High expectations in the low lands


If we are to believe most real estate investment brokers, the Netherlands is on the verge of recovery. After months of deteriorating net initial yields throughout Europe, it is now widely believed that yields have bottomed out. Despite the low occupier demand, that will inevitably cause lower rental prices and higher vacancy rates, investor sentiment is improving accross the board. This is leading to stabilisation of prime net yield and to prices of propertyshares being fueled by investor demand. In anticipation of true recovery, I may add.

Take Jones Lang LaSalle, who has called the bottom of the market back in September 2009 (article in Dutch). According to JLL’s Capital Market Bulletin, stating that after a sharp decline in market transactions and -prices in the H1 of 2009, investors’ interest is clearly on the rise.

The number of investment transactions in Q2 exceeded those made in Q1. This is striking, as the investment dynamics in Q1 are tradionally stronger than in Q2. The increased activity on the Dutch property investment market could indicate that the bottom may have been reached. […]

Primarily private investors with sufficient equity have been relatively active, accounting for 44% of the total investment volume, amounting to EUR 800 million.

Institutional investors have been and still are the most active sellers in the Dutch property market. Some notable transactions have taken place in the course of this year, that indicate institutional investors are seeking alternative allocations. This is either a strategic re-orientation causing pension funds to shift from direct to listed property (e.g. Unilever’s Progress), or self-inflicted by decreasing capital values of their real estate portfolios.

Something strange is going on in the Dutch commercial real estate investment market. So, cash-rich private and foreign investors are buying and institutionals are selling. The best-prices and most sought-after investments are the institutional ones: trophy buildings with grade-A tenants and a minimum of 8 years remaining on the lease. Ten years is better, actually. Retail investments (shopping centers and high street shops) are slightly more popular than offices. But still: a new 10-year lease is tempting for most investors (and their banks, obviously).

The headlines are turning positive again, fuelling the high expectations that investors seem to have. An article by CBRE for instance, only confirms the positive outlook that (international) investors have on the Dutch commercial real estate market:

With a number of international investors increasingly taking the view that the major Dutch markets have repriced sufficiently to be of interest, the outlook for the Dutch market is positive for the remainder of 2009. Private investors and property companies accounted for the majority of activity in the first half of 2009 and investors such as the German Funds, both Open-ended and Closed-ended, expected to be more active during the second half of the year.

With the investors’ appetite on the rise, as reported, many market players are ‘back in business’, meaning that prices of market transactions are, too. The fact that investors tend to start acquiring assets again, may be caused by their sentiment (“we do not want to miss the boat”), rather than market fundamentals. Occupier demand -to mention just one funamental factor- is still weak (JLL-report):

The economic malaise also became apparent with the usual delay in the occupier market figures. Take-up figures of office space are reflecting a downward trend in virtually all office markets, while supply is on the increase. […]

The economic downturn is having a major impact on the demand for property among retailers. Nevertheless, high-end locations […] continue to be popular, particularly among international and financially healthy retailers. 

To sum up: occupier demand is on a downward slope on all but the prime retail and office locations/objects. Prime rents are now stabilising on lower levels, vacancies are rising at secondary locations and this process is likely to continue over the following months and quarters.

I have mentioned the second dip in real estate before. The second dip, being the normalisation of rental prices, has not been swallowed yet. Nor has it been priced into today’s market yields. On the contrary, as we see investment yields improving. As a result, investors are paying to high a price, taking into consideration that the objects are over-rented. Reversionary yields are likely to be way below the current initial yields.

Leading magazine on the Dutch real estate market, ‘Vastgoedmarkt’, published an article (in Dutch) earlier this week heading: “Commercial real estate lost a quarter of its value”, stating that investors are holding on to their assets to avoid ‘taking the pain’ of realising a downward revaluation. Anyone can relate to that, because who wants to make a loss, especially when they are huge? Investors do not. Banks do not. Understandably, because investors and banks alike, would have to write off on their complete portfolios.

Banks wish to avoid foreclosure sales, because they will have to write of on the value. ‘They don’t want that, so banks do not put on the thumbscrews. They rather search for alternative solutions when interest and dedemption payments stay out.’ However, the revaluation may end up lower when the economy is improving again. [link to article, translation by me]

In other words: the pain of the current negative revaluation of real estate assets has not yet been swallowed by investors and banks. Sooner or later, they will have to, because “the current crisis accellerates the understanding that the Netherlands is suffering from a structural oversupply of commercial real estate like offices and warehouses”, saysreal estate professor Piet Eichholtz in the article [translation by me].

So, where does this leave us? Based on the above, I believe investors -domestic and international ones alike- are taking an advance on the Dutch market recovery that may or may not take place. Given the fact that the commercial real estate market is overrented ánd oversupplied, with implied lower values that have not been accounted for yet , I am inclined to believe that much of the revaluation -in terms of rental value and capital value- has not been priced into current prices. That is a pretty long way of saying: Dutch property prices are still too high.