ECONOMIC BACKGROUND

2005 has been a year of limited growth in the EU countries with an anticipated 1.3% increase in GDP across the Euro area. The better performers included Ireland (5.5%), Spain (3.4%), Sweden (2.3%) and Denmark (2.2%) but the major economies of Germany, France and Italy showed lacklustre performance at 0.9%, 1.5% and 0.2%, respectively. The figures for the third quarter for Germany and France did, however, show some improvement. Stronger growth occurred in the economies of the recent entries to the EU in central Europe: Czech Republic, Hungary and Poland and their latest figures show increases of 5.1%, 4.6% and 2.8%, respectively. There remains concern at the state of the German economy – traditionally the powerhouse of Europe – and the recent, deadlocked election result is unlikely to facilitate the economic reforms which are generally agreed to be necessary. Other events such as the failure of the EU to ratify a new constitution and the terrorist attacks in London have also had unsettling effects in 2005.

The other key economic indicators across the Euro area are also somewhat gloomy: retail sales: +0.9% (September), industrial production: +2.6% (August) and unemployment at an average of 8.4% (September.) Unemployment remains a particular cause of concern in Germany (11.6%), Spain (9.3%) and France (9.8%) and is thought to have been one of the causes of the recent civil unrest in France.

THE OCCUPATIONAL MARKETS

EMEA OFFICES

The sluggish growth in the principal European economies in recent years led to a general slowdown in development activity across the continent. There has been evidence of an increase in take-up in the key centres of London, Paris and Frankfurt in the course of 2005 and this has been mirrored in most of the other markets. We have generally therefore experienced declining vacancy rates and stabilising or modestly increasing rentals across the continent.

In the City of London the relative strength of the financial services sector has led to approximately 450,000 sq m of space being absorbed in the first three quarters of the year, a significant increase on 2004. We anticipate that take up for the year will increase to approximately 550,000 sq m. The vacancy rate has fallen to approximately 10.5% with little additional space scheduled for completion in the near future. Prime rents remain broadly static at around £45 - £50 per sq ft but significant incentives still have to be offered to tenants to achieve this level.

In the West End of London approximately 280,000 sq m of space were absorbed in the first three quarters of the year but the total annual figure is unlikely to exceed the total take up in 2004 of around 420,000 sq m. Demand has been principally from the financial and service sectors. Limited supply has led to a fall in the vacancy rate to around 5%. As for the City of London, prime rents remain broadly static at around £75 per sq ft with smaller suites changing hands at up to £90 per sq ft.

In Paris there has also been an improvement in the level of space absorption with some 1.4m sq m taken up in the first three quarters of the year – an increase of 5% on the same period last year. Much of the demand, however, continues to derive from companies undertaking cost reduction and rationalisation activity. As in other European cities, development activity remains relatively subdued and the vacancy rate has therefore continued to decline to around 4.4% in Paris CBD and to around 6% for the Paris Region. Higher rates prevail in the western business district and La Défense (10.4%.) Whilst average rents have been broadly stable, prime headline rents in the Paris CBD have increased to €650 per sq m.

A similar pattern emerges in Frankfurt where, somewhat contrary to earlier expectations, take up has improved in 2005 (approximately 375,000 sq m in the first three quarters.) However, much of this has derived from the cost reduction and space rationalisation activities witnessed in Paris, so the net absorption remains low. Prime rents are around €33 per sq m per month (€396 per sq m p.a.), a slight fall on the previous year’s level, and, whilst vacancy has fallen in the last 12 months to around 8%, development activity has increased with potentially some 350,000 sq m due for completion in the next two years, albeit much of this being dependent on pre-lets being found.

The picture in the other western European markets is broadly similar. In Madrid take up in the first nine months of the year is slightly less than in the previous year but the relatively low level of development activity means that the overall vacancy rate has fallen to about 8.1%. Prime rents have increased to around €324 per sq m due mainly to a limited supply of trophy buildings. Average rents are stable. In Stockholm the office market stabilised in 2004 and the pattern in 2005 is broadly the same: vacancy in the CBD is around 10% and 12% in Greater Stockholm. Prime rents remain stable at approaching SEK 4,000 per sq m per year. In Copenhagen the picture is again one of stability with CBD vacancy at around 7.75% and prime rents broadly unchanged at up to DKR 1,900 per sq m per year. In Austria the Vienna market has seem a somewhat stronger recovery and the take up at the end of the third quarter already exceeded that for the whole of 2004. The vacancy rate has fallen to around 6.1% - a reflection both of increased demand and the low level of development activity. Prime rents have, however, remained stable at around €22 per sq m per month (€264 per sq m per year.) Dublin too has experienced a significantly stronger office market reflecting one of the highest growth rates in GDP in the whole of the EU. Take up has strengthened and vacancy is around 10%. Prime rents have increased to around €538 per sq m.

