcome the stagnation of the past year and return togrowth, albeit subpar in comparison with the rest of the E.U.Little more can be expected because political leadership is lack-ing and Italy’s structural problems will not be confronted untilafter the elections that take place this year. Likewise, the policyinitiatives needed in France are unlikely to be seen until afterthe next elections there, which don’t take place until 2007.

The Benelux countries are all forecast to achieve highergrowth on the back of the uptick in German activity, butwhether this will be sufficient to generate stronger occupiermarkets this year is open to question. Once again, the strongestgrowth is expected in the periphery of the Eurozone, i.e.,Spain, Finland, and Ireland, and this is reflected in the enthusi-asm for these markets in our survey, despite market pricingthat a number of those interviewed regarded with discomfort.

Growth rates are expected to be relatively stronger outsidethe Eurozone, as was the case in 2005. The Nordic region islikely to maintain firm if unspectacular growth, with Swedenexperiencing a pick-up to 2.9 percent thanks to the low inter-est rates that were maintained throughout 2005. However,this will not bump up occupier demand sufficiently to eradi-cate an office vacancy rate in Stockholm that exceeds 17 per-cent. The U.K. is expected to recover modestly from its dis-appointing performance in 2005 thanks to easier monetarypolicy, although the forecast 2.2 percent GDP growth rate iswell below the 3.2 percent achieved in 2004. Consumers’reluctance to take on more debt is one cause of the slowergrowth and this is hitting U.K. retailers. However, occupier

The economic picture looks a bit rosier for Europe’s occupier markets this year than it did at the start of 2005.


Exhibit 1-4 European Economic Growth: Consensus Forecasts

Source: Consensus Economics Inc. (www.consensuseconomics.com)November 2005.

* Projections.

Percentage Real GDP Growth2003 2004 *2005 *2006

Russia 7.3 7.2 5.9 5.7Turkey 5.8 8.9 5.1 5.0Ireland 4.4 4.5 4.7 4.6Czech Republic 3.2 4.4 4.8 4.3Poland 3.8 5.4 3.2 4.3Hungary 3.4 4.6 3.9 4.0Spain 3.0 3.1 3.3 3.1Greece 4.6 4.7 3.2 2.9Sweden 1.6 3.1 2.5 2.9Finland 2.4 3.5 2.1 2.9Denmark 0.6 2.1 2.4 2.2United Kingdom 2.5 3.2 1.8 2.2Austria 1.4 2.4 1.9 2.1France 0.9 2.1 1.6 1.8Belgium 1.3 2.7 1.4 1.8Netherlands -0.1 1.7 0.6 1.8Switzerland -0.3 2.1 1.2 1.7Portugal -1.2 1.2 0.9 1.4Germany -0.2 1.6 0.8 1.2Italy 0.4 1.0 0.1 1.2

Eurozone 0.7 1.8 1.3 1.7

demand for the important London West End and City officemarkets has already turned the corner.

Once again, top E.U. growth honours go to the newaccession countries. Poland, Hungary, and the CzechRepublic are all expected to grow at rates in excess of 4 per-cent, with inflation remaining well contained despite higherenergy prices. These economies have very close trading tieswith Germany, so they will benefit from the increased activityin Europe’s core economy as well as from firm domesticdemand driven by consumption and investment growth.Foreign direct investment continues to pour into all threecountries and that bodes well for the long-term future oftoday’s real estate investments.

However, the highest growth rates for the markets coveredin this report are again to be found well outside of the E.U.Russia’s oil- and commodity-fuelled economy will continueto benefit from the consumer boom that is being fed by ris-ing incomes, falling unemployment rates, and the increasingavailability of credit. Investment appears to be picking upnow, too, so GDP growth is likely to be more balanced in2006 than last year, although inflation will remain a problem.The outlook for the Turkish economy is equally impressive.Turkey is expected to achieve another year of firm growthcombined with falling inflation. This should allow the mone-tary authorities to cut interest rates further, which will pro-vide a boost to the new retail and commercial mortgage mar-kets. Turkey’s E.U. accession talks have started, and while theprocess is expected to take at least a decade, it is providing agenuine spur to economic stabilisation efforts.

All in all, the economic picture looks a good bit rosier forEurope’s occupier markets this year than it did at the start of2005. What worries real estate investors is that an externalevent that no one has foreseen will suddenly materialise to“upset the applecart.” “It’s often a bolt from the blue that turnsthings upside down.” “The thing to worry about is the disrup-tive event that you can’t predict.” Some of those interviewedexpressed concerns about bird flu crippling the business envi-ronment. One interviewee noted, “I was in Toronto during theSARS outbreak and you could have shot a cannon down themain thoroughfares.” “If bird flu turns into a human pan-demic, all bets are off.” Still, as another player put it, “Themarkets have already had everything you can imagine thrownat them—wars, terrorist attacks, tsunamis, earthquakes, hurri-canes . . . and we still have more investors coming in.”

Returns Still AttractiveRelative to Other Asset ClassesOur survey indicates that investment prospects for 2006 haveimproved for both real estate and equities relative to a yearago. Surprisingly, those surveyed still believe that real estatehas the best outlook relative to other asset classes despite thephenomenal performance of the past year. Asian real estatetops the charts for the second year running, but Europeandirect real estate investment and European private vehicles arenot far behind. The laggard is U.S. real estate, which mayexplain why so many U.S. investors are now hunting aroundEurope and Asia. Our sister publication on the U.S. real estatemarket shows that sentiment on the other side of the Atlantichas moved hugely to the “sell” side, while our European sur-vey is overwhelmingly weighted to the “buy” side.


it did at the start of 2005.

0% 5% 10% 15% 20%

2004

2003

2002

2001

Exhibit 1-5 Real Estate Total Returns forSelected Countries

Sources: Investment Property Databank (IPD), KTI Finland.

Note: In local currencies. Figures for 2005 are available for Ireland and the U.K. only. Ireland provided 19.6 percent total returns for the 12 months ending in September 2005, and the U.K. provided 17.5 percent total returns for the 12 months ending in October 2005.

U.K.

Ireland

Spain

Portugal

France

Italy

Netherlands

Denmark

Sweden

Switzerland

Germany

The outlook for Europe’s publicly listed real estatecompanies is even perkier than the outlook for the widerEuropean equity market, according to those surveyed. Thisoptimism might be due to enthusiasm about the introductionof REIT legislation in the U.K. (although there will be noU.K. REITs before 2007) and the expansion of the SIIC(French REIT) sector in France.

Once again, prospects for bonds are deemed to be unex-citing, which is not surprising given the low level that yieldshave been chased to. Meanwhile, cash comes in at the bot-tom of our survey, which is consistent with the view that biginterest rate rises are not in the cards for 2006.

Pan-European Investment:the Flexible FriendPan-European investment will continue to expand in 2006.The usual motivations of diversification and the potential tomake higher returns than those available in one’s home marketremain. But, on top of this, the flood of money coming in

and the increase in competition that accompanies it meanthe big players need more options in order to merely acquiresufficient assets. “There is no way you can get large amountsof money into this market without being pan-European.”“You can’t focus too narrowly; you have to be flexible.”

Cross-border investment grew 27 percent during the firsthalf of 2005 in comparison with the same period a year ear-lier, according to Jones Lang LaSalle, and there is no reason toexpect growth will slow in 2006. “Cross-border is an unstop-pable trend.” This growth is not due to government initiativesat the European level to foster cross-border investment sincethere have not been any. In fact, quite the opposite is occur-ring. “There’s no hope of E.U. harmonisation.” “Property lawand tax law will be the last bastions of sovereignty since it’smore or less impossible to harmonise legislation.” What hascontinued to evolve is transparency and the efficiency of serv-ice providers such as lawyers, accountants, and agents. “The

more you do things, the more efficient everybody gets.” “Thetax side remains a challenge, but not a barrier.”

Legal experts are working hard to try to find holdingstructures that could enable investors from anywhere to investat the top level of a fund of funds, but this legal Valhalla hasnot been discovered yet. So, for the present, building a pan-European portfolio remains the cumbersome bespoke task ofstringing together properties in a myriad of special-purposevehicles under the umbrella of an appropriately domiciledholding company (usually in Luxembourg). On the plus side,

“There is no way you can get large amounts of money into this market without being pan-European.”


0.0 4.5 9.0

Exhibit 1-6 Investment Prospects by AssetClass for 2006


1 5 9Abysmal Fair Excellent

Asian Direct Real Estate Investments

European Direct RealEstate Investments

European Private Real Estate Vehicles

European Publicly ListedReal Estate Companies

U.S. Direct Real Estate Investments

International Equities

European Open-Ended Funds

European Equities

International Bonds

European High-Yield Bonds

European Investment-Grade Bonds

Cash

6.70

6.55

6.48

5.88

5.87

5.78

5.47

5.46

4.95

4.80

4.66

4.21

0

20

40

60

80

100

120

2H 2005 ProjectionCross-Border Investment

Domestic Investment

Exhibit 1-7 European Direct Real EstateInvestment

Source: Jones Lang LaSalle European Research.

Note: Figures exclude Portugal and Denmark. Cross-border investmentactivity is defined as any direct transaction that involves a foreign buyeror seller.

Billi

ons

of E

uro

2000 2001 2002 2003 2004 1H 2005

62.23

23.59

39.64

72.87

25.05

47.82

84.80

33.91

50.89

85.74

40.24

45.50

102.20

46.32

55.88

105.96

58.02

24.07

23.87

a degree of standardisation has crept in among the big lawfirms that has somewhat reduced the time and expenseinvolved. Documentation is now often done in English withan Anglo-Saxon model for leases. However, a pan-Europeanportfolio remains a much more expensive beast to assemblethan its single-country equivalent. For many, the level ofexpense and complexity is daunting—and this is assumingthat you have somehow managed to obtain the assets.

For the majority of investors, a local office or a local part-ner is still needed if one is to have any hope of success inaccessing product, even in core markets. As to markets out-side the core, “they remain fragmented and lack transparency,which is a huge barrier to doing business unless you partnerwith someone local.” “Real estate is, and always will be, alocal business.” “You have to team up with a long-term localpartner who knows the hidden rules.” Ironically, as cross-bor-der investment grows, so does demand for trustworthy expertlocals, and the difficulty in finding or retaining them is fre-quently mentioned. Some local experts who used to work asoperating partners with international investors are becomingfund managers themselves as they see more lucrative opportu-nities to capitalise on their expertise through going it alonewith their own fund.

Indirect Investment GetsGrowing PainsThe financial and human resources, critical mass, and localexpertise required for pan-European investment continue topush a significant number of those who wish to diversifyacross borders into indirect investment. Both listed funds and

private vehicles continue to multiply and attract new adher-ents. They are available in every style, sector, and geographi-cal region. Some are diversified and others are specialised.Investing indirectly neatly circumvents many of the obstaclesfaced by those who wish to go cross-border, making them thepreferred route for all but the largest institutions. However,they are not without their problems at present.

The number of investors now wishing to get into fundshas created a veritable logjam that is likely to persist wellbeyond 2006. Many of the vehicle managers we interviewedsaid that they had long waiting lists to get into their fundseven after accepting double the amounts they had initiallyhoped to attract. “People are now deliberately oversubscribingfor funds because they know they’re going to be cut back.”“Raising money isn’t the problem—investing it is the prob-lem.” “Not everyone who has raised money will be able to getit all in the market.” More than one client institution admit-ted, “We assume a certain percentage of the funds in thesevehicles will never get invested.”

The difficulty of getting money into the market has pos-sibly been responsible for fewer (albeit larger) funds beinglaunched during the first three quarters of 2005, according toINREV. This is a considerable change from the past eightyears in which relentless growth in the number of new fundswas witnessed in the INREV universe. Another change intrend is occurring in fees. These had previously been declin-ing for several years due to competitive pressures, but fees arenow on the rise as experienced fund managers capitalise onincreasing demand for their services. Of course, “track recordis what you pay for and it is by far the most important factorin fund selection.” Also, under current market conditions


without being pan-European.”

0%

10%

20%

30%

40%

50%

Exhibit 1-8 Cross-Border Real Estate Investment Activity by Country

Source: Jones Lang LaSalle.

U.K. France Sweden C.E.E. Spain Netherlands Italy Germany Belgium Finland

n 2000 n 2001n 2002 n 2003n 2004 n 1H 2005

greater effort is required by fund managers to achieve thedesired returns. However, it remains to be seen whether man-agers can deliver returns in more difficult markets. Thesefunds did not exist at the time of the last market cycle.

Along with rising fees, investors are observing a weaken-ing in covenants in favour of the fund managers. Technicalpoints such as default clauses, exclusivity, and terminationrights are critical to some institutions, and several long-termparticipants in the indirect market are now turning backtoward doing more direct investment with local joint venturepartners due to the deterioration in covenants. In addition,many large institutions are questioning the utility of investingin closed-end funds when the biggest problem they face isreinvestment risk. “What good is a fund that matures andreturns my money after seven years when I can’t even get tomy target weighting?” In response to the latter problem, thenew “flavour du jour” is the institutional open-ended fundthat has no expiration date. Several of these have already beenlaunched and more are expected in 2006.

Despite the current problems, indirect investment is stillthe most efficient route to cross-border investment for themajority of investors. There are more systematic data onfunds, and this will continue to improve during 2006 withinitiatives from organisations such as INREV and IPD. There

is also growth in the number of “fund of funds” on offer andthese are attractive to those seeking to have diversification oftheir holdings done by specialists in this area, albeit at aprice. And for those who want “hands-on” exposure, theclosed-end unlisted vehicles are a good compromise because“the investors are closer to the properties and the managersthan they could possibly be with a listed investment.”

You Can Get It if You ReallyWant—but at What Price?The past two years have seen investors forced relentlessly upthe risk curve in order to meet promised internal rates ofreturn (IRRs). Vacant assets, short-lease properties, and build-ings in need of major refurbishment are now sought after. Thelogic is: “You want assets where you can add to the incomestream to mitigate your risk.” As a result, many of those wespoke to observed that secondary yields have compressed evenfurther than prime in the past year. “There’s a hint of madnessat this point. Buyers are getting less rational.” “One day, thesepeople are going to wake up and say, ‘What do I own all thisjunk for?’ The risk-adjusted returns are now considerablyhigher for prime assets than for secondary.”

Reputedly, some deals are being done just to get moneyinto the market. In some cases, this is a cynical move to triggerthe fund manager’s fee structure, but for others there is gen-uine pressure to get real estate exposure rather than sit on low-yielding cash. More investors are moving out to cities theynever considered before where liquidity is lower and the risk ofbeing stuck with an empty building if the existing tenant leavesis much higher. Some claim this might be more rational than itappears at first glance if there is a permanent increase in liquid-ity, “but who knows if the interest in these markets will stick.”Some make the argument that smaller cities have higher risk-adjusted returns than major markets because both prices andvolatility are lower. Marseilles, Valencia, Zaragoza, Cologne,and Dusseldorf are most frequently cited as new investmenttargets, but there are many others.

“Nothing is easy out there right now,” so people are try-ing to get creative about sourcing product. In a retrogradestep, more investors are attempting to do off-market trans-actions in order to escape the auction process. However, it is usually in the seller’s interest to enjoy the fruits of a trans-parent market, so off-market deals can be full of angles. “Off-market you might pay less, but these deals are usuallysmaller—and of course you can get shafted.” As one investorobserved, “The challenge right now is to resist the temptationto rationalise others’ irrational behaviour.”

The past two years have seen investors forced relentlessly up the risk curve in order to meet promised internal rates of return


0

50

100

150

200

0

100

200

300

400

500

Sources: Investors in Non-listed Real Estate Vehicles (INREV), InvestmentProperty Databank (IPD), November 2005.

* Note: Total number of vehicles including German open-ended fundsequals 442 funds.

Exhibit 1-9 Growth of Private Property Vehicles in Europe

Gross Asset Value €Billion (left scale)Number of Funds (right scale)

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2005 German

Open-Ended Funds*

Development Is Back on the MenuOne of the most notable changes from last year is the growingnumber of investors now prepared to take development risk.The thirst for high-quality assets has pushed even core inves-tors in this direction. In some markets such as the centralEuropean cities and the less developed markets, it is virtuallythe only way to obtain high-quality product. Elsewhere, devel-opment is seen as the best way to avoid overpaying for stand-ing assets.

Speculative development is making a comeback and thishas some investors running scared. “The new pipeline couldcome in too early and choke off the rent recovery before itgets going.” Others insist that the average quality of existingstock is too low and new development is badly needed. “Weshould be tearing down the rubbish and replacing it withworking environments that people really want.” The propo-nents of sustainability tend to support this contention.

The Universe Is Expanding—Even Core Investors AreGoing NicheThe shortage of conventional real estate is forcing investors tolook at a much broader range of assets than ever before. As aresult, the investment universe is well and truly expanding.Even venerable institutions that were once synonymous withcore investment are focussing on assets that would not havebeen considered real estate a few years ago. Hotels—once aniche sector—are now considered mainstream. And a hugearray of investors are interested in gaining exposure to newareas such as nursing homes, retirement communities, studenthousing, self-storage, car parking facilities, pubs, recreationalfacilities, spas, resorts, entertainment complexes, condo-hotels,schools, hospitals, airports . . . you name it. As one investorput it, “If it’s nailed to the ground, we’ll look at it.”

Many of these niches fall within the ambit of what iscalled “opco-propco” (short for operating company–propertycompany), which used to be territory dominated by venturecapital, private equity players, and hedge funds. Given theirpresence, these niches are not short of competition when thebidding starts. However, the real estate investors tend to splitthe deals into two separate businesses, the operating companyand the property company, and the latter can usually befinanced more cheaply than the finance on offer for the com-pany as a whole. This often gives real estate bidders an edge.

Mixed Use Moves Up theAgendaThe hunt for investment possibilities has also begun toincrease acceptance of mixed-use schemes, although themajority remain wary. “Mixed use is riskier because there aremore pieces to go wrong.” “In the U.S., they say that forevery successful piece of retail in a mixed-use scheme there is a bust hotel.” While more investors accept that this is thekind of development many governments want—which meansit is the kind of product that will be increasingly on offer—they require higher returns for the additional complexity.Many do not want the residential exposure that is typicallypart of such schemes. Even the proponents are alert to theproblems posed. “I love the concept because people want theconvenience that mixed use offers. The problem is the ten-ants hate each other.”

Since most urban regeneration schemes are mixed-use ones,the problems noted above need to be dealt with carefully inorder to achieve support. At present, there is a lot of scepticismabout planning authorities’ ability to get it right. Nevertheless,there is increasing openness to well-designed developmentswith strong input and backing from the private sector.

Wanted: Corporate andGovernment Assets Once again, there are hopes that the relentless rise in capitalvalues will finally trigger corporate entities and owner-occu-piers to release a substantial slug of property into the invest-ment market. So far, this long-predicted trend has not materi-alised in anything approximating the size anticipated. “Atsome point, more corporations are going to want to capitaliseon the generous prices they can obtain for their real estateassets. It’s only a matter of time.” In fairness, there has been“an upward creep” in the number of sale and leaseback dealsdone voluntarily (in addition to the usual distress selling), but,on the whole, owner-occupiers are not queuing up to sell.

Perhaps more interesting is the rising number of sale and leaseback deals that are being proactively initiated byinvestors. Disillusioned with wasting millions of euros on duediligence for unsuccessful bids, many investors are trying tosource deals themselves. In some cases, they or their agentsare actively approaching owner-occupiers or corporate ownersin order to initiate sale and leaseback deals. Occasionally,


to meet promised internal rates of return

investors are even sourcing new premises for the formerowner-occupiers to move to so that they can reposition theassets they acquire. Some buyers even offer a piece of theleveraged upside to the seller to induce them to sell.

Governments are also starting to help free up corporateassets through legislation that lowers the capital gains taxpayable when assets are sold. The French SIIC III legislationannounced at the end of 2005 might lead the way, enablingcorporate sales for cash to these REIT-type vehicles atreduced tax rates (previously, sellers were only allowed pay-ment in shares). German G-REIT legislation is expected tocontain similar tax concessions and Italy is considering givingsubstantial capital gains tax concessions for corporate realestate sales without any tie to a REIT. Given that well over70 percent of commercial property in Europe is still in thehands of owner-occupiers, there is a lot of potential toincrease the institutional stock if tax systems foster suchtransactions.

Where central governments show fewer signs of helpful-ness is in privatising state-owned properties. Many previouslymooted programs have simply been put on hold. There is lit-tle prospect that 2006 will see any major initiatives in thissphere, although a trickle of sales will probably continue inthe majority of European countries. The most high-profileprivatisations have been in Germany at the Länder and citylevel with the sell-off of huge residential portfolios. These willno doubt continue as long as the financial arbitrage drivingthem remains to be exploited and the prices paid purportedlyexceed the wildest expectations of the vendors.

Infrastructure Gets a NewFan ClubOne area where governments are planning an importantrelease of assets is infrastructure. Many fixed-income investorshave already discovered the attractive attributes of bondsissued in connection with public/private partnership (PPP)financed projects. They have long duration, relatively highcash flow (often linked to inflation), and low correlation withequities and other types of bonds. In short, the risk-returnprofile is very much akin to that of real estate.

Infrastructure is gaining increasing profile among asset-starved real estate investors in Europe and is already anaccepted extension of the real estate universe for those in thevanguard. “In a world with a wider definition of what is con-sidered real estate, infrastructure makes sense.” “Reservoirs,tunnels, toll roads, [and] bridges can all deliver strong long-term cash flows with good residual values.” Germany, France,Spain, Poland, Sweden, Greece, and the U.K. all have PPPinitiatives or ongoing programmes. Expect to see more realestate investors gain exposure.

