Real Estate Risk Premiums Should Rise To Reflect Eurozone Breakup
Real estate investors in the eurozone should be demanding higher risk premiums to reflect the probability that individual countries will exit the currency bloc due to the sovereign debt crisis, even though a widespread break-up is unlikely.
Analysts from investment bank Natixis and its property affiliate AEW Europe made the argument at a seminar during the ExpoReal real estate trade fair in Munich.
Patrick Artus, Global Chief Economist at Natixis said: “The sovereign debt crisis in the eurozone has driven up banking risk and corporate risk, creating an environment characterised by high risk aversion, abundant liquidity and sluggish growth in the OECD countries. We believe, however, that at the brink of the precipice the EU will muster sufficient financial firepower and political will to refinance the banking system, allow an ‘orderly default’ of Greek debt and prevent the break-up of the eurozone.”
Sylvain Broyer, deputy chief economist at Natixis, added that the abundance of liquidity is only benefitting safe haven assets, including gold and a select few government bonds. “This category doesn’t include emerging market assets, for example.”
Real estate pricing within the eurozone isn’t yet generally reflecting the possibility that the contagion of the crisis won’t be stopped and that a “two euro” system may emerge, with a core bloc centred around Germany, and sharply devalued currencies in periphery countries forced to exit the euro.
AEW Europe has analysed the core real estate investment market in the eurozone on the basis of these two scenarios: a low probability that the eurozone will experience a catastrophic breakup; and a high possibility that it weathers the crisis, but faces a protracted period of anaemic economic growth.
The investment manager then weighted the risks of countries exiting the euro, to produce an average probability risk yield premium, relative to the yield a core asset should generate were the country certain to stay in the euro. For Germany, the Netherlands, Austria and Finland, this risk premium is nil given the state of their public finances.
But for other individual eurozone core real estate markets, these yield risk premiums included:
– France and Belgium – 10 basis points (bps)
– Italy and Spain – 50 and 90 bps respectively
– Greece – 375 bps
Mahdi Mokrane, head of Research & Strategy at AEW Europe said: “We think that whatever the scenario, the search for safe havens could be beneficial for core long leased properties in the safer eurozone countries. And these properties will command ever sharper yields.
“However, there is something wrong with pricing relative risk in eurozone real estate markets when, say, Milan or Rome offices are now being offered at low yields of 5.0% to 5.5% or core Spanish retail at 5.0%, in the middle of the sovereign debt crisis. We believe investors should be demanding higher risk premiums, according to the circumstances of individual markets, and that non super-safe yields will be rising across the board in the Eurozone by year-end unless a convincing solution to the crisis is found to satisfy financial markets.”