Offices in London's City district and Prague offer the best defensive plays for property investors seeking to safeguard total returns if the pan-European sector is dragged into a second recession by the Euro zone debt crisis, research showed.
Property consultancy DTZ
Overall we think that London would benefit from a flight to quality and its appeal as a 'safe haven' outside of the troubled Single Currency bloc, DTZ said in a research note.
DTZ measured the effects of a second recession on European office property, sparked by the 20 percent possibility of a euro zone debt crisis unfolding, causing equity markets to collapse, market confidence to fall, and producing negative euro zone GDP growth in 2012 and 2013.
In London City, for the period 2011-16, office total returns would be 6.6 percent in a second recession case, against 7.7 percent if the economy continued its current muted rebound. In Prague total returns would be 7.4 percent, against 8.6 percent.
On average, across 16 European cities surveyed, the second recession scenario would produce total returns of 3.2 percent out to 2016, against 7.8 percent if the economy continued to tiptoe its way back to health.
Cities outside of the euro zone see less of an impact. Markets within the euro zone, on the other hand, are directly exposed to the impact of the crisis and see sharply lower forecast returns under the crisis scenario, DTZ said.
As such, the profile of DTZ's forward-looking Fair Value Index materially shifts for the worse. A double dip would see just two office markets -- London's City and Prague -- where prices were within 5 percent of fair value, against 18 otherwise.
The number of office markets priced 5-15 percent over fair value would fall to eight, from 18. But office markets 15-30 percent overvalued would number 22, from eight. Thirteen office markets would be 30 percent-plus overvalued, DTZ said.
We consider that in the event of a further escalation of the sovereign debt crisis, investors would be better off in markets outside of the euro zone, and that core German and French markets traditionally regarded as safe havens may actually present a higher risk of value falls, DTZ said.
OPPORTUNITIES BY 2014
Under the double-dip scenario, euro zone GDP growth would plunge below zero in the period 2012-13 before starting to edge higher in 2014 and then gaining out to 2016, DTZ said.
We estimate that by 2014, market pricing would be considerably more favourable for investors, DTZ said, referring to the pricing of direct investment opportunities.
By this time, we would expect to see yields still elevated, but rents beginning to recover in several markets. Following capital value falls in 2012 and 2013, investors could position themselves to benefit from the nascent recovery.
Euro zone office rents would be worst hit by another debt crisis, with falls expected in most markets, including Munich, Frankfurt and Paris CBD. Downward rent revisions would be more muted in non-euro zone countries, with London's City and West End districts, Prague and Moscow showing small gains.
Across Europe, companies' demand for floor space would wane, with expansion plans put on ice and headcount cuts likely, leading to yields widening. London's City area, Prague, Istanbul and Warsaw would see valuations remain in positive territory.
Capital values for offices in London's City area would rise 11.8 percent between 2012 and 2016 if a second recession hit, against 12.9 percent otherwise. In Prague, they would rise by 7 percent over that period, against 11 percent otherwise.
In Dublin and Oslo capital values drop by nearly 30 percent between the end of 2011 and 2016. In most other euro zone markets they fall by around 20 percent, DTZ said.
(Editing by David Cowell)