Sustainability Issues BarelySurfaceAwareness of E.U. sustainability legislation has a long way togo if our survey and interviews are anything to judge by. Asignificant proportion knew little and cared less about theissue. “Sustainability is just a slogan.” “A sustainable buildingis just a good building in a good location.” “Sustainability isjust an additional layer of cost for developers.” Agents do notbelieve that tenants care enough about energy efficiency topay more for a sustainable building (although some corporatepremises managers might disagree). Likewise, investors tendto believe that overall good design is more important.

Like it or not, the issue of a building’s compliance with sus-tainability requirements will rise up the agenda in the future. Itcould shorten the life cycle of many existing assets and alter therelative merits of refurbishment versus building new. In theory,it should also hit the relative pricing of assets, with sustainableproducts attracting higher prices. However, for the present,E.U. governments need to raise awareness of sustainability leg-islation because it appears to be woefully lacking.

Going East for OpportunityThe sustained downward shift in yields across most of themarkets covered by this report has sent many investors seek-ing higher returns out to new markets—most of them tothe east. A year or more ago, some opportunistic investorsheaded for the countries that will make up the next wave ofE.U. entrants. They are now being followed by a surprisinglydiverse set of investors, including a few that were once on theconservative end of the investment spectrum. In this regard,Romania is the most-often mentioned because it is relatively

Infrastructure is gaining increasing profile among asset-starved real estate investors in Europe and is already an accepted extension of the real estate universe for those in the vanguard.


large and Bucharest is thought to have the potential toachieve a transformation similar to that seen in Warsaw,Budapest, and Prague. At present, the assets are few, the legaland title risks are myriad, and there is a distinct gap in mar-ket professionalism, but none of this has deterred investors orstifled hefty yield compression.

Other central and eastern European markets attractinginterest are the main cities in Slovenia, Bulgaria, Croatia, theUkraine, and a great many secondary cities in Poland, theCzech Republic, and Russia. These markets will no doubtbecome more interesting to a broader spectrum of investorsas new development and refurbishment enhance their builtenvironment. However, the amount of investment they canabsorb at present is limited. The big movers are heading tothe Far East and India, where rapid growth and big, expand-ing urban populations offer opportunities in larger scale. Thismay take a brick or two out of the “wall of money” trying toget into European markets, but it’s unlikely to bring that walldown. The major challenge for European real estate marketsin 2006 is to negotiate the imbalance between investablefunds and available assets without moving pricing to a dan-gerously unsustainable level.


Europe and is already an accepted extension of the real estate universe for those in the vanguard.

RealEstate

RealEstate


There is thwartedcapital hunting everywhere.

c h a p t e r 2

Capital MarketsThe one thing Europe’s real estate investment markets

are not short of is capital. “If you have an asset withan income stream to sell, there are 50 people queuing

up to take it off you.” In most markets, the ample funding ofa few years ago has given way to surfeit. Indeed, the excess ofcapital given the shortage of investment stock is seen as oneof the most serious problems facing investors over the comingyear. Nearly 56 percent of those surveyed think that capitalwill be either moderately or substantially oversupplied in2006 and the availability of both debt and equity capital willcontinue to increase relative to last year.

However, a significant minority—nearly 29 percent—think that capital will be moderately or substantially under-supplied during the same period. This result appears to becontradictory, but it is not. Capital shortage is the stark real-ity for small- to medium-sized developers who depend ondebt finance. There is now little appetite for lending to devel-opers unless they have a prelet or presold project because thecapital requirement to back lending for speculative develop-ment is so onerous under the rules for Basel II.

The European Parliament approved the Capital Require-ments Directive—the law that makes the Basel II bank capitaladequacy rules obligatory throughout the E.U.—in Sept-ember 2005. Thus, those banks that are planning to use the“Foundation Internal Ratings Based” (IRB) approach under

the new rules are now doing a final year of “parallel running”of systems before the full move to Basel II at the end of 2006.Those banks that have elected to use the more sophisticated“Advanced IRB” approach will do parallel running until theend of 2007. Regardless of which system banks have chosen,speculative development lending is now very costly in termsof the capital that needs to be committed, and the Basel II

Exhibit 2-1 Real Estate Capital Market BalanceProspects for 2006


15.6% In Balance 38.8% ModeratelyOversupplied

20.4% ModeratelyUndersupplied

17% Substantially Oversupplied8.2% Substantially Undersupplied

German Open-Ended Funds:The Prisoners’ DilemmaThe German open-ended fund industry is in grave trouble.Assets under management shrank by €3.43 billion in 2005(€3.05 billion in December alone) but we may never knowthe precise extent of the outflow because official statistics aredistorted by emergency support operations from the funds’parent institutions. Three funds have taken the unprece-dented step of freezing redemptions, thus locking their luck-less investors into unwanted holdings for an indeterminateperiod of time (funds are legally allowed to freeze for up totwo years). Accusations of misselling are being voiced withincreasing vehemence and the finance ministry is so alarmedthat it is calling for legislative change to restore diminishing

The German open-ended fund industry is in grave trouble.


regime is designed to make sure that there will be less of it.There are good reasons for this stern approach, since impru-dent lending for development has caused the majority ofbanking crises over the past 40 years. However, that is coldcomfort for the developers struggling to obtain debt finance.Speculative development now requires plenty of equity and avery good business plan to get backing from one’s bankers.

A mere 15.6 percent of those we surveyed believe that thecapital markets will be in balance this year. Small wonder,then, that investors with significant funds to deploy are look-ing to team up with developers to get product for their port-folios. We’ll see a lot more of this in the next few years.

Capital Trends: Equity“There is thwarted capital hunting everywhere” and it is com-ing from every conceivable corner of the world. More capitalcame into the markets last year than anyone anticipated andthere is no letup in sight. Increasing investment flows areexpected from all over Europe, but they will be met with stiffcompetition from Middle Eastern, North American, Asian,and Australian money. “An Australian pension fund wouldnot have thought of investing in the E.U. ten years ago. Nowthey’re everywhere.” “Oil money from the Middle East willmake an even bigger impact this year—and we’ll see Russianpetro dollars, too.” “The full force of Asian money has notbeen seen yet and the impact will be big.” “There are riversof capital pouring in from the U.S.—investment banks andall kinds of funds with massive institutional backers.”

Our survey predicts that we will see more capital fromevery type of investor. To the dismay of the professionals, pri-vate investors and private partnerships top the table for pro-jected increases in activity. Some players are nervously won-dering whether real estate is going through something remi-niscent of the dot.com boom. “Even taxi drivers are nowtalking about real estate.” Almost all of the usual sources ofequity will be expanding—most importantly, the pensionfunds. But in addition, there may be more capital committedby the new entrants first seen in 2005, the hedge funds. Theonly source of equity where a question mark looms is theGerman open-ended funds, where “event risk” has once againsent shock waves across the industry. This time, the problemarose so late in the year (mid-December 2005) that our sur-vey does not reflect the unwelcome developments.

Exhibit 2-2 Change in Availability of Equity Capitalfor Real Estate by Source Type

All Sources

Private Investors/Partnerships

Pension Funds

Private PropertyVehicles (PPVs)

Private PropertyCompanies

Opportunity Funds

Syndicates/Consortia

Closed-Ended Funds

Publicly Listed Property Companies

Venture Capital Firms

Insurance Companies

Open-Ended Funds

1 5 9Very Large Same Very Large Decline Increase

0.0 4.5 9.0

6.566.82

6.876.93

6.646.69

6.626.80

6.616.65

6.446.61

6.386.57

6.186.31

6.176.20

6.146.29

6.136.10

5.605.63


n 2006 n 2005

public confidence in the sector. Changes are also being pro-posed by the fund management industry body, the BVI, inhopes this will stem the outflows that are threatening to spi-ral out of control. The outlook is so uncertain at the time ofwriting that no one knows whether this will be a short-livedscare or the onset of a contagion that will force many morefunds to freeze.

Massive redemptions from those funds with significant expo-sure to the German real estate market started in December 2003and escalated well into 2005. However, during the course of lastyear it appeared that the funds had restored public confidencesufficiently to contain the worst of the damage. Parent institu-tions of troubled funds had been purchasing fund units andbuying assets from the fund portfolios at book value in order toreliquefy their offspring. Like the participants in the best-knownexample of game theory, “the prisoners’ dilemma,” these parent

firms realised that if they all supported their funds until theGerman market picked up, they could potentially find anorderly way out of difficulty. Then, one parent bank brokeranks and refused to support their fund—indeed, they tookthe unprecedented step of freezing it—and the fragile, hard-won confidence of the public was sent into a tailspin. Amonth later, two more funds were frozen. The problems thatunderlie the mass redemptions from the latter were corporategovernance– rather than performance-related. Nevertheless,there is an escalating feeling of panic seizing the entire open-ended fund market.

German assets dominate the portfolios of the largest andoldest open-ended funds. These “historic big battleships fromthe 1960s” own some “old and not very structurally soundstuff ” as well as the impressive new assets that take pride ofplace in their annual reports. Their allocations are heavilyweighted towards offices, and book values are well in excessof market values in some cases. This is partly because of thecharacteristics of the officially mandated method for valuingfund assets (described in our 2005 edition of Emerging Trends)but also partially due to the ill-judged use of that valuationmethodology. The book values rely on assumptions aboutfuture rents and occupancy, and the optimistic estimates forthese factors used by some funds’ valuers have led to system-atic overvaluation of German offices for the past several years.“The problem is epidemic. You can’t take a few assets out of afund and solve it.”

The difference between market and book valuations ofGerman office assets in some open-ended funds is purportedto range between 10 and 30 percent. The bank that firstdecided to freeze its fund did so in front of a revaluation thatcould take up to one-sixth off of its total value, according tonews reports. And the current reductions may not be the endof the story. A lot of older secondary office space is over-rented and now being abandoned in favour of new primeoffice space at cheaper rents with long rent-free periods.“Who is going to lease this tired old space in a stagnant econ-omy with a shrinking workforce?” “A lot of the secondaryoffice will never be relet.”

Revelations about the valuation of fund assets are destinedto change the way they are overseen and possibly the fre-quency with which they are done. It is also likely to lead tomore external regulation of the open-ended fund industry.However, some are questioning whether the industry has afuture, particularly if a successful G-REIT structure is intro-duced. “Open-ended funds are flawed in their present form.It’s illogical to have a liquid fund based on illiquid assets.”“The REIT is a far more joined-up financial concept and itwill replace open-ended funds.” Some open-ended fund man-agers are already planning to float G-REITs when they are


Exhibit 2-3 Change in Availability of Equity Capitalfor Real Estate by Source Location

Middle East

United States

United Kingdom

Asia

Spain

Other EuropeanCountries

France

Australia

Germany

Netherlands

Italy


0.0 4.5 9.0

6.606.56

6.536.46

6.476.68

6.476.2

6.46.65

6.256.07

6.16.18

6.076.08

6.025.56

5.965.96

5.815.83


n 2006 n 2005

introduced. Although open-ended funds cannot be directlyconverted to REITs under current laws, many of their assetscould find their next home in a REIT. The parent institu-tions of funds can buy the assets out of the funds at bookvalue—which many have already been forced to do—marktheir prices down to market level, and put them into a REITportfolio to await an initial public offering (IPO).

Not all open-ended funds are invested in Germany andexperiencing outflows, but those that focus on foreign mar-kets are having their own problems. They have continued toattract investors and they are now sitting on billions of eurosin cash that they cannot get invested into their target mar-kets. A number of managers have stopped selling units intheir international funds because the cash piles are reducingreturns and ruining performance figures. Many funds com-plain that they are consistently outbid by the debt-drivenbuyers because they are allowed only modest overall gearing.“We’ve been forced to sit on the sidelines in some markets.”

The open-ended funds clearly face a tough year and somebig changes are potentially afoot in their regulatory and stat-utory environment. It is unlikely that they will be addingmuch to the European equity pool in 2006, given the recentfund freezes and the contagion that could be triggered. How-ever, they are not suddenly going to disappear and they couldlive to fight another day. The revival of international interestin German real estate markets may have come just in time tobail out the old battleships.

Private Equity, Venture Capital,and Hedge Funds: Crowdinginto the Same Space“The lines are blurred between private equity, venture capital, andhedge funds.” They are all absolute-return investors (i.e., they tar-get specific return levels and do not invest relative to an estab-lished index or bench mark), they can all do opco-propco—but hedge funds are very diverse, so this comment refers onlyto a subset of these funds—and when they are not competingagainst one another, they occasionally do deals together. It isalso not unknown for hedge funds to put money into privateequity funds. The other thing they have in common is they arethe recipients of increasing percentages of institutional alloca-tions. They share the moniker of “alternative investments”along with direct real estate, and all have been beneficiaries ofthe decline in returns on conventional bond and equity portfo-lios. It is now not uncommon to see institutional allocationson the order of 20 percent in “alternatives” (which generallyinclude the real estate allocation).

Private equity used to be synonymous with opportunityfunds, but this is no longer the case. “The opportunisticreturns don’t pencil out as often anymore in Europe, so privateequity has moved into value-added investing.” Opportunityfunds are still being launched, but the target returns have been

lowered. “You used to see a typical target of 20 percent net.That’s now moved to 20 percent gross—which is around 16 to17 percent net—but no one believes them.” Of course, in aworld with euro cash returns of sub –2.5 percent, that sort ofreturn looks great, but “20 percent was always an arbitrarynumber. Anyone who started a fund in the mid-1990s shouldhave done better than that, and anyone launching a fund nowwill have to turn over a lot of stones to get anywhere nearthere.” As a result, some opportunity funds have moved tomore realistic target returns on the order of 18 percent gross.

No one knows how much private equity money earmarkedfor real estate is out there. Ernst & Young conducted a surveyof real estate private equity fund managers in the United Statesand the responses for their sample alone added up to US$118billion in leveraged buying power awaiting deployment. Someof that money is definitely earmarked for European invest-ment. “Forty percent of participating fund sponsors, and 76percent of fund sponsors with aggregate capital raised in excessof $1 billion, indicated that at least a portion of their capital isearmarked for markets outside of the United States.”

However, this is by no means the full picture. Interviewsconducted for this survey indicated that around 30 percentof the real estate private equity funds have been raised fromEuropean investors by European-domiciled sponsors. On topof this, private equity money is being raised in the Far East forEuropean real estate investments, but no one has a feel for theamounts. Add to this the competition for opco-propco dealsfrom global non–real estate focussed private equity funds,which are estimated to have £275 billion (US$485 billion)according to The Times newspaper in London, and the wallof money looks intimidating. Bear in mind that in 2004 thetotal turnover in European real estate markets was only €100billion (US$120 billion).

Of course, private equity investment is not just focussedon the conventional real estate assets covered in brokers’ mar-ket statistics. The majority of opportunity funds may still bediligently seeking distressed and difficult assets to repositionso that they can be sold on to core investors. However, manyof the big headline deals of the past two years have been seenin areas like German residential portfolios, where assets arepurchased from government or corporate owners, and nonper-forming loans (NPLs) that are purchased from banks trying toclean up their balance sheets.

German Residential Portfolios: Shock and Awe. TheGerman residential deals have inspired a mixture of awe,scepticism, and distaste among onlookers. They were a topicin the German elections last autumn when the funds werereferred to as “locusts” flying in to asset-strip the economy,then take the money and run. These deals are “financial arbi-trage driven” and thus highly leveraged—generally in theregion of 90 percent. The downside is limited if underwrittencorrectly because the rental incomes are very stable on large

Many of the big headline deals of the past two years have been seen in areas like German residential portfolios and nonperforming loans


German residential portfolios. And these portfolios are big—deals have been done in sizes as large as 150,000 units. Thekicker is the potential equity uplift if units bought wholesalecan be sold to the residents retail—or, failing that, sold on ata higher price to another investor. Those funds that got inearly are already feeling smug since cap rates have fallen byover 200 basis points in the last 18 months. However, thereare plenty of people in the market who do not believe that thefunds doing the recent deals—let alone those going forward—will achieve their targeted internal rates of return (IRRs).German observers are particularly scathing. “Where is theexit at that level of leverage on these prices?” “There’s noreal estate exit, just ‘the greater fool.’ ” “The opportunityfunds don’t know what they’re buying; €1,000 per squaremetre in Berlin is one thing, but €1,000 per square metre onthe outskirts of Dresden is not a good investment—thoughyou won’t lose money.”

The fact remains that only 44 percent of Germans owntheir own homes and the tenant protection laws are veryfavourable to renters. Nevertheless, there are homebuyers outthere and some private residential developers in Germanyhave found that they can sell over 50 percent of the unitswithout much effort when they refurbish a nicely designedbloc. Whether this points to potential for similarly successfulsales of the former state- and corporate-owned portfolios(many of which are rather aged) that the opportunity fundsare buying remains to be seen. “The first 30 percent is easy,but it’s the last 30 percent where you make the money.” Ifthe ‘wholesale-to-retail’ exit strategy doesn’t fly, there is onemore potential exit—the G-REIT. At least one big buyer ofGerman residential portfolios appears to be positioning foran IPO as a REIT if the legislation is enacted, and there maybe several others.

Nonperforming Loans: Profits from Others’ Mistakes.The sales of big German NPL portfolios hit the front pagesof the business papers in 2004, but last year saw fewer of theseheadline-grabbing deals. However, the lack of press coveragedoes not mean that the market has stopped growing. “Thereare more smaller deals being done on an exclusive basis, sothe market doesn’t know what’s going on.” “Players are try-ing to avoid competitive bidding wars when possible. Thesemake it too expensive for the smaller deals to be worth-while.” The sellers of NPL portfolios also have good reasonto keep a low profile because they do not want to upset theirclient relationships. As a result, it is hard to gauge just howmuch is changing hands. However, some big deals were donein the final months of 2005 and it is likely that more NPLschanged hands last year than in 2004.

Depending on which estimate one wishes to believe, thereis somewhere between €160 billion and €300 billion of NPLsin Germany. The market is extremely competitive and domi-

nated by U.S. investment banks along with private equityexperts in distressed debt and experienced Far Eastern play-ers. “The bigger the transaction, the more competitive thedeal—if you have a lot of money to get into the market, youwant size.” Not all NPLs involve real estate, but the propor-tion is high. Prices have risen in tandem with the increasingliquidity the investment banks have brought to the market,but, generally, the impression is that “the sellers are valuingtheir assets more realistically.” Most important of all, the sell-ing banks have put on more loan loss provisions so they arein a better position to sell, indicating that the market willcontinue to expand. Also, the exit strategies are tried andtested. Billions in distressed loans have already been rebun-dled, packaged, and sold on by the investment banks, oftenfor a quick turn of around 3 percent of face value.

Of course, like every other market, it has its detractors.“Paris NPLs in 1995 were done at 20 to 40 percent of facevalue. You could approach the borrower and ask for 50 percentof the original loan back and they could borrow that fromanother bank. We got our return and they kept their building.These deals in Germany are being done at 70 percent of face.They’re going to have to repossess a lot more real estate, withall the legal costs that entails.” On the other hand, a player inthe current German market noted, “There’s a lot of moneystuffed in mattresses in Germany. The old lenders didn’tapproach the borrowers, and we’ve found that they often comeup with the money when pressed.” Just the same, planned exitstrategies do include repossessions and securitisations.

Hedge Funds Hit the Market. The last thing anyonewanted to see was a major new source of equity capital enteringthe European real estate markets. But, in a world of fast-flowinginformation, it was perhaps inevitable that hedge funds wouldnotice the returns being made in real estate and attempt to get apiece of the action. According to the Financial Times, hedgefunds have global assets of €1,000 billion (US$1.2 trillion)under management. They are so diverse in terms of their invest-ment mandates that there is no uniformity in their activities.

Hedge funds have been seen in many different areas ofthe real estate markets in the past year. According to ourinterviews, they have been encountered bidding for healthcare deals, bidding for core offices, backing local players tobuy assets, taking illiquid positions in residential developers,and taking out the equity pieces in securitisations and othertypes of mezzanine loans. “They have loads of money andthey will take any piece of the structure.”


German residential portfolios and nonperforming loans

Some do not take them very seriously. “The guys I’ve seendon’t know what they’re doing.” “They’re not a danger—more of a pest. They get into companies when there arerumours, but they don’t do hands-on real estate.” “They’reirritating because they drive prices up.” Others are respectful.“Hedge funds are hiring some experienced real estate profes-sionals and they are moving into our space.” Whatever theopinion of their skills, if they stick around, they will add tothe pressure on real estate prices by sheer virtue of theirfinancial clout. They will also add depth to the mezzaninemarket, where their skill sets in fixed-income investmentmeet real estate.

Institutions and PrivateVehicles: Asset StarvedAccording to a number of studies done in recent years, Europeanpension funds are woefully underweight in real estate. Asset/liability modelling exercises tend to indicate that they shouldbe holding between 10 and 15 percent of their portfolios inreal estate, depending on the maturity of the fund. Yet, themost recent figures available indicate the average weighting ofreal estate in European pension funds is still only around 6.5percent. They are now trying to close this gap, but the sumsinvolved are formidable. Several of those we interviewed admit-ted, “Just trying to reinvest our cash flows and dividends isdifficult—we’re behind.” Real estate allocations may be higher,but the money has not made it into the market yet.

