Spanish real estate builds hopes of a sustained recovery

The Spanish property market is consolidating the path of recovery it started in 2014, establishing itself once again as an attractive sector for investment.

The expansionary cycle of the economy, low financing costs and rental yields in a zero percent interest rate environment are creating a favourable climate for Spanish real estate.

While returns reached a record high for the decade in 2015, prospects for the sector this year remain “quite positive” with expectations of a “strong” total return, according to Luis Francisco, senior associate at MSCI.

Latest data from MSCI’s IPD Spain Annual Property Index point to 15.3% total return in 2015, up from from 9.4% the previous year. This performance was driven by strong capital growth which accelerated to 9.7% from 3.6% in 2014.

Last year’s capital value growth was the result of a yield compression scenario and rising market rental values, which is occurring this year too.

PRESSURE ON YIELDS

Spanish real estate is in high demand from investors, Francisco explains, which puts pressure on property yields, positively affecting capital values of related assets.

This is good news for investors already holding properties in the country, as they are seeing the value of their assets increase. But institutional investors navigating an environment of low interest rates might find Spanish property returns – even where there is a yield compression scenario – more interesting than ones generated by European fixed income.

“Real estate is once again becoming an attractive sector for investment that can generate returns, even when they are starting from near historic lows, at around 4.5% in retail and the best offices of Madrid and Barcelona,” says Jesús Amador, financial analyst at Spain’s Bankinter.

“Return rates remain very attractive, especially when compared with the negative return obtained from both sovereign and corporate fixed income of high creditquality in Europe,” Amador says.

“A return higher than 3.5% is for us particularly attractive in a period of low interest rates and very low inflation,” he adds.

According to Francisco, real estate became an attractive asset class for investors last year, as it outperformed bonds and equities.

This might explain why Spain this year has been considered the third most attractive European country in which to invest in real estate, the study ‘Global Investors Intentions’, carried out by CBRE, reveals.

“There is significant growth potential in the Spanish real estate market and a long way to go in terms of value creation, which continues to attract foreign investment. The Socimis [Spanish real estate investment trusts], with local teams with extensive professional experience in the sector, have captured an important part of that foreign investment,” says Carmen Boyero-Klossner, head of Investor Relations at Spanish Reit Axiare Patrimonio.

SLOWDOWN IN ACTIVITY

In spite of these drivers favouring property investment, the level of Spanish real estate investments fell 24% to €4.1bn in the first half of 2016, according to CBRE.

“Before starting the year, it was already considered very difficult to maintain activity at the level of 2015, mainly because product on offer was greatly reduced off as a result of high investment activity,” says Lola Martinez Brioso, head of Research at CBRE Spain.

Alejandro Campoy, general manager of the investment area at property consultancy firm Aguirre Newman, says the fall in real estate investment, particularly in offices, was driven by a slowdown in activity by Socimis, which are now focused on management of the assets they previously acquired.

The fall is also linked to a decrease in asset supply, political uncertainty in the country following the inconclusive elections of December last year, and lower prospects for global economic growth, Campoy adds.

But investment activity is expected to be reactivated in the second half of the year, he explains, as low returns on fixed income, in some cases negative, and high volatility of equities, accentuated after the UK’s vote to leave the EU, will increase the attractiveness of investments in office properties.

Property consultant Knight Frank echoes Campoy’s view, and a recent report from the firm states that “low interestrates and bond yields will continue tosupport property investment activity, withcentral bank interest rates expected tostay lower for longer in the aftermath of the Brexit decision”.

ECONOMIC IMPROVEMENT

As latest indicators point to an improvement in the Spanish economy, the real estate market is expected to be positively impacted.

Growth rates are forecast at 2.8% and 2.5% in 2016 and 2017 respectively. This expansion is expected to consolidate improvement in employment levels – some half a million jobs have been registered by authorities over the past year. The increase in employment levels will be one of the most influential factors on housing demand.

“The environment of low interest rates, coupled with the drop in oil prices as well as in the marginal income tax rates, has led to an increase in individuals’ disposable income without affecting companies’ competitiveness. This has significantly boosted domestic consumption,” Boyero-Klossner says.

“The Spanish economy continues to grow at a good pace. GDP growth [with an inter-annual growth rate of 3.2%] has a strong correlation with the real estate market, in particular the office sector,” she adds.

According to Bankinter’s biannual report on Spanish real estate, the commercial segment continues to develop well, with an upward trend in asset prices, rents and occupancy rates.

In the office segment it is noted that monthly rents in the central business district (CBD) area of Castellana in Madrid already exceed €27/m2. In the area of Diagonal, Barcelona the figure is €20/m2, representing annual increases of 6.8% and 12.5% respectively.

Bankinter’s report suggests that rental levels will increase at least through the end of 2017, as rents are still below record CBD highs of €40/m2 reached before the financial crisis.

“Rent levels in Spain remain very low by historical standards and in relative terms across Europe, which is encouraging major multinationals to consider moving parts of their operations to Spain,” Boyero-Klossner says.

Price increases in CBDs are also pushing rents up for buildings located on the outskirts of Madrid and Barcelona, which went through a turning point in 2015 and are already growing at annual rates of 10%.

According to Bankinter’s report, investors will be willing to invest in Spanish commercial real estate despite higher asset prices and the yield compression, in the absence of alternatives offering higher returns.

The residential segment is also showing positive indicators, in terms of demand, prices and promotional activity. Residential demand is expected to grow over the next 18 months to a volume of more than 470,000 homes in 2017.

Meanwhile, residential prices will increase in the range of 3% to 5% annually, as result of increased demand and a very limited offer of new housing in Spain’s bigger cities.

Thus, as property prices are expected to rise moderately across the country, the local real estate sector continues to show steady signs of recovery some eight years after Spain’s property market crashed.

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