The European Central Bank’s larger-than-anticipated €1.1 trillion bond-building programme over the next 18 months will trigger second order effects in Europe’s commercial property debt and equity markets.
ECB president Mario Draghi’s announcement yesterday surprised the market on the scale of the Quantitative Easing programme, which will comprise €60bn in government and private sector bond purchasing per month until at least September 2016, has prompted the euro to fall to an 11-year low against the dollar.
The ECB’s measures, designed lift the Eurozone out of deflation and back up to an inflation rate of close to 2%, will likely only include the purchase of commercial real estate asset backed securities at the margins, but the European sector will be stimulated through “second order” benefits.
The ECB’s regular purchase of investment grade, highly liquid sovereign and corporate bonds will drive down yields on such instruments, including government-linked bonds, covered bonds and highly rated corporates.
This will trigger a “displacement effect” in which investors, typically pension funds and insurance companies, will be forced to redeploy their capital into higher yielding asset classes which should lead to a move up the risk curve.
At the same time, the cost of money for governments and highly rated corporates will reduce which should stimulate investment.
This redeployment of capital across higher yielding asset classes could, in part, be redistributed into higher yielding commercial real estate – across debt and equity.
Increased capital flows into debt and equity markets would see credit spreads compress and asset prices rise. The extent to which this happened would be relative to the capital flows, mitigated of course by counterbalancing property fundamental drivers.
“The consequence of launching a sovereign QE programme may also have the additional benefit of increasing the potential investor base for ABS,” wrote Christian Aufsatz, in a research note this morning.
Sabina Kalyan, global chief economist at CBRE Global Investors, yesterday said in a statement: “The QE programme adds further momentum to the strong and broad recovery in European real estate capital markets that we have seen developing over the past 18 months.
“By keeping bond yields low, the QE programme will affirm the attraction of property as a higher yielding asset class offering an attractive income premia over bonds. We should therefore see a continuation of the aggressive investor interest in good quality assets with long leases to good quality tenants, and for prime yields to move even lower.
“The QE programme also puts a floor under the Eurozone economic recovery, reassuring investors that they should continue to see a slow improvement in occupier market fundamentals. However, as the Eurozone still has much structural reform to enact, the capital market impact on property pricing is likely to be larger, and certainly in advance of, than the positive boost to occupier market demand.
“What this really means is that investors will be facing capital appreciation driven by yield movements rather than rental value growth in the near term, with the rental recovery coming through later as improved corporate confidence feeds into job creation and improved occupier demand.
“After all, QE is not a panacea – it merely allows the room for the Eurozone member states to continue the hard work of rebuilding their balance sheets.”
David Hutchings, head of EMEA investment strategy at Cushman & Wakefield said: “If the QE programme is successful, the impact on property markets in general could be substantial as even more demand will now be diverted into the market. As a result, yields are set to fall more than expected and volumes will be pushed further back towards record levels.”
Cushman & Wakefield predicts that without QE, the market would be expecting a 5-10% increase in European investment volumes this year alongside a 20-30bp prime yield fall.
With a successful QE package delivering lower for longer borrowing costs, more growth and some reform, that forecast is increased to a 40-70bp yield fall and a 20% plus jump in property trading.
Cushman & Wakefield adds that this of course assumes investors can find the stock to buy, which relies on bank sales and deleveraging as well as profit taking and stock recycling.
Hutchings added: “We can expect increased interest in a range of global markets as Europeans export capital in search of opportunities, and also a move back into development, helped by recent falls in commodity prices softening build costs. In addition, we are now anticipating more corporate activity – including asset sales by corporates, joint ventures and takeovers.”