According to studies done by a number of differentsources (which are nicely summarised in the CB Richard Ellisreport The Pensions Crisis and the European Property Market),a reweighting of current European pension fund allocationsto the recommended 10 to 15 percent level in real estatewould require between €150 billion and €350 billion in realestate acquisitions. In a European market with an estimatedtotal annual turnover of only €105 billion in 2005, this is animpossible task to do in short order. There would be formi-dable problems even achieving this reallocation in global realestate markets. The problem will be exacerbated if govern-ments move to funded pension schemes, as this wouldrequire additional real estate investment of between €15billion and €45 billion per annum.

“The previous trend was public to private. The new trend will be private to public.”


0

50

100

150

200

250

300

Exhibit 2-4 Private Property Vehicles byType of Fund: 1995–2005


n German Open-Ended n Opportunityn Value-Addedn Core

Euro

(bill

ions

)

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

0 30 60 90 120 150

Exhibit 2-5 Private Property Vehicles by TargetCountry and Type of Fund: 1995–2005

n Multicountry Fundsn Single-Country Funds

United Kingdom

France

Germany

Italy

Netherlands

Spain

Other

Portugal

Belgium

Switzerland

Czech Republic

Poland

Hungary

Austria

Luxembourg

Sweden

Finland

Greece


Pension funds and their advisory consultants are tryingto negotiate this minefield, but there is obviously a limit towhat they can acquire, even in the medium term. There isalso a fear that the objective of providing pensions for an age-ing population will be negated by everyone trying to pile intoreal estate at the same time, with a resultant distortion inpricing. To some extent, this cannot be avoided because thereare investment deadlines to be met and the returns on cashare miserable. Clearly, more assets are needed because thereis a structural shortage of institutional-quality real estate.

Some of those we interviewed from outside the pensionindustry optimistically stated that “more product will comeon the market soon, because the scheduled liquidation ofclosed-end private vehicles between 2007 and 2011 willrelease huge amounts of assets.” But the majority of investorsin these closed-end vehicles are none other than the institu-tions themselves. This means that these institutions will havethe additional headache of getting the money released by thefunds back into the market. For this reason, open-endedfunds with no end date are becoming more popular as notedearlier in this report.

Publicly Listed Real Estate:High Hopes for the FutureThe listed real estate sector slightly underperformed thebroader European equity market but still turned in a robustperformance in 2005. The EPRA Europe index served up anample total return of 26.1 percent, while the FTSE Europetotal return index notched up a 27.7 percent increase. Thecontinued support was quite an achievement for a sector that

is normally abandoned when the broader market is strong.The returns were driven by hefty increases in the French mar-ket’s premium to net asset value (NAV) as investors hoppedonto the SIIC (French REIT) bandwagon. The Spanish mar-ket benefited too as another major Spanish listed companyacquired semi–tax transparent status by acquiring nearly 70percent of the largest French SIIC. The U.K. market laggedits continental counterparts, but it benefited from anticipa-

tion of future REIT status. The U.K.’s discount to NAV nar-rowed to the point where it no longer exists if adjustmentsare made for tax treatment. All markets (except Germany)benefited from yield shift in the underlying assets.

A Mercers survey of 157 investment management firmsworldwide with US$20 trillion under management showsthat expectations for equity performance this year are modestin comparison with last year. However, our own survey indi-cates that listed real estate in Europe will receive continuedfirm support in 2006. There is significant growth expected indedicated global listed real estate funds and this sector wasalready around US$14 billion in size at the end of last year,according to UBS. There is also growth in retail investorinterest everywhere and, of course, European institutionshave huge sums to put into listed real estate, particularly ifmore tax-transparent vehicles become available. REITs behavesomewhat like direct real estate and have a fairly low correla-tion with the broader equity market, so they are used some-what interchangeably with direct investments by some insti-tutions. The problem for European listed real estate is that


50

75

100

125

150

175

200

225

250

12/30/056/30/0512/31/046/30/0412/31/036/30/0312/31/02

Exhibit 2-7 EPRA Europe Return Index vs. FTSEEurope Return Index

Sources: European Public Real Estate Association (EPRA) Europe Index,a European publicly traded real estate return index and FTSE.

Note: Returns rebased to 100 (beginning December 31, 2001).

Valu

e (R

ebas

ed to

100

)EPRA Europe Return IndexFTSE Europe Return Index

0

5

10

15

20

25

Exhibit 2-6 Private Property Vehicles in Europeby Termination Year and Fund Type


Note: From 2007 to 2012, 167 funds with GAV €76 billion are planned to end.

Gros

s As

set V

alue

(GAV

) in

Billi

ons

€

n Core n Value-Added n Opportunity

2005 2006 2007 2008 2009 2010 2011 2012 2013

the sector is tiny—only around €100 billion in total—andonly 27 percent of it is in REITs. But that is going to changesoon. “The previous trend was public to private. The newtrend will be private to public.”

The French Listed Market: SIICs Forge Ahead. InFrance, the listed sector has increased by over 50 percent sincethe introduction of SIICs. The SIIC II legislation (along withits recent amendments that allow companies to sell their assetsto a SIIC for cash instead of shares) will motivate more com-panies and assets to come to the market. Corporates haveuntil the end of 2007 to take advantage of the time-limited 50percent reduction in capital gains tax on the sale of real estateassets to SIICs. “It’s taken companies awhile to become awareof the legislation, but 2006 and 2007 should be big.” “Shellcompanies are changing into REITs and the sector will be wellinto double digits in size. It can now cope with more money.”“We could conservatively see €3 billion in new assets hit themarket over the course of the three years.”

Of course, there are detractors. “New issuance is going tohold back the sector, so it will be a quiet year for returns.”There are also worries about the big premiums to NAV. “Themarket is overcooked and will have to come back.” The morephilosophical say, “The premium to NAV will not always bethere, but at least we no longer have a structural discount.”

Players outside the listed sector are more concerned thatSIICs have added to the competition for assets. And manyare annoyed that the listed sector in France is being favouredover other types of investors who would also like to get theirhands on some French corporate assets.

The Dutch FBI: Time to Remodel? The Dutch govern-ment has eyed the success of the French SIIC and decidedthat its own REIT-type vehicle, the FBI, could do with someupdating to make it more flexible and competitive. Proposalsare now being considered to relax restrictions on developmentactivities, capital taxes, foreign shareholders, withholdingtaxes, and the minimum required payout. While the changesare not a done deal, there is considerable pressure to relax therestrictions on foreign ownership at very minimum, sincethese appear to violate E.U. law. As to the other measures, it islikely that at least some will be adopted since the Netherlandsis currently losing business to more favourable regimes.

U.K. REIT Proposal: Unfinished Business. The U.K.government “finally got its act together” and draft legislationwas put before parliament in December 2005 that will enablethe U.K. REIT to be born on January 1, 2007. Under currentproposals, the vehicle will be closed ended and tax transpar-ent, although it will have a withholding tax of 22 percent.U.K. REITs will have to distribute 95 percent of their profitsto investors and they will have to obtain 75 percent of theirincome from rents, although the other 25 percent can come

from development and services. There will be no limits ongearing, but they will have to meet an interest cover test thatis fairly stringent. Also, no shareholder will be allowed to ownmore than 10 percent of a U.K. REIT. What is unknown—and will not be announced until the spring budget—is theconversion charge that companies will have to pay to becomeREITs. If the conversion charge is set at a realistic level, it canbe assumed that the majority of the listed sector will convertto REIT status. If not, the legislation will be irrelevant. Thereare already viable tax-transparent vehicles offshore and the sec-tor will continue to migrate in that direction.

As one would expect, concerns about the draft U.K. REITlegislation are already being voiced. The 95 percent distribu-tion level is seen to be too high, given the need to retain cashflow to maintain properties. The interest cover restrictioncould also pose problems if the government suddenly raisedinterest rates. There is also a chorus of criticism regarding therule that no one can own more than 10 percent of a REITbecause many of the companies have existing shareholderswith larger holdings. While the government clearly wanted toavoid the kind of foreign takeovers that have been such a fea-ture in the French SIIC market, they may have gone a bitoverboard on the ownership restrictions. Given that changescan be made to the draft legislation, the current proposals maynot be the final word. But, it has been made abundantly clearthat the Labour government will not consider any change thatwould lower its current tax take from the property industry.Any hopes for “REIT II” legislation to encourage corporatereal estate release will take a lot of pleading and may possiblyhave to await another government.

The G-REIT: Obsession with Tax. The U.K. REITproposal “has put the cat among the pigeons in Berlin.” “TheGerman government wanted to beat the U.K. to the marketwith a REIT. Now the pressure is on—not just to come upwith a G-REIT, but to come up with a competitive struc-ture.” The front-running proposal for a G-REIT is not whatmost investors would consider a REIT because it is not taxtransparent. It is a complex hybrid involving both an AGcompany and a “trust vehicle.” The trust vehicle would holdthe real estate and income would be distributed as “rents”rather than dividends. This would enable the government totax the income at source at a proposed rate of around 20 per-cent and—since income is not dividends and thus not subjectto international dividend withholding tax treaties—Germanywould keep the tax revenues. The proposal is understandablegiven the parlous state of government finances, but the result-ing vehicle may not be attractive to international investors.On top of this, it may not even be legal under E.U. law.

Many of those interviewed thought that the German gov-ernment had become too obsessed with worries about taxtake. “They’re worried about withholding tax leakage abroadand foregone capital gains tax at home, but if they don’tcome up with a competitive structure, no one will partici-

While not all private investors are doing irrational deals, the new players are frequently blamed for driving yields into “crazy” territory.


pate.” “They won’t get the capital gains taxes from corporatesunless they give them the incentives and a successful vehicleto sell into.” “They should be trying harder to get a competi-tive structure.” As the listed real estate sector in Germany iscurrently a paltry 0.45 percent of the equity market while thecountry’s stock of real estate is Europe’s largest, it can only behoped that the government will come up with somethingworkable. If it does, our survey indicates that there will betremendous enthusiasm. “It will be new and sexy—theinvestors will love it.” “The G-REIT could easily reach €30billion to €60 billion in size within a few years if the govern-ment gets it right.” However, many of those surveyed andinterviewed doubted that we will see a G-REIT in 2006.

Perhaps, for inspiration, Germany should take a look atwhat the introduction of a French-style REIT has done forBulgaria’s fledgling real estate market. At a stroke, it hasraised the professionalism and transparency of the sector andbrought in long-term foreign investors. There are already tenfunds, another six are preparing to list, and market capitalisa-tion is up to lev 100 million (€50 million), which is 1 per-cent of the Bulgarian equity market. Not bad for starters.

Derivatives and Exchange TradedFunds: Off the Starters’ BlockThe past year saw the emergence of a real estate derivativesmarket in the U.K. Somewhere between £600 million and£800 million (but possibly more) transactions were done, andthis total could grow steeply in 2006 as investors gain familiar-ity with the market and the types of transactions on offerexpand. Most of the transactions to date have been done inproperty index certificates (PICs), which are bonds with anembedded return based on the Investment Property Databank(IPD) index. However, the range of potential transactions typesis already on the rise because established derivatives playersfrom the capital markets are coming in. A Property DerivativesInterest Group (PDIG) was set up by the Investment PropertyForum to promote understanding and this should help themarket gain further traction. According to a survey conductedby the PDIG, investment groups with collective assets of £43billion now have a mandate to use property derivatives and 63percent of them are actively preparing to use them.

Commercial property is the largest physical asset class cur-rently not taking advantage of derivative products, and thederivatives professionals who are familiar with how quicklythese markets can grow are getting in to develop the market.The world’s largest interdealer broker has expressed intentand another major international interdealer broker has part-nered with an international real estate advisory group to cre-ate over-the-counter (OTC) property derivatives for bothU.K. and continental commercial property. In addition, atleast three major international banks have committed them-selves to the market and one has set up a dedicated propertyderivatives trading desk. The latter did the first-ever sector-specific deal in which an investor group took a position based


blamed for driving yields into “crazy” territory.

on the view that the U.K. retail sector would underperformagainst a LIBOR-based return over 15 months. The bankwarehoused part of the risk, so a full counterparty did notneed to be found immediately. If more are willing to do this,many such transactions will follow.

On the listed side, there are now two exchange-tradedfunds (ETFs) that track the continental European listed realestate markets. These can be used to take indexed exposureto the entire Eurozone market in one transaction. They canalso be sold short if one wishes to make a tactical allocationchange without selling one’s own portfolio of stocks. Alas, themarket is still waiting for an ETF based on the U.K. listedreal estate sector. The advent of U.K. REITs may mean thatthis will have to wait until 2007, as there could be enormouschanges in the market.

Private Investors, Syndicates,and ConsortiaPrivate investors have seized on European real estate to sucha degree that they are now the biggest growth group in themarket, according to our survey. And they are not just Euro-pean investors. Private wealth is flooding in from all over theworld and in many cases those with this wealth are bringingtheir bankers with them. The private investors most fre-quently cited in the markets by those we interviewed wereIrish, Middle Eastern, Israeli, Italian, and Spanish. However,just about every nationality got a mention. Their presence isa source of perpetual consternation to the seasoned profes-sionals because many appear to have “never met the realestate rule book.” “Discipline in markets has gone down andit’s the nonprofessionals who are doing damage.” “These peo-ple have no thought for residual values.” “We lost an Italianasset because the seller gave bidders only one day to do duediligence and a private investor accepted their terms.”

Clearly, not all private investors are inexperienced andunprofessional. Many have made fortunes in their home mar-kets and are seeking exposure in new regions. They see mar-kets that are potentially at the bottom of the rental cycle andthey are willing to take the bet that cap-rate compression willbe replaced by rental growth in a couple of years. Fortunatelyfor them, they do not have institutional clients to answer toor targeted IRRs to meet and their banks are willing to backthem as long as the properties they go for have an incomestream. In addition, some are investing cash for the next gen-eration and want a trophy asset that will be in the family in50 years’ time. Crucially, private investors are able to makequick decisions that are simply impossible for the institutionsand the funds that invest on their behalf.

While not all private investors are doing irrational deals,the new players are frequently blamed for driving yields into“crazy” territory. This may not be entirely fair. “It’s the peoplewho do the 200 million deals, not the 10 million deals, thatdrive the market.” In any case, if private investors are using

substantial equity to fund their deals, it is not a huge prob-lem if they overpay. However, since many are leveraged thereis concern. “Do new players really understand the fundamen-tals of real estate? There’s too much emphasis on initial yieldand the differential with finance costs.” “Many have lost sightof residual values”—if indeed they ever had sight.

Most worrisome are the highly leveraged private buyers.“These guys aren’t using equity—they’re borrowing at thebanks to do the deal, then borrowing against the deal withanother bank.” “When you see this stuff, you realise we havemaybe two more years. Then someone’s got to lose somemoney.” Equally disturbing are the proliferation of syndi-cates, some of which are run by inexperienced (and occasion-ally unscrupulous) advisers luring in high-net-worth individ-uals. The advisers get their money upfront and the deals areoften done on a highly leveraged basis, leaving little or nomargin for error. “If there’s an accident waiting to happen, it’s in the high-net-worth market.”

Capital Trends: DebtThere will be no shortage of debt capital for real estate acqui-sitions in 2006. Our survey highlights a substantial increase inthe availability of debt finance from all sources. Commercialbanks, mortgage banks, investment banks, and savings banksare all competing aggressively for business. Banks that pulledback from the markets in the early 1990s are reentering thefray. Those that have been continuously active are expandingtheir coverage and their expansion is not just confined to theE.U., but is spreading to markets like Turkey and Russia.“The banks are tripping over themselves to lend money.”

The increase in competition has sent margins on a down-ward trajectory and no one expects any relief this year. Theinvestment banks engaged in securitisation are frequentlycited as the major force behind the increasingly aggressivepricing. This is “a new pool of capital” and “it needs to feedits conduit programs with a continuous supply of loans.”“Margins have drifted down from 2 percent to a few basispoints to keep the conduit programmes going.” Since financedetermines what the buyers can bid for a deal, competitionhas pushed the more aggressive banks to underwrite accord-ing to the buyer’s exit strategy. As a result, there are more bul-let deals being done. The loans are then either syndicated orsecuritised, so that the risk is taken off the balance sheet.“Lenders don’t take as much risk on their books as in thepast, but there may be more risk out in the market.”

Not all banks are trying to shift everything off the balancesheet. Some are trying to grow their loan books, and thesebanks are less inclined to syndicate unless the loan sizeexceeds their “hold level.” Some have increased the size oftheir maximum exposure to single assets in order to beef up

the size of their books. However, others need to get theirreturn on equity (ROE) up, which implies that they need tobecome issuers rather than holders. In a world of consolida-tion in banking, self-preservation is a keen motivator. “TheGerman banks need to get their ROEs up before they geteaten.” On the other hand, “Bankers are rewarded for doingdeals, not the bank’s ROE.” For those attempting to do moreconventional relationship banking in order to write morebusiness, the demands of the client inevitably lead to moreflexible pricing than many would wish. In general, LTVs areup (typical levels mentioned for a private investor or privateproperty company are 90 percent versus 85 percent a yearago) and margins are well down.

Underwriting Standards Will BeMore Stringent in 2006Once again, the level of underwriting discipline was generallythought to be high by borrowers. “A lot more effort is goinginto pricing risk.” “Lenders are being disciplined.” However,the banks themselves were less certain. “Lenders have been lessdisciplined in the past year. If you don’t take on more risk,you can’t remain competitive.” “We’re seeing less amortisationand more interest-only loans.” “The banks are the ones takingthe risk when they underwrite a 95 percent LTV. If somethinggoes wrong, the borrower can just hand them the keys.”

Over 40 percent of those surveyed thought that under-writing standards would become more stringent this year.This is curious, given that most believed that lending wouldbe subject to increasingly aggressive competition. However,

“The banks are tripping over themselves to lend money.”


Exhibit 2-8 Change in Availability of Debt Capital for Real Estate


0.0 4.5 9.0


n 2006 n 2005

All Sources

Commercial Mortgage–BackedSecurities (CMBS)

Mortgage Banks

Commercial Banks

Savings Institutions

6.45

6.50

6.49

6.48

6.35

6.36

6.30

6.33

5.97

5.91

one can reconcile the contradictory appearance of higherleverage and greater discipline on two levels. The banks maybe less demanding than a couple of years ago on their under-writing for standing investments, but they are no longer tak-ing big risks in speculative development. This constitutes asubstantial increase in discipline and a step change in riskexposure in comparison with the last real estate cycle. Inaddition, if you believe that we are in an era of lower and lessvolatile bond yields “it’s rational to have higher leverage whenthe rate environment has lower volatility.” However, a long-term move to higher leverage and cheaper debt financeimplies that you have to accept higher real estate pricing,because it is the price and availability of debt finance thatare dictating what investors can pay.

There is no doubt that lending for commercial propertyhas taken a disproportionate share of the recent growth inlending. According to the Bank of England, lending to U.K.resident commercial property companies has grown morethan twice as fast as other corporate lending and is now thecommercial lenders’ single largest industrial exposure. Risinglevels of debt and asset price inflation have been the focus ofincreasing concern among all central bankers. They, too, arewondering whether we are in an asset price bubble—not justfor real estate, but for all asset classes—or a period of struc-tural change due to the growth in savings. However, the cen-tral banks are not in control of the situation. Increases in offi-cial rates have had little impact on market-determined yieldsand, in some cases, perverse effects. To illustrate, euro swaprates and bond yields have actually fallen in comparison witha year ago for periods longer than six years, and this hasoccurred despite a 25–basis point December rate increasefrom the European Central Bank and threats of more tocome. It may be the case that the more proactive the centralbanks are on interest rate policy, the lower long-term yieldswill go. “If the ECB raises rates too much now, it will onlydepress GDP growth and put further downward pressure onlong yields.” And, of course, lower growth means fewer cor-

porate lending opportunities and continued emphasis on realestate lending. But, “lower GDP growth will also postponeoccupier recovery, piling up the pressure on residual values.”

CMBS and Mezzanine: TheCapital Markets Come to TownAfter years of just ticking along, the European commercialmortgage–backed securities (CMBS) market burst into growthmode in 2005. Our survey last year predicted that CMBSwould deliver the highest growth rate in the debt markets forreal estate and that is exactly what happened. Issuance reacheda new record high of €40.7 billion in 2005 according to theLondon CMBS team at Barclays Capital, which was more thandouble the 2004 level of €19.4 billion. The U.K. dominatedCMBS issuance with 73 percent of the total, but Germany’scontribution grew to 10 percent and there were also deals fromthe Netherlands, France, Italy, Spain, Sweden, and others. Thedominant source of growth was CMBS conduit programs andthey accounted for 59 percent of the total issued. These areprogrammes set up by commercial and investment banks withthe specific intent to originate loans for securitisation. Therewere 17 European CMBS conduits in 2005, according toBarclays Capital, but their number is still growing.


Exhibit 2-9 Underwriting StandardsProspects for 2006


17.2% Less Stringent 42.5% The Same 40.3% More Stringent

0%

1%

2%

3%

4%

5%

6%

U.K. Base Rate E.C.B. Short-Term Repo Rate

Euro Five-Year Swap RateU.K. Sterling Five-Year Swap Rate

12/1/

05

11/1/

05

10/3/

059/1

/058/1

/057/1

/056/1

/055/2

/054/1

/053/1

/052/1

/051/3

/05

Exhibit 2-10 U.K. Sterling and Euro Base Ratesand Five-Year Swap Rates

Sources: Datastream, European Central Bank, Bank of England.

Our survey this year predicts that we can expect very sub-stantial further growth in CMBS issuance for 2006. This willbe driven by rising numbers of conduit programs, expandingappetite for CMBS on the part of a widening pool of investorsfrom all over the world, and the plain fact that this is thecheapest form of real estate finance for many borrowers.Spreads averaged a mere 21 basis points for AAA issues in2005 and 93 basis points for BBB over the same period.

