CNBC Business | Continental shifts

Continental shifts

Ross Tieman detects rising yields amid the turbulence that has defined European property markets in 2008

Looking at a map of Europe and the River Oder carving its way down the border between Germany and Poland, you'd be forgiven for thinking that the squiggly blue line represented simply a geographical feature. But the River Oder is so much more than that: it's where east meets west, the border between the old EU and central and eastern Europe; and it's one of the few firm features in a tumultuous property market, demarking where real estate adventure becomes real estate adversity.

Whether it's office blocks, shopping centres, or warehouses, you can be certain there's a stability in the east that's absent in the west.

But that doesn't necessarily mean the East is a bargain. Stuart Cunliffe, director of international retail investment at property services group DTZ says: "There are opportunities for value, but it depends as much on the nature of the seller as on the location of the assets. If a seller can afford to wait, they will."

As Timo Tschammler, DTZ's managing director for international investment, observes, the credit crunch hit Europe's property markets simultaneously in the summer of 2007.

But some reacted faster than others. Prices of residential property in Britain and Spain, buoyed to extraordinary heights in previous years, nose-dived. As over-geared developers and speculative investors faced soaring borrowing costs, prices of offices in London and Madrid followed suit. Suddenly, investors began to worry that indebted consumers, notably in Britain, Spain and Italy, would rein-in their spending, weakening demand and causing economies to falter. They were right.

For a while, the economies of Western Europe continued to grow, albeit at a slower rate. But in the second quarter of 2008, ever-cautious French and German shoppers started shoving their spare cash into the bank rather than retailers' tills.

Now, prices of offices, shopping centres and warehouses in much of continental Europe are tumbling too. However, not universally: Scandinavian office blocks have largely been spared the bloodbath, says Tschammler; so have those in the former Warsaw Pact countries. With Poland on course for GDP growth of 5% this year, and 7% likely in Slovakia, prices of offices in cities such as Warsaw, Bratislava and Prague have scarcely budged.

It's true in Brussels too, where few Eurocrats are likely to lose their jobs, or Geneva, home to a host of UN agencies. For really spectacular price movements in the office market, you need to look to London, historically Europe's most liquid property market, or Madrid.

According to Michael Haddock, director of investment research for Europe and the Middle East at property services group CB Richard Ellis, "Prices are now down 20%-25% for London offices. Transactions show yields of 5.9% to 6.1% for City prime, up from less than 5% a year ago."

The big question for investors, says Tschammler, is "whether there is only one round of price corrections, or whether there will be another after the summer break."

Already, some institutions, funds, and sovereign investors are prepared to buy in London, believing that over ten years, they'll come out ahead. Most notable are the German open-ended property funds. Deka and Houseinvest, are two that have tiptoed into the London office bargain basement.

Michael Birnbaum, spokesman for the KanAm Grund fund, says: "We are willing to buy offices in 24-hour cities. The markets are getting better; the problem is that there aren't many transactions. Only people who have to are selling, and it's very hard to see if the prices are right."

But in the search for bargains, much depends upon how you define value. As Haddock says, most investors "are not looking to catch a falling knife". Some investors are seeking what look like bargains from forced sellers. Others are looking to see where valuations are holding up. And a third group craves long-term growth from markets deemed over-sold.

If London and Madrid attract the bargain-hunters, Paris/Ile de France, Europe's second largest office market, offers historic stability and improving yields. You might find some quality in Germany's fragmented market too.

But KanAm Grund has placed its bet on Moscow, spending $900m this spring on four city-centre offices. It also bought a shopping centre in Riga, Latvia, last year, hoping rising wealth will lead to more retail spending.

Across western Europe, prices of shopping centres now look more like Aldi's discount offers than Tesco's frills. Cunliffe has just sold Lion Walk Shopping Centre in Colchester, UK, to LaSalle UK Ventures. In summer 2007, the centre narrowly missed changing hands for £85m, at a 5% yield. In July 2008, it sold for £69m, some 19% less, at a yield of 6.5%.

Forum Steglitz in Berlin, on offer last summer at a yield of 5.25%, is now believed to be changing hands at a yield of 7%. And a centre in Lille, France, that was offered on a 4.5% yield will deliver 5.5% for its new owners.

"The retail action is in Western Europe, where there are willing sellers," says Cunliffe.

And how do the goods get to the shelves? Increasingly, from central and eastern Europe, which is why Gary Anderson, president for Europe and the Middle East region for ProLogis, the world's biggest distribution centre developer, is as optimistic as ever about investing. His company is pouring €1.4bn into new distribution centres in Europe this year, of which 40% will go into Poland and countries to its east and south.

Anderson reasons that even if demand slows in western Europe, Poland's domestic market of 40 million people will take up the strain, while the country is perfectly positioned to ship goods eastward to supply the ongoing consumption boom in Russia.

But Anderson is also keen on the UK market. Distribution yields are rising, and up from 5.5% to as much as 7% - comparing favourably with Poland or the Ukraine. But other forces are at work. Land constraints continue to drive scarcity of distribution centres and major new UK distribution centres need rail connectivity to win planning consent.

And it has to be green. But the UK does have one advantage. ProLogis, which built Britain's first carbon-neutral distribution centre at Dartford, believes Britain's vanguard position in sustainable development is a model that is spreading fast to continental Europe.