AMSTERDAM-Industrial leasing market fundamentals continued to weaken throughout Europe during the first half of the year, says a new research report from ProLogis. According to "Looking for the Rainbow," released in mid October, the pan-European market occupancy rate slipped to 86% in Q2 from 87% in Q1 and 89% a year ago.
"Europe's logistics property markets are feeling the weight of both a severe economic downturn and a lingering credit crunch," observes Len Sahling, first vice president of the ProLogis Research Group. "The European economies are starting to emerge from several quarters of negative GDP growth, and the logistics property leasing markets will follow suit, albeit with a lag. Meaningful GDP growth combined with obsolescence and no new supply will eventually pull Europe's logistics property leasing markets out of their slump."
According to the report, headline rents across Europe have held up surprisingly well over the past 18 months. However, as the global recession has worsened, property owners have responded by offering increasingly generous rental incentives primarily in the form of free rent, pushing net effective rents downward. But results vary widely, with rates in the UK and France declining less than 5% and those in Northern and Central Europe remaining virtually flat. Annual per-square-meter rents currently range from a low of $46.81 in Central Europe to a high of $62.77 in Northern Europe.
The report finds that new deliveries to European markets have remained relatively stable throughout the recession, largely because of a sizable overhang of construction projects begun before the credit crisis erupted. However, new starts have tapered off in recent months, with most involving build-to-suit projects. As a result, construction pipelines have begun to shrink and deliveries will soon begin to dwindle.
Report author Lisa Graham says the deteriorating fundamentals have prompted investors to develop a renewed appreciation for market risk, making sharper distinctions between the economic, currency and property market challenges of different countries. She notes that market conditions in Germanyare in the best shape, with France close behind, while those in Hungary are in the worst shape.
In regard to investment, Graham claims investors have placed renewed focus on prime properties with strong lease covenants and lease terms of at least five years. Until about a year ago, she says, yields across Europe had converged into a tight band of about 100 basis points from 5.5% to 6.5%. Today, this band has widened to about 175 basis points, with yields ranging from 7.25% in the UK, Hamburg and Frankfurt to above 9% in Hungary. More importantly, during Q3 yields decreased by about 75 basis points in the UK, leveled off in Northern Europe and continued to rise elsewhere, albeit at a decelerating pace.
In regards to the future, the report points out that because much of Europe's existing warehouse inventory is outdated, the continued development of large, modern and efficient distribution facilities and emphasis on improving the efficiency of distribution networks have generated unexpected buoyancy in demand for space. Moreover, Graham remarks, "[O]nce the world economy is back on track, Europe's under supply of modern, efficient distribution facilities will be a key driver bolstering the structural demand for the logistics property markets."