The CMBS market is likely to see further growth in dealsbased on pools of loans because many investors prefer these fortheir diversification characteristics. However, there should stillbe a hefty percentage of single-borrower issues. We may also seemore non-U.K. issuance—almost certainly from the Eurozone,according to our interviews and possibly from outside. EvenRussia has put legal structures in place to promote securitisa-tion, and while only consumer loans have been done to date,there are plans for mortgage-backed securities in the future.

The CMBS market is likely to see further growth in deals based on pools of loans because many investors prefer these.


Exhibit 2-12 European CMBS Issuance by Property Type

Source: Barclays Capital.

n Office 46%

n Retail 23%

n Residential 6%

n Industrial 6%

n Other 5%

n Mixed 2%

n Health Care 1%

n Telecom 8%

n Leisure 3%

n Office 37%

n Retail 34%

n Residential 13%

n Industrial 6%

n Other 6%

n Mixed 3%

n Health Care 1%

Exhibit 2-11 European CMBS Issuance by Collateral Location

Source: Barclays Capital.

n United Kingdom 71%

n Germany 2%

n Netherlands 5%

n Italy 3%

n France 7%

n Spain 3%

n Sweden 3%

n Other 6%

n United Kingdom 73%

n Germany 10%

n Netherlands 6%

n Italy 3%

n France 2%

n Spain 2%

n Sweden 1%

n Other 3%

1997–2004 2005

1997–2004 2005

It is hoped that the growth in CMBS will engender somemuch-needed clarity in the mezzanine market. The Europeanmezzanine market is often ill defined and still lags its U.S.counterpart in terms of efficient pricing. “We’re frequentlyoffered something that turns out to be totally mispriced sen-ior or undisguised equity.” Nevertheless, the market contin-ues to grow and attract more investors. “Five years ago, therewere four or five names to sell B pieces to. Now there are 30buyers looking for every piece.” “There’s been a proliferationof buyers—even the hedge funds are in there.”

One of the problems for holders of CMBS (A-notes) isthey often don’t know who holds the B-note/mezzanine posi-tions. According to our survey, the banks and opportunity orvalue-added funds are major buyers, which should give the A-note holders some comfort that they are likely to be dealingwith professionals if a default trigger occurs. However, the mar-ket needs increased transparency on the identity of B-noteholders and more clearly defined intercreditor agreements ifCMBS is to broaden its appeal. This is because there is apotential conflict of interest between A-note and B-note hold-ers when defaults are triggered. The B-note holders are oftenmore inclined to hold on when a deal gets into difficulty, whilethe senior CMBS holders usually want to cut their losses.

B-note issuance will inevitably grow because it enablesCMBS arrangers to achieve better pricing on the senior or A-note of a securitisation. An issue that might only achieve asub–investment grade rating can be repositioned to invest-ment grade by means of tranching subordinated positions. In2005, around 23 percent of CMBS issuance was supportedby loans that also had B-notes, according to Barclays Capital.

The big benefit for mezzanine to be derived from thegrowth of the securitisation market will be better transparencyand more efficient pricing. This should also enable improvedpricing of mezzanine loans that are not connected to securiti-sations—if they ever take off again. Many investors complainthat there is little call at present for conventional mezzanineloans because the senior lending has become so generous. Toomany borrowers can now get all they want from a friendlybanker with an onerous underwriting target to hit by thefinancial year-end.


because many investors prefer these.

Marketsto

Marketsto


Respondents continue to

express optimismfor most European property

markets in 2006 as they

did in 2005.

c h a p t e r 3

Survey respondents consistently expressed optimism formost European property markets in 2006 as they alsodid in 2005. Based on overall benchmarks and ratings at

the property market or city level, and including specific office,retail, and industrial property types within each city, respon-dents believe that European property markets offer diverseopportunities for investment and development in 2006.

However, the growth in optimism for European propertymarkets does not appear to be as great as that expressed byrespondents in the Emerging Trends in Real Estate Europe2005 report. There are caution signals for investors anddevelopers as 2006 unfolds based on survey results, directcomments from many pan-European interviews, and year-end 2005 property market reports. The spirited search forproperty investments and development in mainstreamEuropean cities is now spreading to many new targeted sec-ondary property markets. Respondents frequently mentionedcities in Cyprus, Croatia, Ukraine, the Baltics, Slovenia, andRomania in surveys—an early indication for future capitalflows and an expanding investment horizon?

Paris continues as the number-one city based on the aver-age of total return and city risk ratings, followed by London,Helsinki, Madrid, and Barcelona; Stockholm, Dublin, Lyon,Copenhagen, and Lyon round out the top ten. New entrantsinto the top-ten rankings for 2006 include Madrid, Dublin,and Copenhagen, as Milan, Brussels, and Zurich slipped outof the top ten (see Exhibit 3-1). Frankfurt is the lowest-ranked city in the survey by a wide margin, with modestlypoor prospects for total returns and a below-average risk rat-

ing. But on the bright side, its prospects have improvedmarkedly from last year.

A comparison between 2005 and 2006 survey responsesclearly indicates that investors believe overall total return andcity risk ratings will improve in 2006—a continuing trendfrom the initial survey in 2004 and 2005. Yet, there areselected cities where year-over-year ratings changes suggestprudence due to slight deterioration of city risk ratings inParis, Lyon, Milan, and Istanbul, and total return ratingdecreases in cities such as Edinburgh, Prague, Brussels, Rome,Milan, Vienna, and Moscow.

If we shift gears and look at cities with the best develop-ment prospects, the picture changes a bit. From this perspec-tive, the fast-growing but riskier markets of Istanbul andMoscow rise to the top of the chart. Paris, Barcelona, andLondon round out the top five for development prospects.

There are several themes for European property marketsin 2006 that emerge through the interviews and analysis ofthe survey results:n The majority of the European property markets previouslyranked in the top ten and bottom ten in 2005 remain intheir respective clusters in 2006, indicating that respondentsdon’t envision significant movements in favourite and chal-lenging property markets over the next year.

Watch

Respondents often mentioned Paris and London in the same breath as tops for opportunities in 2005 and prospects for 2006.


Exhibit 3-1 City Return/Risk Prospects


Paris

London

Helsinki

Madrid

Barcelona

Stockholm

Dublin

Lyon

Copenhagen

Edinburgh

Prague

Zurich

Brussels

Hamburg

Rome

Budapest

Munich

Milan

Istanbul

Vienna

Lisbon

Warsaw

Amsterdam

Berlin

Athens

Moscow

Frankfurt

0 5 101 5 9Abysmal Fair Excellent

6.226.056.396.25.986.426.115.896.335.9565.95.916.075.745.895.576.25.835.75.955.765.95.625.7456.475.75.366.045.525.895.145.494.676.315.455.135.775.425.035.85.4155.825.385.814.945.375.125.615.355.145.555.296.544.045.284.795.765.235.185.275.155.674.634.984.485.484.844.754.934.835.324.334.85.733.864.283.954.61

n Risk-Adjusted Total Returnsn Total Returnsn City Risk Rating

Exhibit 3-2 City Development and MarketBalance Prospects


Istanbul

Moscow

Paris

Barcelona

London

Lyon

Prague

Milan

Budapest

Madrid

Helsinki

Rome

Munich

Dublin

Hamburg

Athens

Warsaw

Stockholm

Vienna

Edinburgh

Lisbon

Zurich

Brussels

Berlin

Amsterdam

Frankfurt

Copenhagen

0 5 101 5 9Abysmal Fair Excellent

6.324.95

5.855.05

5.795.63

5.765.58

5.735.43

5.715.39

5.545.08

5.544.97

5.534.97

5.55.5

5.475

5.254.86

5.234.65

5.175.06

5.174.71

5.144.85

5.134.61

5.114.68

5.065

4.954.78

4.94.72

4.774.85

4.584.78

4.363.95

4.094

4.033.86

44

n Development Outlookn Property Market Supply/Demand Balance

n Although cities in the bottom ten have not significantlychanged from 2005 results, average ratings for city risk andtotal returns increased for Frankfurt, Moscow, Athens, Berlin,Amsterdam, and Warsaw.n Buyers are on the hunt with little to hunt. Although yieldsare historically low and property values potentially peaking, itappears that only a minor segment of respondents believethat 2006 is a good time to sell regardless of property marketor property type across Europe.n The lack of acquisition opportunities in primary Europeanproperty markets and CBD submarkets will force domesticand foreign investors and developers to widen the scope oftheir strategies to include secondary European property mar-kets and non-CBD submarkets in major European markets.n Urban regeneration, mixed-use development, and move-ment into noncore property types such as student and sen-iors’ housing will also increase in 2006 (and 2007) in mostEuropean property markets.

The next section briefly provides an overview of the 27European property markets covered in this year’s survey. Theranking methodology used remains consistent with last year’sEmerging Trends in Real Estate Europe. At the end of this chap-ter, we present a new cluster analysis of the European marketsthat provides an alternative view of the 27 cities. Rather thanbeing ranked, cities are clustered based on several key buy-hold-sell ratings in order to help readers create new, or chal-lenge existing, investment and asset management strategies.

The Top Ten Markets

ParisParis reigns supreme again, taking the top spot in our risk-adjusted total return rankings for the second year running.Does it really have everything? Many survey respondentsthink so and are quick to praise its ability to offer “long-terminvestments in a consolidated city.” In this capital-rich, prod-uct-poor property environment, the city also gets top marksfor its size and liquidity. “You can buy and sell at the sametime depending on the opportunity,” says one respondent.

Total return prospects for Paris are among the best inEurope (third in our survey), and this, together with itsattractive risk rating (also third), pushes it into first placeoverall. Notes one respondent, “Assuming the economicgrowth in France will not stagnate, Paris is one of the struc-turally healthiest real estate markets in Europe.” At 1.8 per-cent GDP growth predicted for France in 2006 by ConsensusEconomics, it is just about in line with European averages.

Respondents often mentioned Paris and London in thesame breath as tops for opportunities in 2005 and prospectsfor 2006, but few speak with as much enthusiasm and

romance about London. The relative yields of the two citiesexplain why Paris edges ahead on the office side: Paris ispretty steamy at 5.1 percent, according to CB Richard Ellis,but it is 60 basis points above London at 4.5 percent. Parisoffices were in soft recovery last year, according to ourrespondents, and the city is now looking at certain submar-kets experiencing strong recovery for 2006, with prices sup-ported by actual and expected rental growth. Also, somedevelopment is expected to commence again (but not in LaDéfense submarket, where vacancy still exceeds 10 percent),and with supply having started to fall in 2005, this is lookingto be a main trend for 2006.

However, Paris’s popularity is resulting in some dissatis-faction among investors. With the capital a little too hot forsome, there is a marked move towards second-tier Frenchcities as investors chase apparent mispriced opportunities.“In provincial markets, rental growth is not yet reflected inprices,” commented one respondent. There is also sustainedinterest in industrial and retail property types, and Paris hasretained its top-ten ranking in both these sectors as it relatesto buying opportunities. Yet, competition is heating up witha short supply of shopping centres, with the 60 percent “buy”rating being a wish more than a reality. For industrial, thetransport links and the density of the city make it a good betfor 2006, say respondents.

opportunities in 2005 and prospects for 2006.


Exhibit 3-3 Prospects for the Paris Real EstateMarket in 2006

Prospects Rating Ranking

Risk-Adjusted Total Returns Modestly Good 6.2 1stTotal Returns Modestly Good 6.1 3rdRisk Modestly Low 6.4 3rd

Rent Increases Modestly Good 5.6 5thCapital Growth Modestly Good 5.9 5thSupply/Demand Balance Fair 5.4 3rdDevelopment Modestly Good 5.6 1st

Investment Recommendation of Survey Respondents

Buy Hold Sell53% 38% 8%




Office

Retail

Industrial/Distribution

LondonSurvey respondents continue to be positive about the Londonmarket, hence its second-place ranking. As one respondentobserved, the depth and size of the market, just like Paris,continue to give it merit for both buy and sell opportunities.The survey results indicate investors in all property sectorswanting to continue to buy or hold in 2006, with littleemphasis on selling.

The property product crunch is likely to continue in2006. For many, it is a recovery market gathering pace in2006—”the cyclical upturn is underway,” says one intervie-wee. The West End still outranks the City, where recovery isslower. At a vacancy rate of 5 percent, the West End has itslowest vacancy rate in four years and CBRE’s rental index forthe area is up 3.6 percent year over year. In addition, new sup-ply is 40 percent lower than its peak in 2003 and many inter-viewees see the West End as a healthy development option.

Respondents generally believe the office sector has two tothree good years of performance ahead of it. The City lags inits recovery, but it is starting to see positive demand figuresthat have reduced ready-to-occupy space to 10 percent.Tenant incentives need to be worked out of the marketbefore anything more than marginal rental growth is seen.

For retail property, high-street retail yields in London areamong the lowest in Europe at 4.25 percent, and London isone of the lowest-rated cities in our survey for retail propertybuying prospects. However, interest could pick up for OxfordStreet if plans by the local business improvement districtsproceed with a major refurbishment to provide more flagshipstores, hotels, and restaurants.

One word litters the survey responses from the U.K.:REITs. Finally, the market’s ambitions for a tax-transparentvehicle look set to be realised, though several issues are yet tobe resolved. Notably, the government made no early indica-tions on the level of an exit tax other than to reiterate that itwould take no chances in losing tax revenue from the REITs’introduction. There are also concerns that the governmentwill introduce a development land tax. Worries about theimplications of the tax have come from all sectors. The retailindustry is worried that schemes in regeneration areas couldbe at risk, while the housing industry says fewer sites couldcome forward for residential if they become subject to this tax.

HelsinkiHelsinki jumped from sixth place last year to third in therankings for 2006. The city ranks in the top ten in risk-adjusted total returns (third), total returns (seventh), and cityrisk (fourth). Rent increases and capital growth should bemodestly good in 2006, and a high percentage of surveyrespondents recommend buying office (65 percent) and retail(62 percent) in Helsinki, while less than 5 percent believe

Domestic and foreign investors alike see a variety of redevelopment opportunities in Madrid and Barcelona in ageing industrial locations.


Exhibit 3-4 Prospects for the London RealEstate Market in 2006


Risk-Adjusted Total Returns Modestly Good 6.2 2ndTotal Returns Modestly Good 6.0 5thRisk Modestly Low 6.4 2nd

Rent Increases Modestly Good 5.9 1stCapital Growth Modestly Good 5.8 8thSupply/Demand Balance Fair 5.4 4thDevelopment Modestly Good 5.7 5th






Office

Retail


Exhibit 3-5 Prospects for the Helsinki RealEstate Market in 2006


Risk-Adjusted Total Returns Modestly Good 6.1 3rdTotal Returns Fair 5.9 7thRisk Modestly Low 6.3 4th

Rent Increases Modestly Good 5.5 8thCapital Growth Modestly Good 5.8 7thSupply/Demand Balance Fair 5.0 9thDevelopment Fair 5.5 11th






Office

Retail


that 2006 is a good time to sell in either property sector.Industrial properties are seeing far less interest. Yields are rel-atively high for Europe at 6.5 percent for both office andhigh-street retail properties, and very high for industrial at10.3 percent.

Office vacancy rates increased in 2005 and there are struc-tural differences between older and newer office stock, withoversupply a potential risk in 2006. Helsinki has “passed theworst,” states one experienced investor in the market. Thereis strong demand from foreign investors for Helsinki officeproperties; according to a year-end market report, 20-plusforeign property investment firms have been active in themarket over the last several years.

MadridThere’s a national victory for Madrid this year as it beatsBarcelona in the rankings for the first time. This reflectsinvestors’ sentiment that the Spanish capital is reaching aturning point. Last year, there was caution over the huge sup-ply of offices on the outskirts—which was still mentioned inseveral 2006 interviews. While it remains a heavily suppliedmarket, there has been little change in the vacancy in 2005,and speculative supply in 2006 and 2007 will be no morethan 550,000 square metres. Demand has been steady in2005, giving respondents more confidence for including

Madrid on their prospects list. A solid majority (61 percent)rate Madrid a “buy” market for office properties. Enthusiasmamong some is tempered by the perception that Madrid is a“medium-term” prospect, while others note the possibility ofundersupply in key areas and think central Madrid providesopportunities for Grade A office development.

Solid prospects for industrial are expected in 2006 as itslocation creates opportunities in the main corridors fromMadrid to Barcelona, Valencia, and Toledo. Respondentsexpect to see a rise in demand from tenants and investorsin these areas. The best possibilities of development in thissector are between Madrid and Zaragoza. Madrid is also ahighly rated “buy” market for industrial properties, with 63percent giving a buy recommendation.

Madrid ranks in the mid range for retail (55 percent rec-ommend buying) and there is a 50/50 view among intervie-wees as well. Madrid has some of the worst prospects forsome, whereas others say there is still value in the eastern sideof the city. An infill approach appears to be favoured, withdevelopers looking at smaller centres for more innovativeschemes such as development at train stations.

Survey respondents frequently mentioned Madrid whenquestioned about urban regeneration opportunities acrossEurope. Domestic and foreign investors alike see a variety ofredevelopment opportunities in Madrid and Barcelona in age-ing industrial locations. Infrastructure improvements support-ing urban regeneration include the extension of the Paseo de laCastellana thoroughfare, which will have associated develop-ment of 1 million square metres of offices and retail space.

BarcelonaOn many levels, Barcelona should reign supreme over Paris.Without the adjustment for city risk, Barcelona actually takesthe top spot as it beats Paris this year in outlook for both rentincreases and capital growth, and it places second behindIstanbul for total return prospects. Barcelona is also on parwith Paris for its supply/demand balance and developmentoutlook. The city just doesn’t have the size and the liquidity,which holds back this continually attractive city at fifth placeoverall, though it rose from its eighth-place position last year.

The majority of respondents are attracted by what theythink will be a continuation of strong rental growth in 2006.Those surveyed describe it as a “gradual” improvement in fun-damentals. Yet, it is scaring off some investors for 2006; theyrefer to Barcelona as a “difficult” market in which to find


Madrid and Barcelona in ageing industrial locations.

Exhibit 3-6 Prospects for the Madrid RealEstate Market in 2006


Risk-Adjusted Total Returns Modestly Good 6.0 4thTotal Returns Modestly Good 6.0 4thRisk Modestly Low 5.9 9th

Rent Increases Modestly Good 5.9 2ndCapital Growth Modestly Good 5.8 6thSupply/Demand Balance Modestly Good 5.5 3rdDevelopment Modestly Good 5.5 10th






Office

Retail


value and with prime office yields at 5 percent, which is tenbasis points lower than Paris, it is definitely too hot for some.Others continue to find Barcelona appealing and point toopportunities for refurbishment, whether offices or residential.

Respondents believe the fringe and out-of-town marketwill continue to do well in 2006. Demand has picked up,supply is in check, and rents are favourable to prospectivetenants. Second-tier-city syndrome is also hitting Spain.Respondents mention Valencia and Malaga as high-growthareas that are attracting interest from international investorsthat in the past considered only Barcelona and Madrid. Inthese second-tier cities, they say, pricing has not adapted toreflect the growth prospects.

Barcelona industrial jumps to third place in 2006 interms of buy recommendations, compared with mid-rangemediocrity last year. Respondents talk of good prospects inareas where main communication centres link Madrid toBarcelona. Interestingly, retail sparks little interest anecdotallyand it is a stable-to-down market, unlike office or industrial.However, more than 50 percent say it warrants a buy rating,if the opportunity arose.

StockholmStockholm’s prime yields continued to fall in 2005, driven bya competitive investment environment and an increase in thenumber of investors from Norwegian and Danish propertyfirms. Declining office vacancy rates are positive, althoughstill higher than levels seen during the late 1990s. A “jobless”recovery in 2006 coupled with increased construction risksmay dampen future investment capital flows. Respondentsoverwhelmingly choose “buy” or “hold” for each propertytype in Stockholm for 2006. City risk ratings are favourable,while capital growth and development ratings are fair.Speculative office developments in 2006 may signal futuresupply/demand imbalance in the office market.

Interviewees from the Nordic region mention hotels,mixed-use, and industrial property types as alternative invest-ment and development opportunities in Stockholm in lieu ofthe aggressive office sector.

Dublin The Dublin market is its own internal engine. Growth con-tinues to be impressive; it is down from the high levels of thelate 1990s but continues to outpace Europe, with a highergrowth rate expected in 2006. More important, the strengthis domestic, with less reliance on foreign direct investmentand more economic generation of indigenous companies.

The Dublin market is its own internal engine. Growth continues to be impressive; it is down from the high levels of the late 1990s but continues to outpace Europe.


Exhibit 3-7 Prospects for the Barcelona RealEstate Market in 2006


Risk-Adjusted Total Returns Modestly Good 5.9 5thTotal Returns Modestly Good 6.1 2ndRisk Modestly Low 5.7 14th

Rent Increases Modestly Good 5.8 3rdCapital Growth Modestly Good 5.9 3rdSupply/Demand Balance Modestly Good 5.6 2ndDevelopment Modestly Good 5.8 4th






Office

Retail


Exhibit 3-8 Prospects for the Stockholm RealEstate Market in 2006



Rent Increases Modestly Good 5.5 7thCapital Growth Fair 5.3 13thSupply/Demand Balance Fair 4.7 21stDevelopment Fair 5.1 18th






Office

Retail


Domestic demand and capital sources are also the engineof Dublin’s investment and lettings markets. Three years ofsluggish conditions in the office sector turned round in 2004,and early indications are that respondents expect sustaineddemand through 2006, once again primarily from domesticfirms. Office vacancy declined from 13.8 to 11.3 percent dur-ing the year ending in the third quarter of 2005. Drawbacksfor 2006 are that deals are starting to take longer to transactas negotiations are prolonged by fighting over incentives. Insome sectors, particularly manufacturing, Irish companies arefacing competitive pressures from overseas firms. In the officemarket, strong lettings continue to drive rental and capitalgrowth, fuelling investor demand. Once again, the majorityof the investors are locals. Other Europeans are interested butcontinue to find themselves outbid by strong local buyers.Office property yields as of third-quarter 2005 were—togetherwith London—the lowest in Europe at 4.5 percent.