The continuing strong growth in GDP in the central European markets has been reflected in the performance of their respective office markets. In Prague take up has increased with around 100,000 sq m being absorbed, reflecting a vacancy rate of around 13.5%. Rents have remained broadly stable and prime rents are around €20 per sq m per month (€240 per sq m per year.) In Budapest too there has been a record level of take up with some 80,000 sq m being absorbed, thereby reducing the vacancy rate to around 15%. Prime rents in Budapest are similar to those in Prague at around €20 per sq m per month (€240 per sq m per year.) In Warsaw the vacancy rate has fallen below 10% and prime rents are around €240 per sq m per year.

Further east, the office market strengthened in Bucharest which saw some 85,000 sq m of new class A space completed and absorbed in 2005 with 80% of the supply to be completed in 2006 also pre-leased. Prime rents in Bucharest increased by 15% in 2005 and are now at €22 per sq m per month (€264 per sq m per year.) In Kiev the total office stock increased by 22.8% to 420,000 sq m in 2005 but demand was such that the vacancy rate remains at less than 3%. Prime rents are around $37 per sq m per month ($444 per sq m per year.) The shortage of class A space in Moscow has led to rents of $685 per sq m with top rents of up to $850 per sq m. Strong demand has led to a vacancy rate of 4.3% for class A space.

In South Africa office rentals are stabilising but vacancies are still relatively high in all the major cities. In Johannesburg (Sandton), asking rentals broke through the R100 per sq m barrier on Grade A space in March 2005. Class A vacancy is around 14% but some 32% of Class B space remains vacant. Rents in Pretoria are at similar levels but vacancies are much lower (Class A: 1% - 2%, Class B: 2.5% - 6%.) , due to Government take up and conversion of offices to residential.

EMEA WAREHOUSING

The pattern in the warehousing market across Europe is similar to that for the office sector with a gradual increase in demand, particularly for larger units:

• The development sector has been more active, particularly for the logistics specialists such as Gazeley and ProLogis.
• Activity has been prompted by:
o Changing manufacturing patterns – a general shift in production from western Europe to central & eastern Europe and places further to the east.
o The need for greater efficiency in distribution prompted by increasing transport costs: European Union’s Working Time Directive, higher oil costs, just in time delivery requirements etc has led to greater outsourcing in the sector and changes in the distribution pattern.
o The expansion of the EU.
o Increasing globalisation.
• As in previous years, the continental European warehousing market has a high proportion of owner-occupation.

Germany, despite its own general economic problems, has again benefited from its central geographic position and the recovery in its exporting position – it overtook the USA to become the world’s top exporter, capturing 10% of the global share. The strength of the exporting sector has led to increased volumes of freight handled by the ports and major airports. Demand for logistics space has remained firm, particularly from owner-occupiers. Prime rents are around €72 per sq m. A number of major projects are planned to start in 2006 to meet the growing demand with three, totalling some 750,000 sq m, in the Rhine-Main area alone.

In France, the logistics sector has broadly stabilised in 2005, although take up has been slightly less than in 2004. As for offices, much of the activity has been triggered by the need for rationalisation. Development activity has been subdued which has helped to reduce the supply of new or modern space available. There remains a significant supply of older accommodation which does not meet modern occupiers’ demands. Prime rents are generally around €55 per sq m in the Paris Region and up to €45 per sq m in the provincial markets. 

In the UK the distribution market in 2005 was driven by retailers (despite the weak performance of retail sales) and third party logistics contractors. Whilst the market has been reasonably active, there has been a shortage of suitable sites and of existing, high specification, large buildings. Both land values and rentals have therefore held firm. Prime warehouse rents in London and the south east are around £91 per sq m and in the provincial cities around £70 per sq m in the Midlands and around £53 - £61 per sq m in Leeds and Manchester.

Prime rents in the other western European countries ranged as follows: €54 per sq m in Vienna, €67 (DKK 500) per sq m in Copenhagen, €90 per sq m in Madrid, €95 (SEK 900) per sq m in Stockholm and €120 per sq m in Dublin.

