Global Economics

Europe: Commercial Real Estate Sizzles


In the West, sky-high deals and hot growth contrast with cooling residential markets. But are through-the-roof sales a sign the market's peaking?

Turns out, the Gherkin was only an appetizer. The distinctive pickle-shaped London skyscraper, designed by Sir Norman Foster, was sold in February by insurer Swiss Re for $1.2 billion, in one of Europe's biggest-ever real estate deals.

But within weeks that transaction was eclipsed by two even pricier deals: the $2.8 billion sale of the Coeur Défense office complex near Paris, and the $3.7 billion sale of bank HSBC's (HBC) London headquarters.

While residential housing markets across Europe are starting to cool, commercial real estate is sizzling. IPD, a London-based research group, says the value of investment property in Western Europe—retail and office space, as well as big residential developments—rose 7.8% in 2006. Growth last year topped 20% in Ireland, and was over 10% in Britain, France, Spain, and Scandinavia. By contrast, the average increase across Europe was 5.9% in 2005, 3.6% in 2004, and less than 1% during the three preceding years.

What turned up the heat? Europe's recovering economy is one explanation. Growth in the euro zone was 2.8% in 2006 and is expected to hit 2.7% this year, ahead of a projected 2.1% in the U.S. Interest rates also remain near historic lows. "You can borrow at 3% to 5% and get a property that's yielding 6% to 10%" annual returns, says Sabina Kalyan, IPD's chief economist.

REITs Make Investing Easier

At the same time, money is pouring into Europe from big institutional investors and private-equity funds that are trying to diversify their holdings. Many of these players have set up special funds targeting European real estate that they are marketing to investors. Britain, Germany, and France all recently have enacted legislation allowing real estate investment trusts (REITs), which also makes it easier for investors to get into the market.

Until recently, there were relatively few vehicles for foreign investors wanting to get into the European property market, says Nick Tyrrell, head of European real estate research and strategy for J.P. Morgan (JPM) in London. But now, Tyrrell says, "There are a whole bunch of funds. The whole asset class has opened."

There's certainly no shortage of property to buy. To strengthen their balance sheets and concentrate on their core businesses, big European companies are selling off real estate as never before. German insurer Allianz (AZ) has unloaded some $4.1 billion worth of property this year, including the Frankfurt headquarters of the European Central Bank.

Often, activist shareholders are the instigators of such sell-offs. After taking a major stake in French hotel group Accor in 2005, for instance, U.S. real estate-investment group Colony Capital has pushed Accor to sell off more than $1 billion worth of hotels in sale-leaseback deals. Now Colony has teamed up with French luxury magnate Bernard Arnault to exert pressure on French retail giant Carrefour to trim its real estate portfolio (see BusinessWeek.com, 3/8/07, "Scent of a Bargain for European Tycoons").

Slow, Curves Ahead

Cash-strapped European governments are selling property too. France has unloaded more than $1.5 billion worth in the past few years, including the historic building where the Paris peace accords to end the Vietnam War were signed. France's central bank sold off a portfolio of 34 properties last year to the Carlyle Group, a U.S. private-equity outfit that has two European real estate investment funds totaling $1.6 billion. Former state-owned properties in Eastern Europe have gone on the block, too (see BusinessWeek.com, 6/14/04, "Europe's Great Real Estate Selloff").

Real estate is a cyclical business—and there are already signs that this boom may be running out of steam. The rise in commercial property values in Britain has already started to moderate, and experts say a slowdown could hit the Continent within a year.

Indeed, the recent mega-deals "May signal a turning point in the market, as people seek to cash in," says IPD economist Kalyan. The Coeur Défense office complex near Paris, for example, was sold for $2.8 billion this spring by a group of Goldman Sachs (GS) investment funds that had acquired a majority stake in 2004—when the property was valued at a total $1.8 billion. Numbers like that will continue to attract big attention, as long as the boom lasts.

Matlack is BusinessWeek's Paris bureau chief.

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