Retail properties have been in demand, but prices arenow quite high, with high-street retail yields now at the near-ridiculous level of 3 percent. These yield levels are undoubt-edly among the prime reasons that survey respondents do notgive a high buy recommendation for Dublin retail, suggestingthat holding is the best strategy for 2006. Supply is curtailed,with restrictions on large-scale schemes, but European retail-ers continue to want to get into the high street in an effortto capture the spending power of the young age profile inDublin. Any worries in this sector are out of Dublin, with

concerns that the amount of retail warehousing in provincialcities will be realised.

Investor interest in the hotel market may well tail offfrom 2005 levels as tax incentives designed to stimulatedevelopment end, with qualifying projects needing to be fin-ished by July. Irish buyers’ reputation is just as strong over-seas, but for some it may be time to realise the gains, despiteits seventh-placed ranking for total returns among Europeancities. As one respondent says: “Dublin is very strong andmay be a sell to buy elsewhere.”

One interesting note on Dublin: the sell recommenda-tions for office, retail, and industrial are above average whencompared with other markets. Are the high sell recommenda-tions a market signal that the property cycle has peaked, oran opportunity for foreign investors to buy from willingdomestic owners? As yields for office, retail, and industrialproperties in Dublin are the lowest in Europe, according toCB Richard Ellis, investors will need to bank on growth inrents, rather than further yield compression, to achieveattractive returns in 2006.

LyonLyon punched above its weight in last year’s return-adjustedprospect rankings and it is just about holding its own againthis year. It has dropped four spots to eighth place and, whileit is still named by many as a top ten favourite prospect, thisis countered by talk of competition and increasing prices. In2006, Lyon continues to head the pack of second-tier French


is down from the high levels of the late 1990s but continues to outpace Europe.

Exhibit 3-9 Prospects for the Dublin Real EstateMarket in 2006*



Rent Increases Modestly Good 5.6 6thCapital Growth Fair 5.3 17thSupply/Demand Balance Fair 5.1 7thDevelopment Fair 5.2 14th






* Fewer than 20 (but no fewer than 14) survey respondents rated this city onsome measures.

Office

Retail


Exhibit 3-10 Prospects for the Lyon Real EstateMarket in 2006



Rent Increases Fair 5.3 9thCapital Growth Modestly Good 5.9 4thSupply/Demand Balance Fair 5.4 5thDevelopment Modestly Good 5.7 6th






Office

Retail


cities, which are benefiting from the overspill of competitionin Paris. Office property yields in Lyon at 7.5 percent are still160 basis points above Paris at 5.1 percent. It is a smaller, lessliquid market, but respondents have the confidence to believethat development with some preletting will be possible in2006. While Lyon is perceived as being somewhat risky, over60 percent of survey respondents recommend buying office,retail, and/or industrial properties in Lyon in 2006, making itone of the favourite “buy” markets in Europe.

CopenhagenCopenhagen has moved into the elite top ten market rank-ings in 2006 from the middle of the pack last year. Fallingyields, fundamental improvements, and optimism regardingemployment growth in 2006 fuel positive expectations thatflat prime rents in 2005 will improve in 2006. Investors alsorate Copenhagen as the city with the lowest risk of any in thesurvey, which significantly bolstered its rating. Positive eco-nomic growth is sustaining property market demand and for-eign investment is visible in the market. Retail propertiesattracted foreign investors in 2005 with continued interest in2006. The hold recommendation for industrial at 71.4 per-cent is the highest among all property markets, and the holdrecommendation for office is high as well, with office vacancyat a fairly low 7.2 percent.

EdinburghEdinburgh rounds out the top ten favourite markets—thesame ranking it held in 2005. In 2006, Edinburgh’s officemarket will experience the full impact of its reaction to anoversupply problem dating back to 2000. No new buildingswill be completed in the city in 2006, giving Edinburgh adriver for short- and medium-term rental growth. However,next year also depends on how demand fares. The markethad an expectation of improved take-up in 2005, but this isproving premature as demand was down 40 percent com-pared with the same levels in 2004. Office yields stoodaround 5.5 percent in late 2005.

German investors have been active in the city for morethan a decade and they continue to head a cosmopolitan mixof players. There is little the city can do to satisfy the weightof money it experiences. It is a tighter market than more tra-ditional U.K. locations and, as such, has a stronger disposi-tion towards owner occupation.

On the retail side, a dearth of opportunities for large floorplate retailers is holding the city back compared with com-petitors such as Glasgow. The city is considering for a secondtime a big-bang solution at Waverly Station, but this is in itsearly days yet. The market is well liked overall in our survey,coming in tenth, but on an individual-sector level there ismore scepticism over its place as a buy city, with most recom-mending holding.

Investors rate Copenhagen as the city with the lowest risk of any in the survey.


Exhibit 3-11 Prospects for the Copenhagen RealEstate Market in 2006*


Risk-Adjusted Total Returns Modestly Good 5.7 9thTotal Returns Fair 5.0 21stRisk Low 6.5 1st

Rent Increases Fair 4.9 13thCapital Growth Fair 5.2 20thSupply/Demand Balance Modestly Poor 4.0 25thDevelopment Modestly Poor 4.0 27th







Office

Retail


Exhibit 3-12 Prospects for the Edinburgh RealEstate Market in 2006


Risk-Adjusted Total Returns Modestly Good 5.7 10thTotal Returns Fair 5.4 14thRisk Modestly Low 6.0 7th

Rent Increases Fair 5.2 11thCapital Growth Fair 5.4 12thSupply/Demand Balance Fair 4.8 17thDevelopment Fair 5.0 20th






Office

Retail


The Middle-Ranked Markets

PraguePrague comes in at the 11th ranking in this year’s survey, withfairly strong total return prospects but some investor concernabout risk. Prague also offers one of the better developmentoutlooks in Europe, ranking seventh on this measure.


Office vacancy rates decreased in 2005 to the lower teensfrom the mid teens in 2004 due to information technologyand business service positive take-up. Respondents’ office buyrecommendation decreased from 73 percent in 2005 to 48percent in 2006, indicating that a larger percentage of

Exhibit 3-13 Office Property Buy/Hold/SellRecommendations by City


0% 20% 40% 60% 80% 100%

Sell %Hold %Buy %

Helsinki

Moscow

Lyon

Madrid

Istanbul

Paris

London

Budapest

Prague

Barcelona

Stockholm

Athens

Munich

Milan

Warsaw

Hamburg

Edinburgh

Rome

Brussels

Copenhagen

Lisbon

Frankfurt

Berlin

Dublin

Vienna

Amsterdam

Zurich

65.2

65.2

64.1

60.8

60.0

53.3

52.6

51.5

48.4

47.8

47.8

47.8

45.5

44.2

43.2

40.0

35.7

31.3

28.1

27.8

27.3

26.3

25.0

21.7

20.0

17.2

13.3

30.4

26.1

28.2

27.5

32.0

38.3

33.3

36.4

38.7

41.3

43.5

43.5

45.5

44.2

35.1

40.0

57.1

43.8

46.9

55.6

48.5

36.8

43.2

43.5

60.0

55.2

53.3

4.3

8.7

7.7

11.8

8.0

8.3

14.0

12.1

12.9

10.9

8.7

8.7

9.1

11.6

21.6

20.0

7.1

25.0

25.0

16.7

24.2

36.8

31.8

34.8

20.0

27.6

33.3

Exhibit 3-14 Retail Property Buy/Hold/SellRecommendations by City


0% 20% 40% 60% 80% 100%

Sell %Hold %Buy %

Istanbul

Prague

Budapest

Lyon

Helsinki

Athens

Moscow

Paris

Munich

Hamburg

Barcelona

Madrid

Berlin

Rome

Milan

Warsaw

Stockholm

Frankfurt

Lisbon

Copenhagen

Zurich

Brussels

Vienna

Amsterdam

London

Edinburgh

Dublin

85.2%

74.2%

68.8%

68.4%

65.0%

63.6%

61.9%

61.1%

60.0%

58.3%

55.3%

54.9%

53.3%

52.9%

51.3%

50.0%

45.0%

41.0%

38.2%

37.5%

37.5%

35.5%

33.3%

25.0%

24.1%

20.7%

20.0%

11.1

19.4

25.0

23.7

30.0

31.8

28.6

35.2

31.4

33.3

34.0

27.5

37.8

29.4

35.9

36.1

45.0

48.7

44.1

43.8

56.3

51.6

55.6

60.7

44.4

55.2

55.0

3.7

6.5

6.3

7.9

5.0

4.5

9.5

3.7

8.6

8.3

10.6

17.6

8.9

17.6

12.8

13.9

10.0

10.3

17.6

18.8

6.3

12.9

11.1

14.3

31.5

24.1

25.0

investors see office as a hold in Prague for the next year. Thebuy recommendation for retail has increased to 74 percent,up from 65 percent in 2005, whereas Prague’s top ranking asan industrial buy city in 2005 has decreased slightly to 73percent in 2006—still one of the top industrial buy recom-mendations in 2006.

Prime yields for office, retail, and industrial propertiesremain on the high side for European cities, ranging from 7percent for office up to 8.75 percent for industrial, accordingto CBRE.

ZurichForeign investors are starting to make an impact in whatremains one of Europe’s weakest office markets. It is a bigchange for the market to see international interest in a histor-ically domestic market. Private investors—often MiddleEastern in origin if not location—are taking the long view oninvestments in Zurich, pricing locals out of the market withyields of 4.5 to 4.8 percent, compared with previous levels of5.5 percent. Respondents expect the international presence togrow in 2006. Zurich continues to rank as one of the lowest-risk markets in Europe.

However, the consensus is that 2006 will be a more diffi-cult year and survey respondents agree; only 13 percent rec-ommended buying offices in 2006, placing Zurich at the bot-tom of the “buy” recommendations list. The backdrop is apredicted weak economic growth rate, which has translatedinto little demand for office space. Leasing activity in 2006 islikely to remain the same as occupiers take advantage of con-solidating businesses and upgrading offices rather than activ-ity that affects net absorption. Capital has remained available

Hamburg moves up from the fourth-lowest spot in 2005 to the middle-ranked cities in 2006.


Exhibit 3-15 Industrial/Distribution Property Buy/Hold/Sell Recommendations by City


0% 20% 40% 60% 80% 100%

Sell %Hold %Buy %

Warsaw

Moscow

Prague

Budapest

Barcelona

Lyon

Madrid

Paris

Istanbul

Milan

Hamburg

Vienna

Munich

Rome

Frankfurt

Berlin

Brussels

Stockholm

London

Zurich

Helsinki

Amsterdam

Lisbon

Athens

Edinburgh

Dublin

Copenhagen

74.2

73.7

73.1

72.0

66.7

63.6

62.8

55.1

55.0

53.3

51.9

50.0

46.4

44.0

41.9

40.6

40.0

40.0

37.8

35.7

35.3

34.8

33.3

33.3

20.0

17.6

14.3

16.1

15.8

23.1

20.0

19.4

24.2

23.3

36.7

35.0

30.0

44.4

37.5

50.0

36.0

48.4

50.0

44.0

46.7

46.7

42.9

47.1

52.2

40.0

44.4

64.0

58.8

71.4

9.7

10.5

3.8

8.0

13.9

12.1

14.0

8.2

10.0

16.7

3.7

12.5

3.6

20.0

9.7

9.4

16.0

13.3

15.6

21.4

17.6

13.0

26.7

22.2

16.0

23.5

14.3

Exhibit 3-16 Prospects for the Prague RealEstate Market in 2006


Risk-Adjusted Total Returns Modestly Good 5.5 11thTotal Returns Modestly Good 5.9 8thRisk Moderate 5.1 20th







Office

Retail


and disciplined, although respondents report that this disci-pline is starting to slip away with the desire to invest. Thereare discussions on the horizon to widen to residential the LexFriedrich legislation, which opened up the country to foreignownership of commercial properties. Housing is an emotiveissue in Switzerland and one that is likely to be resolvedthrough a referendum.

Brussels The home of the European Union slipped in overall rankingsfrom 2005 to 2006, primarily due to less favourable city riskratings. Investors appear mixed on office investment anddevelopment, although residential appears acceptable. Severalinvestors ranked residential development in Brussels on parwith London and Paris. Office supply in 2006 is a potentialrisk affecting rent growth expectations, and Brussels is oneof a few markets where office vacancies have been on theincrease, rising 100 basis points over the past year to 11.7percent as of the third quarter of 2005. The private sector isshowing modest gains in office occupancy share and respon-dents indicate a major fight for tenants over the next yearwith significant relocation opportunities. One investor stated,

“…E.U. institutions are prepared to look outside the tradi-tional Leopold area” in Brussels, with non-CBD locationsgrowing increasingly attractive.

Brussels, a very pan-European investment market, showsimproved prospects as a distribution market, as respondentsincreased the “buy” recommendation for industrial in 2006versus 2005. On the other hand, investors’ enthusiasm forbuying retail and office properties has waned considerablyfrom last year.

HamburgHamburg moves up from the fourth-lowest spot in 2005 tothe middle-ranked cities in 2006. “The city may come backin 2006 . . .” asserted one interviewee. The final stages of theFIFA World Cup in July 2006 provide a “world stage” oppor-tunity for Hamburg to showcase itself to a global audience.Survey respondents describe rent increases, capital growth, sup-ply/demand balance, and development issues as fair—very sim-ilar to Munich’s ratings and higher than Berlin and Frankfurt.


in 2006.

Exhibit 3-17 Prospects for the Zurich Real EstateMarket in 2006*



Rent Increases Fair 4.5 24thCapital Growth Fair 4.7 24thSupply/Demand Balance Fair 4.9 16thDevelopment Fair 4.8 22nd







Office

Retail


Exhibit 3-18 Prospects for the Brussels RealEstate Market in 2006



Rent Increases Fair 4.7 19thCapital Growth Fair 4.8 23rdSupply/Demand Balance Fair 4.8 18thDevelopment Fair 4.9 19th






Office

Retail


Hamburg’s buy signals improved for all property sectorscompared with last year. Office vacancy rates were stable in2005 at 8.5 percent, with continued positive take-up trendsthroughout the year. If office rents eventually improve, cou-pled with continued positive take-up trends throughout2006, the fairly strong buy rating for office may turn outto be understated for the year. “Buy” recommendations foroffice have risen to 40 percent in 2006—a significant increasefrom 27 percent in 2005. Buy signals for retail and industrialalso increased from 2005’s ratings of 32 percent and 31 per-cent up to 58 percent and 52 percent, respectively. Officeyields stood at 5.3 percent as of third-quarter 2005, up 30basis points from a year earlier.

RomeRome remains a government town, but some respondentspredict that this stability will soon be the backdrop for some-thing more. “Rome is slowly but surely moving into the lime-light,” says one respondent. “Good, but not amazing,” is amore moderate view expressed by other interviewees. Romeis one of a minority of cities that did not experience yielddeclines in 2005 in the office sector, with yields holdingsteady at 5.75 percent.

Some international investors continue to get exposure tothe city through major portfolio deals such as the CarlyleGroup and private investor Operae’s joint venture to buy26 assets for €255 million in Rome, Milan, and Turin.Refurbishment opportunities are welcomed in a marketwith limited prime space, but interviewees add that thehigh level of middle-quality space offers the market aninherent stability. Tenants may start to look at out-of-townsubmarkets such as the EUR business district, where amajority of new space is proposed.

The attraction of the retail sector has declined for buyers,falling from a 61 percent buy rating for 2005 to a 53 percentbuy rating for 2006. However, there are signs of momentumin this sector as the industry continues to react to Italy’s gen-erally undershopped status. Cushman & Wakefield Healey &Baker (CWHB) estimates that Italy’s retail space per 1,000inhabitants is 130 square metres, well below the E.U. averageof 159 square metres. New retail supply will bring 273,000square metres into the market by the end of 2006 in threemajor schemes in Rome, with expectations of increasinginternational investment interest.

BudapestBudapest gains ground from the lower tier in 2005 to themiddle-ranked tier in 2006, largely due to its improved riskrating. The city ranks in the top ten markets in severalbenchmarks such as prospects for total returns, capital

Budapest gains ground from the lower tier in 2005 to the middle-ranked tier in 2006, largely due to its improved risk rating.


Exhibit 3-19 Prospects for the Hamburg RealEstate Market in 2006


Risk-Adjusted Total Returns Fair 5.4 14thTotal Returns Fair 5.0 20thRisk Modestly Low 5.8 11th

Rent Increases Fair 4.6 21stCapital Growth Fair 5.0 21stSupply/Demand Balance Fair 4.7 20thDevelopment Fair 5.2 15th






Office

Retail


Exhibit 3-20 Prospects for the Rome Real EstateMarket in 2006


Risk-Adjusted Total Returns Fair 5.4 15thTotal Returns Fair 5.0 22ndRisk Modestly Low 5.8 10th

Rent Increases Fair 4.6 23rdCapital Growth Fair 5.3 14thSupply/Demand Balance Fair 4.9 14thDevelopment Fair 5.3 12th






Office

Retail


growth, and development. The industrial buy rating at 72percent remains strong, albeit 11 basis points lower than2005, and compares favourably with the other top-rankedindustrial markets of Warsaw, Prague, and Moscow. Officevacancy rates declined 400 basis points in 2005 to 13 percentas of the third quarter, due to solid demand and limited newsupply. The above-average office buy rating of 51.5 percentreflects survey respondents’ optimism for this property sectorin 2006. Retail receives favourable buy ratings as well, with68.8 percent rating it a buy; retail is diversifying in locationsaround the city and also into various retail formats.

MunichMunich is the second German city to jump from the lowerranks in 2005 into the middle ranks of European propertymarkets in 2006. Just like Hamburg’s, Munich’s rise is dueto improved property fundamentals during 2005. Officevacancy rates remained within the 9 percent range with con-tinued take-up through most of 2005, and respondents’office buy rating has increased from 27 percent for 2005 to45.5 percent in 2006. Office yields increased 20 basis pointsto 5.2 percent as of the third quarter of 2005, according toCBRE. “Munich may start to pick up while Frankfurt maycontinue to underperform . . . “ in 2006, suggests one inter-viewee, a sentiment that was echoed by other respondents.Retail buy recommendations increased from 41 percent for

2005 to 60 percent for 2006 and industrial buy recommen-dations also increased from 36 percent for 2005 to 46 per-cent in 2006. Interviewees mention Munich as a growingmarket for retail warehouse development opportunities.

MilanMilan tumbled down the markets-to-watch rankings this yearfrom second place in 2005 to 18th in 2006. Intervieweesview the market as nonvolatile with modestly low risk, but itsrisk rating declined for 2006. The city also lost its footing inthe retail buy recommendations, falling from first place to15th. Rental and capital growth prospects fared no worsethan last year, and the city appears to have suffered in partfrom the fact that other cities around it are just getting moreattractive. Milan ranks in the middle for industrial prospects,but options are limited with few sites—and small ones atbest—to invest or develop.

Interviewees now see declining interest from internationalinvestors in Milan. Foreign investors’ presence is still very rel-evant, but with fewer corporate spin-off transactions, poten-tial portfolios are becoming too small for foreign investors.Instead, the real estate funds are taking a good share as arethe property companies, which have gained critical mass overthe last five years.


in 2006, largely due to its improved risk rating.

Exhibit 3-21 Prospects for the Budapest RealEstate Market in 2006


Risk-Adjusted Total Returns Fair 5.4 16thTotal Returns Modestly Good 5.8 9thRisk Moderate 4.9 21st







Office

Retail


Exhibit 3-22 Prospects for the Munich RealEstate Market in 2006



Rent Increases Fair 4.8 18thCapital Growth Fair 5.3 16thSupply/Demand Balance Fair 4.7 22ndDevelopment Fair 5.2 13th






Office

Retail


A worry for Milan’s prospects in 2006 is the view thatItaly’s real estate liquidity spreads to many of the smaller townsin the country, thus increasing the number of competitive mar-kets. Investors are starting to see good opportunities all overItaly, mainly in the northeastern part of the country (althoughsome see this as a “one-way” investment), but also in the lesswealthy south. This has been proved, say respondents, with thebreakup of Enel and Ferrovie Italiane’s office and residentialportfolios, which were spread all over the country.

There is scope for development, but investors, particularlyinternational ones, are still cautious over the risks from a pro-tracted process. A prelet might make the proposition morepalatable. On a large scale, a few are taking the risk. Italiandeveloper Risanamento is due to start work on its Montecityscheme in the southeast of Milan, which will provide 170,000square metres of offices as well as housing and retail. Prospectsfor property supply/demand balance are better than for mostEuropean cites, as Milan ranks fifth on this measure.

Hotels pique an interest with some respondents as the city(and country) have few hotel chains and the sector is stillvery fragmented, despite demand from both tourist and busi-ness travel markets. There are a few transactions, but theytend to be small; others note that while there are plenty ofprojects on paper, few are interesting enough to warrant aninvestment in the sector.