In central Europe rents ranged as follows: €63 in Warsaw, €68 per sq m per month in Budapest and €72 per sq m in Prague. Further east in Bucharest, Kiev and Moscow, where the supply of western quality buildings is much more limited, the figures are €96 per sq m,  €100 ($120) per sq m and €100 ($120) per sq m, respectively.

There has been a recovery in the South African industrial market and vacancy has fallen from a national average of 12% in 2001 to around 4%. Prime industrial parks have seen rents increase to R33 per sq m for logistics space and R40 per sq m for high tech.

EMEA RETAIL

The latest annualised growth in retail sales of +0.9% to September 2005 for the Euro area broadly summarises the picture in the continental retail sector: the markets have generally remained stable and 2005 has been a period of consolidation and rationalisation rather than one of positive growth. High unemployment, particularly in Belgium, France and Germany has unsettled consumers and led to some nervousness amongst retailers. In the UK, despite the set-back of the June terrorist attacks with the resultant impact on tourism and the short-term knock-on, adverse impact on retail sales, full employment has broadly under-pinned demand and rents are generally stable. The annualised UK retail sales volume has fallen to +1.5% at September 2005. It is premature to assess any impact on prime central London rents but up to the mid-year point rents were growing at around 3% p.a. In Germany the corresponding retail sales volume figure is –0.7% but rents for prime units in the centre of the larger cities have generally stabilised at their 2003 levels.

Central and eastern Europe continue to see significant new development in this sector with increasing numbers of western retailers entering the new markets. In the last 12 years some 25 new shopping centres of over 25,000 sq m are either open or planned in Prague alone. There has, however, been an excess of hypermarket-anchored schemes which has put pressure on retailers’ profits and the recent sales by Carrefour and Julius Meinl to Tesco and Ahold are likely to be followed by further rationalisation. In Moscow too over 100,000 sq m of new shopping centre space was opened in the first half of 2005.

Retail in South Africa has out-performed offices for the fourth year in succession but there are concerns that the growth in consumer spending cannot be sustained. Prime rents in regional malls have risen to R400 per sq m. Retail centres are expanding dramatically into the less traditional areas, with the small towns attracting substantial development and centre roll outs. Retailers themselves continue to perform way above the projected growth rates.

EMEA INVESTMENT

The paradox of recent years relating to the fact that the global markets for real estate investment have become stronger and stronger at a time when the underlying performance of real estate assets has, at best, been modest has continued in 2005.

Interest rates have remained at historically very low levels with the European Refinance Rate at 2% and Base Rate in the UK at 4.5%.

Recent reports have indicated that transactions in western Europe in the early part of 2005 have increased by some 20% over the previous year’s figures. Total activity in the sector is expected to be of the order of €100bn for the year as a whole. As in previous years the principal interest has been for office and retail property together with some warehousing & logistics. However, scarcity of product and hardening yields in these traditional asset classes have led investors to consider other sectors such as residential and hotels.

Whilst the UK remained the most active market, interest has also returned from foreign investors in the German market with several very large residential and other publicly-owned portfolio transactions, mainly involving US investors. There has also been a notable increase in activity in the Swedish market. As in recent years, demand has remained very strong for property in the EU accession countries. 
 
The main internationally-active investors have come from Germany and the USA but Irish investors too have accounted for a significant share of new cross-border investment. We have seen greater interest in international transactions from Spanish, French and Danish investors, possibly prompted by shortage of investment-grade product in their domestic markets.

Yields have continued to harden across the continent, most noticeably in the retail and industrial sectors, and, geographically, particularly in the central European markets bringing them a step closer to west European yields. Interest is growing in the eastern European markets of Romania, Bulgaria and Ukraine.

Examples of prime office yields across the continent are: 4% in Madrid, 4.50% in London and Dublin, 5.25% in Frankfurt, 5.50% in Paris, Copenhagen and Stockholm, 5.75% in Vienna, 6.5% in Prague, 7% in Budapest, 7.25% in Warsaw, 8.25% in Bucharest, 13% - 14% in Kiev and Moscow.

In South Africa prime office yields have hardened further and are now around 9%. The Listed sector continues to be the driving force behind the demand for properties, with retail still being the most sought after sector. South Africa as a whole outperformed the rest of the world per the IPD report showing a 23.4% against the UK’s 18.3%. This is the 2nd year in a row that it has lead the yields. Government has committed to a 6% growth in the economy year on year and all indications are that this will be achievable.