IstanbulAlthough Istanbul dropped in the rankings for risk-adjustedtotal returns for 2006, its rating remained the same and thecity still captures top ranking for development, capital growth,and total returns and fourth place for rent growth. It suffers inthe overall rankings again because of its poor risk rating, thesecond worst in our survey behind Moscow. Survey respon-dents appear optimistic for sustained economic growth as evi-denced by the very high retail “buy” rating at 85 percent, upfrom 47 percent in 2005. Foreign investors are acquiring sig-nificant shares of existing retail properties and looking for

development opportunities in an expanding market. Well-located office buildings in the CBD of Levent command pre-mium rents in a high-occupancy market, and office yields,while still high at 10 percent, have fallen 300 basis points overthe past year. Survey respondents also give Istanbul a high buyrating for office. Others believe the Mediterranean coast offersresidential and resort opportunities targeting European andMiddle Eastern homebuyers and tourists.

ViennaVienna drops from 14th to 20th place in the risk-adjustedtotal return rankings for 2006. Buy recommendations arebelow average for retail and office, and average for industrialproperties. Austria’s influence in the European theatre tendsto be through its investors, who are increasingly active in cen-tral Europe and Russia, often taking the lead for international

Istanbul remains a favourite with buyers despite its higher risks.


Exhibit 3-23 Prospects for the Milan RealEstate Market in 2006



Rent Increases Fair 4.8 17thCapital Growth Fair 5.3 15thSupply/Demand Balance Fair 5.0 5thDevelopment Modestly Good 5.5 11th






Office

Retail


Exhibit 3-24 Prospects for the Istanbul RealEstate Market in 2006


Risk-Adjusted Total Returns Fair 5.3 19thTotal Returns Good 6.5 1stRisk Modestly High 4.0 26th

Rent Increases Modestly Good 5.7 4thCapital Growth Good 6.5 1stSupply/Demand Balance Fair 5.0 13thDevelopment Modestly Good 6.3 1st






Office

Retail


investment along with the Germans. Back home, domesticproperty firms are regaining territory by squeezing out inter-national investors. According to CBRE, internationalinvestors previously accounted for 50 percent of the invest-ment market, adding that the market is judging acquisitionson lease length and covenant rather than location and condi-tion. This may explain the 20–basis point yield compressionfor office properties in the past year to a heady 4.8 percent.Demand may be up, but everything else—supply and rents—is stable, with nothing set to change for 2006. Investor inter-est in neighbouring eastern European countries such asSlovakia is growing.

LisbonPortugal’s outlying European location has led internationalinvestors to label Lisbon as undiscovered territory in theirpursuit of product. To a certain extent, investors have beendisappointed: the supply of product is no different there andcompetition is as high, with local private investors getting inon the act. Yields are somewhat higher than other primemarkets at 6.75 percent for prime office properties and 7 per-cent for high-street retail. However, Lisbon’s ranking at sev-enth from bottom in our risk-adjusted ratings illustrates thatthe premium is not enough for most, and respondents arenot enthusiastic about buying prospects in office, retail, orindustrial property sectors.

If the government finally settles lease law reforms satisfacto-rily, international interest may increase. A strong majority gov-ernment should ease reforms into place for the beginning of2006. The laws will mean less flexibility for tenants to vacateon short notice, giving more confidence for landlords to invest.Even in light of reforms, the office sector is still risky, with lowdemand and excess supply. Office vacancy rates have increaseddramatically in the CBD, rising from 5 percent in the thirdquarter of 2004 to 9.12 percent in the third quarter of 2005,according to CBRE. According to Jones Lang LaSalle, the citysaw a 54,630-square-metre take-up in the first half of 2005compared with 95,365 square metres in the same period in2004. Excess supply in the out-of-town western Corridor mar-ket will continue to be a problem into 2006.

Any stability for rents is to be found in the CBD, whichrespondents say could also still sustain new development, ifchances arose. Otherwise, the development message for nextyear is to “pick your opportunities carefully.” Retail continuesto be the darling investment class in Portugal, but most ofthe fierce fighting is for properties located outside the capital.One important trend for this sector for 2006 and beyond,which will affect Lisbon, is the move towards intown regener-ation projects and the importance of high-street retail. ThePortuguese economy generally reflects an extreme version ofthe European average—at present, it is the extreme of under-performance; thus, there is cause for concern in 2006.


Exhibit 3-25 Prospects for the Vienna RealEstate Market in 2006*


Risk-Adjusted Total Returns Fair 5.3 20thTotal Returns Fair 4.8 23rdRisk Modestly Low 5.8 13th

Rent Increases Fair 4.9 15thCapital Growth Fair 5.0 22ndSupply/Demand Balance Fair 5.0 10thDevelopment Fair 5.1 19th







Office

Retail


Exhibit 3-26 Prospects for the Lisbon RealEstate Market in 2006


Risk-Adjusted Total Returns Fair 5.2 21stTotal Returns Fair 5.2 16thRisk Moderate 5.3 19th

Rent Increases Fair 4.7 20thCapital Growth Fair 5.2 19thSupply/Demand Balance Fair 4.7 19thDevelopment Fair 4.9 21st






Office

Retail


WarsawWarsaw remains at the lower end of the rankings for 2006,similar to its place in 2005. While total return prospects arenot bad, the city’s risk rating is among the worst in the sur-vey, and its prospects for rent increases and supply/demandbalance also receive low ratings. Survey respondents (70 per-cent) still recommend industrial as a strong “buy,” but officeand retail buy recommendations have declined from last year.Yet, several interviewees identify Warsaw as a best bet foroffice in 2006, but “. . . not a market for speculative officedevelopment.” Office vacancy rates have declined and nowfluctuate in the lower teens to single digits, depending onwhether you’re talking about city centre or noncentral sub-markets; most new office supply targets noncentral areas.Some respondents mention Warsaw as a growing “offshoring”market for Europe, further increasing interest in the officesector. One interviewee noted that Warsaw has “many oldbrownfields in great locations in need of development, espe-cially on east side of the river Wisla.”

Several interviewees mentioned the return of foreigninvestment and development, particularly in the industrialsector from firms like ProLogis, due to Warsaw’s strategiclocation as a major distribution hub, and in general fromfirms such as GE Capital and Heitman, which are back inthe market. According to several respondents, urban regener-ation is described as “. . . promising but slow,” while new res-idential offers potential development opportunities.

Challenging Markets

AmsterdamThere is little change in Amsterdam in our survey rankings,even though its rating improved over last year’s. Rising a fewpositions up the risk-adjusted return league to 23rd for 2006is little compensation for its continued grouping with other“challenging” markets near the bottom of our survey rank-ings. Respondents see few buying opportunities in Amsterdam,but they are not enthusiastic about selling either; it remains asolid “hold” market for most investors.

The office market is seeing a good level of take-up but lit-tle net absorption as tenants take advantage of lower costs torelocate. Amsterdam has the highest office vacancy rate (16.8percent in third-quarter 2005) of the 23 cities covered byCBRE, and this rate showed no improvement over the pastyear. Investors with a strong stomach can risk investing inthis oversupplied office market for yields of around 6 percent.With the right lease length and tenant, investors can under-write on zero or even negative rental growth, say respondents.

Investors also give some credit to the residential market, buteven then a tough local policy on new housing developmentscauses obstacles. For 2006, all eyes could be on retail. A newretail policy from the government will allow more large-scaleretailers to locate on the periphery of cities rather than just “doit yourself” or garden centres. The policy will offer more oppor-

Respondents see few buying opportunities in Amsterdam, but they are not enthusiastic about selling either; it remains a solid “hold” market.


Exhibit 3-27 Prospects for the Warsaw RealEstate Market in 2006


Risk-Adjusted Total Returns Fair 5.2 22ndTotal Returns Modestly Good 5.7 12thRisk Moderate 4.6 23rd

Rent Increases Fair 4.6 22ndCapital Growth Modestly Good 5.6 10thSupply/Demand Balance Fair 4.6 23rdDevelopment Fair 5.1 17th






Office

Retail


Exhibit 3-28 Prospects for the AmsterdamReal Estate Market in 2006


Risk-Adjusted Total Returns Fair 5.0 23rdTotal Returns Fair 4.5 26thRisk Modestly Low 5.5 18th

Rent Increases Modestly Poor 3.8 26thCapital Growth Modestly Poor 4.4 26thSupply/Demand Balance Modestly Poor 4.0 24thDevelopment Modestly Poor 4.1 25th






Office

Retail


tunities for retailers to trade from bigger stores—a certainattraction to international retailers that have been frustrated intheir attempts to find large-scale stores in inner cities. Rents forwarehouse retail are still low in comparison with those in otherEuropean countries, but with a more flexible approach to sup-ply, they are not expected to see dramatic growth from theiryearly range of €60 to €125 per square metre.

BerlinThough it moved up two spots in the rankings, Berlin is stillentrenched near the bottom of rankings for 2006. There aresome positive trends as the office sector has experienced thehighest take-up since 2001 due to public sector demand, out-pacing flat private sector demand. Vacancies remain high ataround 10.3 percent, according to CBRE; office yields rosefrom 5.1 to 5.6 over the year ending in the third quarter of2005. Speculative office development is a major risk in 2006,while new office stock in 2007 appears very moderate. Themarket still has much to prove to investors before rents startto grow appreciably, supporting our respondents’ stable officebuy recommendation at 25 percent in 2006 compared with22 percent in 2005. Industrial buy recommendations are alsoflat from 2005 levels, remaining at 41 percent. However, theretail buy recommendation has jumped from 38 percent in2005 to 53 percent in 2006, reflecting some aspirations forpositive growth in the economy and disposable incomes.

AthensIt will be a testing 2006 for Athens as it adapts to havingvalue-added tax (VAT) applied to new buildings from thebeginning of the year, as opposed to a transfer tax of 9 to 11percent. The impact had already started to be seen with a rushto get building permits before the end of 2005. There also willbe a gradual increase through to 2008 in the “objective values”of buildings, on which tax is based, which has seen those withdisposal plans step them up a gear. While residential is likelyto see more impact from these VAT plans, the commercialsector is on guard. A framework is also being put in place tolaunch private/public partnerships in Greece, which couldprovide more opportunities for developers 2006 onwards.

Athens drops slightly in the risk-adjusted rankings thisyear to 25th place, third from the bottom. The risk appliedto the city anchors it here. Its ratings on prospects for rentincreases, capital growth, and development are a bit betterand are considered to be fair.

High-net-worth individuals continue to have the run of themarket, although the influence of foreign investors is increasing.Their impact is expected to be felt at the €15 million–plus end


about selling either; it remains a solid “hold” market.

Exhibit 3-29 Prospects for the Berlin RealEstate Market in 2006


Risk-Adjusted Total Returns Fair 4.8 24thTotal Returns Fair 4.8 24thRisk Moderate 4.9 2nd

Rent Increases Modestly Poor 4.1 25thCapital Growth Fair 4.6 25thSupply/Demand Balance Modestly Poor 4.0 26thDevelopment Modestly Poor 4.4 24th






Office

Retail


Exhibit 3-30 Prospects for the Athens RealEstate Market in 2006*


Risk-Adjusted Total Returns Fair 4.8 25thTotal Returns Fair 5.3 15thRisk Modestly High 4.3 25th

Rent Increases Fair 4.9 16thCapital Growth Fair 5.2 18thSupply/Demand Balance Fair 4.9 15thDevelopment Fair 5.1 16th







Office

Retail


of the market, with acquisitions below that level remaining thepreserve of private investors. Capital values will be affected posi-tively, say respondents, but not exponentially. Many flag up aworry about land prices continuing to rise in 2006, though.

Debt and equity are available in Greece, with debt look-ing to increase in share in the coming years. Syndicates areexpected to be an important source of financing. Mostrespondents agree that the capital is generally disciplined, butmainly because “there is not an abundance of investment-grade products.” Also, with a less transparent market, morecare is needed before investing.

Retail is a preferred sector, which shows with its sixth-place ranking on retail buying prospects—64 percent recom-mend buying retail in Athens—but there is a shortage ofproduct. This is likely to be exacerbated in 2006 as respon-dents see development interest in retail tailing off but invest-ment interest increasing. Industrial remains an owner-occu-pier market, so little action is forecasted for 2006. In thehotel sector, development of top-end, five-star hotels is a sig-nificant trend for 2006.

MoscowEven though Moscow ranks at the lower end of the pack, sur-vey respondents are conflicted about the market and over-whelmingly indicate strong “buy” signals for all propertytypes, especially industrial. Moscow suffers in the rankingslargely because of its poor risk ratings; respondents rate it thehighest-risk city of all 27 cities in our survey. This is reflectedin office prime yields, which stood at 12.5 percent in thethird quarter of 2005, according to CBRE. There is still the“. . . need for the market to become more transparent andopen; people should be comfortable that there would be fair,open, clear rules,” according to an interviewee active inRussia and other CIS countries. Moscow’s risk-adjusted totalreturn rating puts it in 26th place. On the other hand,Moscow ranks highly (second place) on prospects for bothcapital growth and development.

A limited amount of high-quality space is available in theoffice sector, with economic demand increasing. Class Aoffice vacancy rates have steadily declined over the last twoyears, with rental rates increasing in the mid-$800s persquare metre per annum, while vacancy rates remain in the 6percent range and rents are relatively flat. Foreign investorsare increasing, with some interest growing from Germanmortgage lenders. Retail and warehouse vacancy rates havebeen declining since 2002. The warehouse sector is under-developed with “incredible demand,” stated one respondenton Moscow’s future industrial demand trends. The industrialbuy recommendation jumped from 45 percent in 2005 to 74percent in 2006. Open Investments, Russia’s only traded realestate company, recently received a buy recommendationfrom an investment bank.

Even though Moscow ranks at the lower end of the pack, survey respondents are conflicted about the market and overwhelmingly indicate strong “buy” signals.


Exhibit 3-31 Prospects for the Moscow RealEstate Market in 2006*


Risk-Adjusted Total Returns Fair 4.8 26thTotal Returns Modestly Good 5.7 10thRisk Modestly High 3.8 27th

Rent Increases Fair 5.3 10thCapital Growth Modestly Good 6.1 2ndSupply/Demand Balance Fair 5.1 8thDevelopment Modestly Good 5.9 2nd







Office

Retail


FrankfurtFrankfurt remains at the bottom in this year’s markets-to-watch ranking, with the lowest rankings in risk-adjusted totalreturns, rent increases, capital growth, and supply/demandbalance. Yet, there is some encouraging news; Frankfurt’s risk-adjusted total returns and city risk ratings improved over lastyear’s (3.6 and 4.2 in 2005 to 4.8 and 4.9 in 2006, respec-tively), thus indicating some improvements in prospects aswith many other European markets. Buy recommendationsin 2006 increased over last year’s recommendations for retailand office, while industrial remains flat. Retail’s buy recom-mendation jumped from 27 percent in 2005 to 41 percent in2006, and office increased from an abysmal 11 percent in2005 to 26 percent in 2006. Office vacancy rates fell 50 basispoints over the past year but remain high at 14.5 percent asof the third quarter of 2005, according to CBRE.


about the market and overwhelmingly indicate strong “buy” signals.

Exhibit 3-32 Prospects for the Frankfurt RealEstate Market in 2006


Risk-Adjusted Total Returns Modestly Poor 4.3 27thTotal Returns Modestly Poor 4.0 27thRisk Moderate 4.6 24th

Rent Increases Modestly Poor 3.6 27thCapital Growth Modestly Poor 4.0 27thSupply/Demand Balance Modestly Poor 3.9 27thDevelopment Modestly Poor 4.0 26th






Office

Retail


PropertyTypes in

PropertyTypes in


Retail continues to be the jewelin the crown.

c h a p t e r 4

PerspectiveAn industry struggling for product has shifted the sec-

tor rankings slightly for 2006, illustrating a broaden-ing appetite for real estate in a variety of sectors.

The last two years saw a consolidation of investor interestand appetite towards retail, warehouse, and residential, but thisyear only retail holds its place at the top as warehouse and resi-dential move down the rankings—behind alternative sectorssuch as hotel and mixed use. City centre office, though stilllow in the rankings, has shown significant increases in its rat-ing, and now shows modestly good prospects.

Of the ten property types in our survey, eight have mod-estly good prospects for total returns while two have fairprospects. This is a significant improvement over last year,when only three sectors had modestly good prospects and sixhad fair prospects.

Overall, there is a general upward trend in how sectors arerated; the top spot is rated at a 5.9 rather than 5.8 and thebottom spot—this time manufacturing—takes the place witha ranking of 4.8 compared to business parks and out-of-townoffices with 4.5 last year. This would indicate that the larger,and still growing, appetite for property has seen investors’optimism for all sectors elevate as they desperately seek thoserare sparks of opportunity.

Retail continues to be the jewel in the crown as retailparks and shopping centres tie for first position for totalreturn prospects. Clustered with these two retail categories

near the top are hotels, which moved up with strengtheningfundamentals, and mixed-use properties, a new category forthis year. Mixed use, coming in at a respectable fourth place,illustrates that all those trends around sustainability, regenera-tion, and city centre development are very real and poten-tially profitable for investors.

The middle of the total return rankings are anchored bythe warehouse sector, which dropped a bit in the rankingsbut held steady with last year’s rating of 5.7 (modestly good)for total return prospects. The middle is rounded out bystreet retail, residential, and city centre office. Street retail isnot expected to fair as well as the more suburban retail prod-ucts. Residential prospects have fallen, in part due to fears ofoverheating in two strong residential markets—the U.K. andSpain. City centre offices, while still low in the rankings, haveshown significant improvement, and the sector is now viewedas a good “buy” sector for 2006.

Clearly, the least-favoured sectors for 2006 are businessparks/out-of-town office and manufacturing. The businesspark sector actually moved up from its bottom-place spot lastyear; with more optimism for a demand-led recovery acrossEurope, investors are clearly thinking that there could be justa glimmer of opportunity for good, standard, cheaper Class Aspace on the accessible edge of cities, particularly when put-

parks, and warehousing. The only sector where yields are notexpected to compress further is residential.

From a buy/sell/hold perspective, which tends to bedriven by a longer-term outlook, the picture changes a bit.From this perspective, the prospects for warehousing/distri-bution and city centre offices stand out. Most notably, citycentre offices rise up the rankings from sixth place last year tosecond place this year; 47 percent recommend buying in thissector while only 16 percent recommend selling. This is sup-ported by our interviewees who believe that office perform-ance is at a low point and is likely to improve in many citiesacross Europe over the next several years.

On the development front, the favourites are retail parks,mixed use, residential, and hotels, all with modestly gooddevelopment prospects. Warehouses and shopping centres

Further yield compression will likely occur in most property sectors in 2006.


ting relocation arguments to corporates still operating in leantimes. Manufacturing is largely in decline in much of Europeand out of favour with most investors.

While yields are now quite low, further yield compressionwill likely occur in most property sectors in 2006, mostnotably hotels, city centre offices, shopping centres, retail

Exhibit 4-1 Real Estate Sector PerformanceProspects for 2006

Retail Parks

Shopping Centres

Hotels

Mixed-Use Property

Warehousing/Distribution

Street Retail

Residential

City Centre Office

Business Park/ Out-of-Town Office

Manufacturing


0% 5% 10%


n Total Returnsn Capital Growthn Rent Increases

5.945.925.53

5.945.915.43

5.925.805.67

5.855.835.56

5.685.715.06

5.585.575.26

5.575.655.61

5.555.575.25

4.904.874.49

4.824.774.38

Exhibit 4-2 Development and Market BalanceProspects for 2006

Retail Parks

Mixed-Use Property

Residential

Hotels

Warehousing/Distribution

Shopping Centres

City Centre Office

Street Retail

Business Park/Out-of-Town Office

Manufacturing

0 5 10

n Developmentn Property Supply/Demand Balance

5.835.3

5.85.59

5.785.48

5.785.32

5.75.17

5.515.42

5.274.98

5.265.34

4.724.41

4.654.78



also show some promise, but office, street retail, and manu-facturing offer only fair prospects. It is no surprise that, whilethe prospects for the office market may improve, the sectorcertainly does not need any new development, especially inthe business park/out-of-town segment.

RetailThere is much less consistency of views about the retail sectorthis year from our survey. Retail parks and shopping centreshave remained the top-rated sectors for total returns, withslightly higher ratings than last year, but beneath this head-line the survey ratings show creeping concerns over rentalgrowth and development prospects.

Continuing weak consumer spending across Europe isnow causing concern among investors as well as economists.Spain and the U.K. face a somewhat weaker 2006. Germanycontinues to be somewhat weaker but is set to get a tempo-rary boost with the staging of the World Cup in summer2006. Meanwhile, bucking the trend, at least temporarily, isFrance, which is outpacing economic forecasts for its con-sumer spending.

Despite this, retail remains the sector of choice for many.“Retail has been very attractive, and because of the more sta-ble performance, many investors are looking at it. The out-look for Germany, France, southern Europe, and the Nordicregion is very attractive, while the prices in the U.K. and cen-tral Europe are not.” Yields are quite low, but survey results

suggest that some further downward pressure can be expectedon retail property yields in 2006.

Out-of-town is still a preference for most investors—shopping centres and retail parks—although a generalacknowledgement that city centre regeneration will becomekey could shift some interest back into town.

Best ProspectsGermany provides a restructuring opportunity, and withdomestic investors failing to see even long-term value intheir own market, international investors will continue totake the lead in 2006. Entrepreneurial U.K. investors havebeen very active, but now this has been followed by NorthAmerican capital such as Canadian investor Ivanhoe andLaSalle Investment Management linking up with MerrillLynch. Respondents say that growing interest has alreadymeant that supply is a problem. These investors are lookingfor high-yielding retail investments, which means the sectoris not an option for all. “Opportunities exist in Germany,but risks are higher than markets such as France,” says one.

in 2006.


0%

20%

40%

60%

80%

100%

Mixed-Use/OtherHotelIndustrialRetailOffice

Exhibit 4-3 European Direct Real EstateInvestment, by Property Type

Source: Jones Lang LaSalle European Research.

Note: Figures exclude Portugal and Denmark.

2000 2001 2002 2003 2004 1H 2005

0%

5%

10%

15%

20%

25%

30%Spain

Portugal

Germany

Finland

Netherlands

United Kingdom

Sweden

France

Ireland

Exhibit 4-4 IPD Retail Property Total Returnsfor Selected Countries

Source: Investment Property Databank (IPD).

Note: For Ireland, 2004 figure was not available; figure shown is for the12 months ending in third-quarter 2005.

1999 2000 2001 2002 2003 2004

The top-rated “buy” cities for retail in our survey includeIstanbul, Prague, Budapest, Lyon, and Helsinki. The topthree here are strong growth markets in developing regions,factors that are bolstering consumer demand for retail prop-erty. Other C.E.E. cities, such as Bucharest and Sofia, are alsoin need of more prime centres.

Retail parks offer the best development prospects out ofall property types in the survey. These big box–oriented proj-ects are still new in some parts of Europe, and demand forthe product is fairly strong. Planning constraints will keepdevelopment in check.

Proceed with CautionPotential for shopping centres in central Europe remainsstrong, especially outside the capitals, as the major cities arenow experiencing oversupply and there are also questionmarks over the quality of that supply. “Central Europeancities are overshopped and some of the retail spaces will fail,particularly the ‘first generation’ shopping centres. We haven’tseen a good shopping centre come to the market this year inthe Czech Republic, Poland, Hungary, or Slovakia.”

The better prospects are cities of more than 300,000inhabitants and with a trend to developing smaller retailshopping centres. “We can see large growth in the number ofinternational tenants, which are now willing to move outsidethe city centres.”

Retail in central Europe is still high yielding, says an inter-viewee, but good-quality shopping centres are still difficult tobuy. The market is not yet saturated, so the advice remains toinvest only in dominant centres, but “it is difficult to buy intoretail. There are too many investors and too little product.”

Compared with retail parks, development prospects forshopping centres and street retail are less compelling.

AvoidThe U.K., despite its maturity, is pegged as a no-go area forretail investors for 2006. Weak consumer demand and at leasttwo high-street retail chains going into administration duringthe Christmas period set the scene. “Retail in the U.K. has

Retail parks offer the best development prospects out of all property types in the survey.


Exhibit 4-5 High-Street Retail PrimeProperty Yields

(Percent)2004 2005 Year-over-Year

City Q3 Q3 Change

Dublin 3.50 3.00 -0.50 London Oxford Street 5.00 4.25 -0.75 Amsterdam 5.20 4.80 -0.40 Brussels 5.50 5.00 -0.50 Madrid 5.75 5.00 -0.75 Paris Centre West 6.50 5.00 -1.50 Vienna 5.00 5.00 - Frankfurt 5.25 5.25 - Zurich 5.00 5.25 0.25 Copenhagen 5.50 5.50 - Milan 6.00 5.75 -0.25 Barcelona 6.00 6.00 - Stockholm 6.25 6.00 -0.25 Helsinki 6.60 6.50 -0.10 Athens 7.50 7.00 -0.50 Lisbon 7.50 7.00 -0.50 Prague 7.50 7.50 - Warsaw 10.00 10.00 - Istanbul 17.00 13.00 -4.00

Source: CB Richard Ellis.

Exhibit 4-6 Prospects for Shopping Centresin 2006


Total Returns Modestly Good 5.9 2ndRent Increases Fair 5.4 5th Capital Growth Modestly Good 5.9 2nd

Supply/Demand Balance Fair 5.4 3rd Development Modestly Good 5.5 6th

Direction in Which Prime Yields Will Move by Late 2006: Stable/Down


Buy Hold Sell43.6% 37.6% 18.8%


Exhibit 4-7 Prospects for Street Retailin 2006


Total Returns Modestly Good 5.6 6th Rent Increases Fair 5.3 6thCapital Growth Modestly Good 5.6 7th

Supply/Demand Balance Fair 5.3 4thDevelopment Fair 5.3 8th



Buy Hold Sell36.2% 44.1% 19.7%


peaked, but there are still opportunities on the continent,”says one respondent, with weaker rental growth feeding intolower returns. Ireland is similarly out of favour. Survey resultsshow the cities with the lowest “buy” recommendations inEurope are Dublin, Edinburgh, and London; only 24 percentof respondents rated London a “buy” market for retail,whereas 32 percent rated it a “sell.” Only 20 percent ratedDublin and Edinburgh as “buy” markets. Retail propertytotal returns in the U.K. and Ireland were very strong in2004 due in large part to yield compression, and the very lowretail yields (e.g., 3.0 for high-street retail in Ireland as of thethird quarter, according to CBRE) will likely give pause toinvestors in 2006.

However, investors’ caution will have to be seen to bebelieved. It is a continuation of 2005’s story and that has notstopped predictions of retail at least matching or even top-ping its €20 billion of property trades for 2004.

The main battle in the U.K. has been out on the highstreet, which has offered the weakest rental growth prospectsand has low income return, according to CBRE. Yields in thissubsector have fallen to a staggering 4.25 percent in the thirdquarter, a 75–basis point drop on the same quarter in 2004.

A lack of stock is likely to prevent the 2005 shoppingcentre investment figures from beating the £9.8 billion tradedin the U.K. in 2004, but low yields are encouraging somestock to come to the market.

New shopping centre developments will not ease thelack of stock burden too much, either—2005 will see just230,000 square metres of space come on the market, accord-ing to CBRE, and the majority of this—78 percent—iswithin town centre shopping schemes.

HotelsThe hotel sector looks to be a top prospect both by totalreturn and development outlook, according to our survey. Ittakes third place behind retail parks and shopping centres byjust a slight margin for total return with a 5.92 (modestlygood) rating. It also has modestly good developmentprospects, ranking alongside retail parks, residential, andmixed-use property at the top of our rankings.

For 2006, our survey has upgraded it to a strong buy (44percent) or hold (41 percent) investment recommendation,with fewer respondents wanting to sell: 15 percent this yearcompared with almost 29 percent for 2005.

Terrorism and natural disasters have overshadowed theindustry worldwide, but this has tended to redirect travelflows rather than halt them. The World Tourism Organisation(WTO) estimates that 460 million tourist arrivals were re-corded worldwide in the first seven months of 2005, a 25million or 5.9 percent growth on the same period last year.However, this does incorporate a slowdown in the secondquarter of 2005, which was 4 percent compared with 9 per-cent in the first.

Leisure tourism continues to outpace business due tomore low fares for short-haul travel, but there is anecdotalevidence, according to the WTO, that business travel willimprove. This includes recovery in the conference and meet-ings sector.


in the survey.

Exhibit 4-8 Prospects for Retail Parksin 2006


Total Returns Modestly Good 5.9 1stRent Increases Modestly Good 5.5 4thCapital Growth Modestly Good 5.9 1st

Supply/Demand Balance Fair 5.3 6thDevelopment Modestly Good 5.8 1st



Buy Hold Sell44.0% 39.2% 16.8%


Exhibit 4-9 Prospects for Hotels in 2006Prospects Rating Ranking

Total Returns Modestly Good 5.9 3rdRent Increases Modestly Good 5.7 1stCapital Growth Modestly Good 5.8 4th

Supply/Demand Balance Fair 5.3 5th Development Modestly Good 5.8 4th

Direction in Which Prime Yields Will Move by Late 2006: Down/Stable


Buy Hold Sell43.8% 41.1% 15.2%


There is promising growth in the sector. French consult-ing group MKG reported that revenue per available room(RevPAR) across Europe in the first six months of 2005 wasup 2.6 percent on a year-on-year basis to €61.10. There wasgrowth in both of the sector’s main drivers: a 1.2 percent risein average daily room rate to €93.20 and a 0.9 percentagepoint rise in occupancy to 65.5 percent.

Respondents generally reflect this confidence through theirsupport of the hotel sector. Hotels, for example, are the high-est-rated sector in our survey for rent/rate increases in 2006.Hotels are also expected to see more downward pressure onyields than any other sector, reflecting increasing investor con-fidence in the sector. Some offer it up as a necessity as othersectors get way too crowded and competitive. “There will be a large interest in hotels, mixed use, and warehousing due tooverheated markets in retail and residential,” explains one.There is reluctance among some interviewees to enter the sec-tor, preferring to admire its prospects from a distance.

Others think it is a good bet with more inclination amongpeople to travel, particularly those in the 50-plus age group asthis growing demographic looks to spend the inheritance.

Best BetsThe U.K. and France continue to find favour with investorsand this is matched by the growth their hotel sectors areseeing. The U.K., in particular, saw strong growth, withRevPAR up 5.9 percent, which is well above the Europeanaverage of 2.6 percent. In addition, room rate growth wasstrong for the second year running at 4.5 percent, promptingconcern that this cannot be sustained. Investors in the U.K.have been a main beneficiary of the trend for hotel compa-nies to sell their assets. For example, Lehman Brothers withGIC Real Estate and Realstar Group recently bought a £1billion U.K. portfolio of Intercontinental hotels.

The high levels of capital in the market are likely to temptmore owner-operators. Business Travel International (BTI)says the terrorist attacks in London have been having a smallimpact on provincial markets with bookings up, but from aproperty point of view these tend to be balanced markets inthe short, with early worries over new supply in Manchesterand Birmingham, according to Jones Lang LaSalle Hotels.

France’s growth is less attractive with RevPAR up 2.9percent, but it is still on most hotel investors’ buy list.

Italy offers opportunities for consolidation. Italy hashotels, but in a fragmented ownership structure; Italianchains exist, but they are small compared with European andinternational chains. Respondents see potential here as thechains will consolidate and major brands will be seekingopportunities in well-located hotels, which still have little orno presence in major cities. Rome is high on the list. In the

south, there is also room for development opportunities inresorts. High-profile banks have already provided somefinancing for resorts, which is expected to lead to investmentby funds or property companies in the short term. However,the drawback so far has been that the available investmentstend to be small in size.

Poland also presents selected investment opportunities.“Warsaw is now seeing an increase in room rates and occu-pancy rates after the crisis resulting from oversupply in thelast five years,” is one interviewee’s take on Warsaw, addingthere may still be a few distressed owners wanting to sell.Major cities outside the capital are also looking more inter-esting, with Krakow mentioned in particular followed byWroclaw and Gdansk. Budget hotels have performed betterin these modest conditions, with four- and five-star values inmany cases below development costs.

DevelopmentTwo countries come out as particularly strong for new devel-opment: Russia and Turkey. In Moscow, respondents reportthat demand for hotel space exceeds capacity by four times.The city also holds the record for the largest room rateincrease—a 29 percent increase according to BTI, which putsthe daily rate at £165.21. The market has benefited fromgrowing business development prospects, its growth inimportance to business travellers, and a lack of supply.

Opportunities also extend outside Moscow, with investorslooking at regions with a million-plus people as all have fewhigh-quality hotels. “St. Petersburg needs more hotels,”pleads one business traveller. Investors and developers, sayrespondents, are still primarily local.

Turkey is now ready to further tap its potential as a touristmarket, respondents say, and needs hotels to do this. Golftourism is big in areas such as Istanbul, Izmir, and the Aegean,while high-standard hotels are also needed at ski destinationssuch as Kartalkaya, Erzurum, Sarikamis, and Kastamonu.

Here, the interest has also been picked up by foreign hoteldevelopers looking in Antalya, Bodrum, and Marmaris.Istanbul is on everyone’s list, but it is more difficult to getdevelopment realised there. The major demand in large citiesis for three- and four-star hotels.

IndustrialProspects for the industrial sector in 2006 again see a split inour survey between manufacturing real estate and warehous-ing/distribution (logistics). Manufacturing property comes in atthe bottom of our rankings for total returns and developmentprospects and second from the bottom for supply/demand bal-ance. Only 17 percent of respondents rate the sector as a “buy”while 46 percent see it as a “sell” sector.

Hotels are expected to see more downward pressure on yields than any other sector, reflecting increasing investor confidence in the sector.


While logistics prospects are higher in the rankings, compe-tition from other sectors has pushed them down a few placescompared with 2005. The sector’s third- and fourth-placerankings have been replaced by fifth-, seventh-, and eighth-place spots. Prospects for total returns were modestly good,giving it a fifth-place ranking, with those surveyed expectingthis to be fed by a fairly good prospect for capital growth.Letting it down with an eighth-place ranking are its prospectsfor rental growth. The buy/hold/sell graph is almost a mirrorimage of its manufacturing property subsector, with almost 49percent hoping to buy and just 13 percent wanting to sell.

Industrial has been a beneficiary of a flood of capital inthe market and this is starting to be reflected in its yield com-pression and causing some to believe that “standing invest-ment logistics are too competitive on pricing.” Madrid hasseen a 125–basis point fall in yields from third-quarter 2004to third-quarter 2005, and three other markets—Prague,Paris, and Oslo—have each seen a 100–basis point fall,according to CBRE; most other cities have seen drops of 25 to 75 basis points. The markets with steady yields wereVienna, Frankfurt, Amsterdam, and Zurich. Just Stockholmsaw its yield move out. Our survey results suggest that yieldswill likely remain stable, with some further yield compressionpossible in 2006.

It is a mixed bag of responses reflecting the lack of har-monisation in the sector across the continent, with eachcountry offering some merit for investors. Many countriesstill have substandard stock that needs replacing.

There continues to be a massive restructuring play incentral Europe, “where the infrastructure is being improved,”which explains the yield fall in Prague and interest in Budapestand Warsaw. However, many prefer the more mature “usualhot spots”: the Netherlands, particularly Rotterdam; Paris andnorthern France; and western Germany.

Best BetsThe best bets are still central and eastern Europe as they con-tinue to benefit from E.U. funding for improved infrastruc-ture, enabling them to fulfil the appetite of growing con-sumer spending. The preferred industrial “buy” markets inour survey are Warsaw, Moscow, Prague, and Budapest, withover 70 percent of respondents rating these cities as good buyopportunities. “The best prospects are southern Poland,where you can already be connected with the Czech Republicand Germany. The worst will be northern parts of Poland.”There is the view that in this region “all capital cities areunderprovided with logistic space,” making it a strong sectorfor acquisition and development, but many feel the sector istaking a more regional approach, with logistics spreading outfrom the capital cities as long as it is “close to harbours, air-ports, and highways.”

Respondents do consider what the rise of the east will doto more traditional western locations. “There is a threat tonorthern France as there is a general shift to the east—it’s notimminent, but it is in the short term.” However, Jones LangLaSalle says the effect on existing centres in Belgium and theNetherlands has been slight, as the change eastwards has beenincremental. Third-party logistics providers have tended tosplit service provision among three regions—western Europe,central Europe, and the Nordic countries.

There were favourable words for Spain as well, which stillhas good prospects in many of its major arterial routes. “Notonly do we expect growth in the sales market, but also that ofrents.” The corridors between the capital and cities such asBarcelona, Valencia, Toledo, and Zaragoza were highlighted.Barcelona and Madrid both received strong “buy” recommen-dations in our survey for warehouse/distribution.

WeaknessesThe U.K. market is causing some concern for investors. “Idon’t expect the U.K. to perform strongly,” says one, andanother felt underweight in the market, but “pricing is toohigh.” More broadly, there were also worries of the knock-on


reflecting increasing investor confidence in the sector.

0%

5%

10%

15%

20%

25%

30%

Spain

Portugal

Finland

France

Sweden

United Kingdom

Netherlands

Ireland

Exhibit 4-10 IPD Industrial Property TotalReturns for Selected Countries



1999 2000 2001 2002 2003 2004

effect on distribution of weakening retail demand. The lowestindustrial yields in Europe—5.75 percent—can be found inthe U.K. and in Dublin, each 100 basis points below theother low-yield markets.

Investor focus is on the south in the U.K., which benefitsfrom the stronger regional economy. To counter some of thepricing worries, the U.K. has stable rents, and strong demandin the southeast is seeing a reduction in incentives for ten-ants, according to JLL.

On the continent, there was little short-term interest inthe Italian market, which offers only a “few projects in theinvestment and development market, and those are of smallsize and [low] quality.” However, there is a broadening gen-eral interest in logistics in the medium to long term with the“delocalisation” of production. Most felt that this would haveto be coupled with improvements to infrastructure; goodprospects, for example, were close to the highways linkingTurin with Trieste and Milan-Rome-Naples.

Manufacturing in general remains a weak part of theEuropean property market, with modestly poor prospects forrent increases in 2006 and only 17 percent of survey respon-dents looking to buy in this sector while 46 recommend sell-ing. Rent increases for warehouse/distribution are not expectedto be much better—only fair—and investors will need to lookto capital growth to prosper in the warehouse sector in 2006.

ResidentialThe acquisitions of German residential by U.S. funds havestolen the sector’s headlines this year. The majority of thoseacquisitions have been in a rarefied part of the market reservedfor players with €500 million and upwards (€7 billion in thecase of the Terra Firma’s acquisition of Viterra).

However, down on the ground in Germany, there isexpected to be some kind of knock-on impact on the regularresidential market. Some say the portfolio deals are “gettingpricey,” but for others the pricing of these transactions is“suggesting high retail” prices. Whether this is buyers’ antici-pation or residential growth in Germany gaining momentumis yet to be seen, but interviewees suggest that there are defi-nitely opportunities for the market to mature.

Residential is the only sector in our survey where respondents believe yields are more likely to move up than down.


Exhibit 4-11 Industrial Prime Property Yields(Percent)

2004 2005 Year-over-YearCity Q3 Q3 Change

Dublin 6.50 5.75 (0.75)U.K. Wide 6.35 5.75 (0.60)Barcelona 7.50 6.75 (0.75)Madrid 8.00 6.75 (1.25)Copenhagen 7.50 7.25 (0.25)Brussels 8.25 7.50 (0.75)Vienna 7.50 7.50 0.00 Frankfurt 7.70 7.70 0.00 Amsterdam 7.75 7.75 0.00 Milan 8.25 8.00 (0.25)Oslo 9.00 8.00 (1.00)Paris Île-de-France 9.00 8.00 (1.00)Stockholm 8.30 8.50 0.20 Zurich 8.50 8.50 0.00 Prague 9.75 8.75 (1.00)Helsinki 10.50 10.30 (0.20)


Exhibit 4-12 Prospects for Manufacturing RealEstate in 2006


Total Returns Fair 4.8 10th Rent Increases Modestly Poor 4.4 10th Capital Growth Fair 4.8 10th

Supply/Demand Balance Fair 4.8 9th Development Fair 4.7 10th



Buy Hold Sell16.8% 36.8% 46.3%


Exhibit 4-13 Prospects for Warehousing/Distribution Real Estate in 2006


Total Returns Modestly Good 5.7 5thRent Increases Fair 5.1 8th Capital Growth Modestly Good 5.7 5th

Supply/Demand Balance Fair 5.2 7th Development Modestly Good 5.7 5th



Buy Hold Sell48.7% 37.8% 13.4%


In our survey, prospects for residential were “modestlygood.” It came just seventh in the sector rankings on totalreturns, sixth by capital growth, but second for rent increasesand second for supply/demand balance prospects. Fewerrespondents rate residential as a “sell” this year at 23 percentcompared with 37 percent last year, with the difference nowpreferring to “hold” the sector. Notably, residential is the onlysector in our survey where respondents believe yields aremore likely to move up than down.

Residential is also where some longer-term trends are start-ing to affect respondents, or at least be at the forefront of theirminds. They were very conscious of the impact of increasedmigration into their cities and that volumes and types ofhousing would be needed to respond to that. “Immigration isdriving demand for rent or acquisitions of lower segments ofresidential property,” says one. “There will be an overallincrease in consumption, but we need to develop an appropri-ate housing offer.” The development outlook is thus relativelybright, and residential ties for third in our survey on thismeasure, with modestly good prospects across Europe.

Also, this sector expects to see the impact of demographicchanges, with families living in smaller family units. “There isa changing pattern of residential. The average size of unit isdecreasing, with more one- and two-bedroom units and[fewer] three-bedroom” units, says one. “The structure offamilies is changing, implying a trend of smaller housing and


are more likely to move up than down.

0%

5%

10%

15%

20%

25% Spain

United Kingdom

Germany

France

Finland

Netherlands

Sweden

Exhibit 4-14 IPD Residential Property TotalReturns for Selected Countries


1999 2000 2001 2002 2003 2004

a transformation of the housing stock.” Many already expressinterest in the retirement communities sector as well.

Best BetsThe more opportunity-led money is heading east for 2006.“The residential market continues to be strong in Poland in2006, with good prospects for Warsaw and key secondarycities.” These include Krakow and Wroclaw, but it is “lesspositive in cities below 100,000 inhabitants.” A “solid” yearfor Poland is predicted, with further growth expected on thecurrent 7 percent annual growth of transactions. The CzechRepublic has annual sales growth of 5 percent.

Many are already taking up the opportunities in Poland,prompting some to observe that “the market is overstockedwith large, low-end products. We see potential for develop-ment in smaller and higher-quality projects.” It is very mucha sales-driven market, with few wanting a large portion oftheir salary to go towards rent.

However, with all opportunities comes risk. “Future growthof capital values is uncertain. This is because the rent increasehas to a big extent been fuelled by speculative investmentdemand and not the real demand for apartments.” There arealso barriers to entry, including the “high level of bureaucracyin securing building permits for new developments.”

Rapid population growth and migration into larger citiesare making the Turkish residential market look attractive forsome, although local expertise could be a crucial factor as themarket’s growth will “bring a tougher competitive environ-ment where investors without sufficient local knowledge willbe at risk.” Bigger cities will support the trend, includingIstanbul, Ankara, Izmir, Bursa, and Adana.

The government is also helping promote ownership withchanges in the mortgage law. Buyers will be able to take upfixed- or variable-rate mortgages up to 30 years rather thanthe five- to ten-year time frame, which has been makingownership less accessible. But mortgage rates are at around1.2 percent per month; there needs to be a decline in theserates before take-up improves.

AvoidDid someone say bubble? It is a problem that most respon-dents deny exists for the rest of the market, but when itcomes to either U.K. or Spanish residential, they are happy to adopt the term.

“Yes, there is a bubble in Spain. Residential is overvaluedby 20 to 25 percent,” says one interviewee. Another inter-viewee estimates that housing starts will fall from currentlevels of more than 700,000 to around 400,000.

Pessimists call Spanish housing a “low growth” opportu-nity and that the market’s “oversupply will come into focus” in2006. Any adjustment in pricing, say interviewees, will dependon possible interest rate rises and the pace of those rises.

High land prices have tempted some to look beyond themajor cities for better prospects in Valencia, Murcia, andCastellón, where land is available at a more reasonable price.While a couple of interviewees put Madrid at the top of thelist for the worst prospects, some said the capital affordedconversion opportunities.

Others are looking to the second-home market as havingthe most growth potential as Spain becomes an option formore Europeans. For example, many U.K. residents were tak-ing the chance in 2005 to buy a second home to place intheir Self-Invested Personal Pension. However, the U.K. gov-ernment recently ended this option.

In the U.K., there is a view that the “ownership market isfacing a four- to five-year correction” and that this weakermarket could deter institutional investors, which were startingto feel more comfortable with the sector. A destabilising effecthas come from private purchases of buy-to-let properties,which will suffer as growth fails to come through in 2006.

Greece also could have a tough 2006. Its residential marketwill feel the brunt of the introduction of VAT onto new devel-opment, which will cause a slowdown in the market. “TheGreek residential market shows a similar slowdown every time tax changes are introduced—it usually takes between six months and a year for the market to adjust,” explains oneinterviewee. Regardless of this, the message from Greece is that there is real demand in Athens and other major cities.

Office“Pure cut-throat competition” is how one intervieweesummed up the office investment market. In addition to theamount of capital chasing dwindling stock, there are alsoconcerns about the expertise of that capital. Some expressedthe view that a 90-day economic shock might be good for theEuropean office property industry, as it might chase awaysome of the hot money in the sector, leaving a clearer invest-ment run in the office sector for more experienced players.

In 2006, the sector will also have to continue to contendwith the advent of a new tranche of longer-term capital,which values the income component of property, allowing itto pay higher prices for assets as they were considering invest-ments on a much longer term. These investors are unlikely tobe deterred from the market in 2006, even by a 150– to200–basis point shift in interest rates.

For the office market to thrive longer term, the sector needsto see rental growth in 2006. “If there is no rental recovery,then this could result in problems—maybe not in 2006, but in2007.” The sector is seen as having the greatest potential forgrowth by many interviewed, but can this move quicklyenough in 2006? “For rental growth versus price, it is becom-ing more difficult to see the value,” comments one respondent.

“Pure cut-throat competition” is how one interviewee summed up the office investment market.


Exhibit 4-15 Prospects for Residential RealEstate in 2006


Total Returns Modestly Good 5.6 7thRent Increases Modestly Good 5.6 2ndCapital Growth Modestly Good 5.7 6th

Supply/Demand Balance Modestly Good 5.5 2nd Development Modestly Good 5.8 3rd

Direction in Which Prime Yields Will Move by Late 2006: Stable/Up


Buy Hold Sell36.6% 40.2% 23.2%


Exhibit 4-16 Office Prime Property Yields(Percent)

2004 2005 Year-over-YearCity Q3 Q3 Change

London West End 5.50 4.50 -1.00Dublin 5.25 4.50 -0.75Madrid 5.75 4.75 -1.00Vienna 5.00 4.80 -0.20Barcelona 5.75 5.00 -0.75Paris Centre West 5.75 5.10 -0.65Munich 5.00 5.20 0.20London City 6.00 5.25 -0.75Hamburg 5.00 5.30 0.30Frankfurt 4.90 5.30 0.40Stockholm 6.60 5.50 -1.10Edinburgh 6.00 5.50 -0.50Milan 5.75 5.50 -0.25Zurich 4.75 5.50 0.75Berlin 5.10 5.60 0.50Copenhagen 6.25 5.75 -0.50Rome 5.75 5.75 0.00Amsterdam 6.75 6.00 -0.75Brussels 6.25 6.25 0.00Helsinki 6.80 6.50 -0.30Lisbon 7.25 6.75 -0.50Warsaw 9.10 7.00 -2.10Budapest 8.00 7.00 -1.00Prague 7.75 7.00 -0.75Lyon 7.75 7.50 -0.25Athens 7.00 7.50 0.50Istanbul 13.00 10.00 -3.00Moscow 13.00 12.50 -0.50


This can be seen in the yield shifts experienced in the sectorin a year that has seen only moderate occupier demand. Parisfell 65 basis points to 5.1 percent in the year to the end of thethird quarter, but may even look cheap in comparison withLondon at 4.5 percent (a 100–basis point drop) and Madridat 4.75 percent. The yield shifts also show how far-reachinginvestors have been on the search for office product: Istanbul

has seen a 300–basis point drop in yield to 10 percent, Warsawhas fallen 210 basis points to 7 percent, and Lyon has fallen 25basis points to 7.5 percent. Our survey results suggest thatdownward pressure on office property yields will continue in2006 across Europe, and that this downward pressure will beespecially noticeable in city centre offices.

A clear division remains between city centre offices andbusiness park/out-of-town business space. City centre offices,at 47.4 percent, are the second most favoured sector in oursurvey in terms of the percentage wanting to buy in 2006.This stands in stark contrast to business park or out-of-townspace, where just 24.8 percent want to buy, with the majorityat 39.2 percent wanting to sell the sector in 2006. Businesspark/out-of-town offices also rank at or near the bottom onprospects for total returns, rent increases, capital growth,development, and property supply/demand balance.

Best BetsFor risk-adjusted return prospects, core markets with expecta-tion of rental growth remain favourites in our survey. Parisand London lead the way with solid total return and rentgrowth prospects and favourable risk ratings. In London, theWest End can rely on “good core tenant demand,” but theCity office market is lagging and is “not recovering as quicklyas anticipated,” although London as a location generally has“two to three years’ good performance ahead of it.” “Parisremains robust” and with supply in check, it should seegrowth continue in 2006.

Top “buy” markets for the office sector are Helsinki,Moscow, Lyon, Madrid, and Istanbul, with over 60 percentof respondents suggesting that these were good markets forbuying offices in 2006. Helsinki, Lyon, and Madrid are eachconsidered low-risk markets with reasonable rent growthprospects, and Moscow and Istanbul both rate highly forgrowth prospects. With the exception of Madrid, office yieldsare relatively high in these markets, ranging from 6.5 percentin Helsinki to 12.5 percent in Moscow.

Other investors looking for value will continue to searchcities outside the capitals in 2006. A typical response hasbeen to focus on locations where rental prospects are strongand pricing has not yet adapted to reflect this. “France[except Paris], Spain [except Madrid and Barcelona].” ForFrance, this means Marseilles and Lyons, and Alicante,Valencia, and Seville in Spain. The trend is also spreading toItaly, where “there will be a reduction in the demand foroffices in the main cities and growth in the middle-size cities,both for development and investment.” In most cases, thisinvestor strategy is occurring where the capital city market isfavoured but has become too hot for investors, who neverthe-less want to benefit from the country’s economic prospects.


up the office investment market.

0% 5% 10% 15% 20%

Exhibit 4-17 Office Vacancy/Availability Rates

Amsterdam

Frankfurt

Budapest

Prague

Brussels

Dublin

Berlin

Stockholm

Munich

Helsinki

Warsaw

Lisbon CBD

Madrid

Hamburg

Central London

Copenhagen CBD

Lyon

Vienna

Barcelona

Zurich

Île-de-France

Moscow

Paris CBD

n Q3 2005n Q3 2004


The U.K. is one exception to this, where there is morecaution with regard to the regional markets, which tend to bemore mature relative to continental second-tier cities. “It isvery important to look at local supply in U.K. regional officemarkets,” says one, with others seeing office rental growth inLondon but “less evidence in the U.K. regions.”

AvoidGermany and the Netherlands get the consistent thumbs downfor 2006. For Germany, the caution is patchy; few will touchFrankfurt and Berlin, but the other cities may have some meritin 2006. “The German market is still a question mark andMunich may start to pick up while Frankfurt will continue tounderperform.” Concerns over economic performance con-tinue to underpin the lack of confidence in the German mar-ket, but where there is less of a supply/demand imbalance,markets could recover more quickly, say respondents.

Business park/out-of-town offices rank at or near the bottom on prospects for total returns, rent increases, capital growth, development, and property supply/demand balance.


-5%

0%

5%

10%

15%

20%

25%

30%

35%

40%

Spain

Portugal

Germany

Finland

United Kingdom

Netherlands

Sweden

France

Ireland

Exhibit 4-18 IPD Office Property Total Returnsfor Selected Countries



1999 2000 2001 2002 2003 2004

Exhibit 4-19 Prospects for City CentreOffices in 2006


Total Returns Modestly Good 5.6 8thRent Increases Fair 5.3 7th Capital Growth Modestly Good 5.6 8th

Supply/Demand Balance Fair 5.0 8th Development Fair 5.3 7th

Direction in Which Prime Yields Will Move by Late 2006: Down/Stable


Buy Hold Sell47.4% 36.5% 16.1%


Exhibit 4-20 Prospects for Business Park/Out-of-Town Offices in 2006


Total Returns Fair 4.9 9th Rent Increases Fair 4.5 9th Capital Growth Fair 4.9 9th

Supply/Demand Balance Modestly Poor 4.4 10th Development Fair 4.7 9th



Buy Hold Sell24.8% 36.0% 39.2%


Berlin and Frankfurt are near the bottom of our office“buy” list, while Hamburg and Munich fall more towards themiddle. Office yields in the German markets as of the thirdquarter were generally in the range of 5.2 to 5.6 percent, butyields actually rose 20 to 50 basis points from third-quarter2004 to third-quarter 2005, according to CBRE.

The Netherlands’ poor rating is more a concern over sup-ply. “We expect a natural balance back in the market in threeto five years. There will be a shortage of high-quality officewithin two years.” Amsterdam, Rotterdam, and the Hagueare highlighted by many as particularly poor prospects. At astretch, good markets in the Netherlands are named asZwolle, Breda, and Maastricht.

Zurich, Amsterdam, and Vienna received the lowest “buy”recommendations for office in our survey, with Dublin, Berlin,and Frankfurt also near the bottom of the shopping list. How-ever, such extremes do encourage contrarian investors. “Ourtargets are where rental growth prospects are poor but pricing isattractive, such as Germany.” Or: “With Amsterdam, Frankfurt,and Brussels there are relatively high yields, so depending onlease length/tenant you can underwrite on zero or even negativerental growth.”


returns, rent increases, capital growth, development, and property supply/demand balance.

Interview Participants Aareal Bank AGSenay AzakKarl Wilson

Aareal Property ServicesRobbert Jan van Zinnicq Bergmann

Aberdeen Property InvestorsAlessandro Bronda

ABP

Alfa Capital PartnersJack Kelleher

Allied Irish BankMichael Cooke

AMVEST Vastgoed BVTak Lam

AP Fastigheter ABAnders Ahlberg

Arlington Property InvestorsAndrew Smith

ASPRIMAJosé Manuel Galindo Cueva

ATIS Real WeatherallsKeith Steventon

AXA REIMBruno GuiotPaul MarcuseKiran Patel

Banca IntesaFabrizio Bonelli

Banif ImoLuis Saramago Carita

Barclays CapitalHans Vrensen

Beni Stabili SpAAlexandre Astier

BIG BundesimmobiliengesellschaftErnst Eichinger

Blackstone GroupErik Moresco

BPF BouwinvestDouwe W. Swierstra

BPN ImofundosMiguel Faria

BVIC GroupPanos Anastasakis

Capital PartnersErkan Erkek

Castellum ABLars-Erik Jansson

CB Richard EllisNick AxfordPedro Seabra

CB Richard Ellis GunneMarie Hunt

Citigroup Property InvestorsStuart Webster

Colony CapitalSerge Platonow

ComiturJoão Charters

Credit Suisse Asset ManagementDaniel B. Tochtermann

Credit Suisse First BostonIan Marcus

Curzon Global Partners/IXIS AEW EuropeRic Lewis

Cushman & WakefieldDavid HutchingsEric van Leuven

Cushman & Wakefield Stiles & RiabokobylkoMark B. Stiles

DEGIThomas Beyerle

Deka Immobilien Investment GmbHJohannes Haug

Deutsche Bank AGKlaus D. Droste

Deutsche Bank Real Estate InvestmentBankingGianluca Muzzi

Deutsche Bank Real Estate SAEIsmael Clemente

DIFA Deutsche Immobilien Fonds AGReinhard Kutscher

DTZMiguel GalvãoMiguel Queiroz

DTZ Asset ManagementFrançois Brisset

EFG Eurobank Properties SAAristotle Karytinos

EPRAFraser Hughes

EurazeoPhilippe Brion

Eurohypo AGMarcus CielebackKenny EvangelouBernd KnoblochAlexander von Trotha

Europa CapitalNoel Manns

Ferrovial Inmobiliaria SAAlvaro Echániz

Freshfields Bruckhaus DeringerChris Morris

FundBoxRui Alpalhão

Gabetti Holding SpARoberto Nicosia

GE Real EstateOtakar LangerFrancois Trausch

GLL Real Estate PartnersBrigitte Schmale

Goldman Sachs InternationalRichard PowersEdward Siskind

Greenwich Investment Services LLCDmitri Dorofeev

GrosvenorRichard BarkhamJeremy Newsum

Grupo ReyalRafael Santamaría Trigo

GVA GrimleyStuart Morley

HeitmanGordon BlackSkip SchwartzDavid Watkins

Henderson Global InvestorsAlice BrehenySimon BryantMichael Novak

HinesLee Timmins

Hines ItaliaManfredi Catella

HRO FranceClive Llewelyn

HSBCIBNick LemingGuy Morrell

Hunter AdvisersDavid Hunter

Immofinanz Immobilien Anlagen AGKarl Petrikovics


IMN Conferences

ImometricaAntonio Gil Machado

ING Real Estate Investment ManagementPieter A. Hendrikse

Inmobiliaria EspacioJosé Antonio Fernandez Gallar

INREVLisette van Doorn

Insight Investment ManagementMark Long

Invesco Real EstatePaul KennedyBen Maudling

IVG Immobilien AGThomas RuckerEckart John von Freyend

IXIS AEW Italia SpAAndrea Amadesi

JER PartnersMalcolm LeMay

Jones Lang LaSalleTony EdgleyAlasdair HumpheryAnne KavanaghMichael LangeTomasz Trzóslo

JP MorganAndrew S. Penny

JP Morgan Fleming Asset ManagementBernard PenaudNick Tyrrell

Kaspar AssociatesKaren Sieracki

Kemer HoldingSerdar Karada¤

KEOPS A/SSusanne Lindø

KFNPaul Vismans

King SturgeAngus McIntosh

Knight FrankDorota Latkowska

Lambert Smith HamptonNick Chatzitsolis

Lamda DevelopmentLambros Anagnostopoulos

LaSalle Investment ManagementGerald Blundell

Layetana Real EstateSantiago Mercade

Lehman BrothersGerald Parkes

LinklatersSimon Clark

Lone Star GermanyKarsten von Koller

Matrix Group Ltd.Ian BlakeMischa Davies

Mercer Investment ConsultingGreg Wright

Merrill Lynch InternationalJohn R. Herbert

Metro Group Asset Management EmlakYönetim AfiGöksel AtikelerGündüz Bayer

Morgan StanleyMartin Allen

Morgan Stanley Real Estate InvestmentsStephane Theuriau

Morley Fund ManagementNick Mansley

Nurol Real Estate Investment CompanyBekir Cumurcu

Orion Capital ManagersAref H. LahhamVan J. Stults

Oy Realinvest AbArto Ihto

Patrizia Immobilien AGGeorg Erdmann

Pensimo Management AGRichard Hunziker

PGGMPeter de HaasJan van der Vlist

PINNACLE Real Estate InnovationMartin Carr

Pirelli Real EstateFilippo Peschiera

PlanbelasGilberto Jordan

Pradera–AM PLCColin J.C. Campbell

Pramerica Real Estate Investors LimitedJonathan Short

Protego Real Estate Investors LLPIain Reid

Prudential Property Investment ManagersPaul Mitchell

PSP Swiss PropertyFritz Jörg

Riofisa SAMiguel Rodríguez

Rockspring Property InvestmentManagers Ltd.José Luis Pellicer

Rodamco EuropeMaarten Hulshoff

RREEF/DB Real EstatePeter Hobbs

SEB ImmoinvestBarbara Knoflach

SEG Immo AgAlfred GablerSivia Wustinger-Renezeder

Société Foncière LyonnaiseAlec Emmott

Sonae SierraÁlvaro Portela

Sopedi Real Estate Financial ProductsGerard Philippson

STAM EuropeAntoine de Broglie

The State Pension Fund, FinlandIlkka Tomperi

Strategic Real Estate AdvisorsJeremy Gates

Tishman Speyer PropertiesMichael Spies

TMW PramericaThomas Hoeller

TSKB Real Estate CompanyCansel Turgut Yazici

UBS Investment BankWilson Y. LeeSeth M. Lieberman

Winterthur GroupRainer Suter

Züblin ImmobilienBarbara V. Stuber

Zurich Financial ServicesRoland Stockmann

Other IndividualsMarc MogullHolger Muller



PricewaterhouseCoopers real estate group assists real estate investmentadvisers, real estate investment trusts, public and private real estateinvestors, corporations, and real estate management funds in develop-ing real estate strategies; evaluating acquisitions and dispositions; andappraising and valuing real estate. Its global network of dedicated realestate professionals enables it to assemble for its clients the most quali-fied and appropriate team of specialists in the areas of capital markets,systems analysis and implementation, research, accounting, and tax.

Real Estate Leadership TeamPatrick R. LeardoGlobal Real Estate Business Advisory ServicesNew York, New York646-471-2666

Frank van ZelstEuropean Tax LeaderAmsterdam, Netherlands 31-20-568-6872

John ForbesU.K. Real Estate LeaderLondon, United Kingdom 44-20-7804-3161

Peter F. KorpaczReal Estate Business Advisory ServicesBaltimore, Maryland301-829-3770

www.pwc.com

ULI–the Urban Land Institute is a nonprofit research and educationorganisation that is supported by its members. Its mission is to provideresponsible leadership in the use of land in order to enhance the totalenvironment.

The Institute maintains a membership representing a broad spec-trum of interests and sponsors a wide variety of educational programmesand forums to encourage an open exchange of ideas and sharing ofexperience. ULI initiates research that anticipates emerging land use trends and issues and proposes creative solutions based on thisresearch; provides advisory services; and publishes a wide variety ofmaterials to disseminate information on land use and development.

Established in 1936, the Institute today has more than 28,000members and associates from some 80 countries, representing the entire spectrum of the land use and development disciplines.Professionals represented include developers, builders, property own-ers, investors, architects, public officials, planners, real estate brokers,appraisers, attorneys, engineers, financiers, academics, students, andlibrarians. ULI relies heavily on the experience of its members. It isthrough member involvement and information resources that ULIhas been able to set standards of excellence in development practice.The Institute is recognised internationally as one of America’s mostrespected and widely quoted sources of objective information onurban planning, growth, and development.

Senior ExecutivesRichard M. RosanPresident, ULI

William P. KistlerPresident, ULI Europe

Cheryl CumminsChief Operating Officer

Rachelle L. LevittExecutive Vice President, Policy and Practise

ULI–the Urban Land InstituteWashington, D.C. 202-624-7000www.uli.org

ULI EuropeLondon 44 (0) 20 7487 9570www.uli.europe.org


Emerging Trends in Real Estate® Europe 2006What are the best bets for real estate investment anddevelopment in 2006 across Europe? Based on personalinterviews with and surveys from more than 250 of themost influential leaders in the European real estate industry,this forecast will give you the heads-up on where to invest,what to develop, which markets are hot, and how theEuropean economy and trends in capital flows will affectreal estate. A joint undertaking of PricewaterhouseCoopersand the Urban Land Institute, this third edition of EmergingTrends in Real Estate® Europe is the forecast you can counton for no-nonsense, expert advice.

Highlights

n Reports on how European and international economic trendsand issues are affecting real estate.

n Describes trends in the capital markets, including sources andflows of equity and debt capital.

n Tells you what to expect and where the best opportunities arefor both investment and development.

n Assesses real estate prospects and opportunities in 27European cities.

n Discusses which metropolitan areas offer the most and leastpotential.

n Features detailed analysis and prospects for office, retail,industrial, hotel, and residential property sectors.

n Explains which property sectors offer opportunities and which to avoid.


www.pwc.comwww.uli.org

ULI Order Number: E24

ISBN: 978-0-87420-949-5

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