However, at SWIP we believe this pessimism has been overdone. This is not the apocalypse that many would have you believe, rather an overdue correction in the real estate market. This is something we have been predicating for a while as the stellar gains in the sector over the last five years were unsustainable. The UK commercial property sector alone averaged 15% per annum from 2001 to June 2007 (Investment Property Databank UK monthly property index).  The US subprime crisis and consequent credit squeeze, though, were unforeseen and resulted in the market cooling more quickly than most anticipated. But a slowdown was forecast nonetheless.

There is no doubt it has been a difficult year and we expect this to continue through to 2009. There remains, however, a glimmer of light at the end of the tunnel. The fundamentals underpinning the European commercial property market remain relatively sound and we expect this position to continue as the eurozone economies avoid recession. While monthly total returns in the UK are still in negative territory, they have been on an improving trend since the turn of the year. Areas of the eurozone, particularly Germany, are also giving the market reason to be more optimistic. Redemption rates from retail and institutional investors have also moderated in recent months. 

Germany
Looking at Germany, the property market has finally emerged from its long downward trend, with total returns for 2007 climbing to 4.5% from 1.3% the previous year (Investment Property Databank index). This represents the highest total return in five years, and occurred at a time when other European markets, particularly the UK, were experiencing a downturn. Industrials was the best performing sector in 2007 with a total return of 7.1%, followed by retail, which was up from the previous year from 5.4% to 6.8%. The property sector’s performance in 2008 is likely to be weaker than the year before but we believe the economic fundamentals support our continued confidence in the region.

Although recent economic data, particularly June’s Ifo survey of business sentiment, have surprised on the downside, the nation’s economy has been one of the most robust in the face of the credit crunch. This is due to it being the largest and most diversified economy in Europe. While we expect growth to slow - with the rising euro, record oil price and a weaker market for exports in the US, it would be remarkable if it didn’t - it will remain relatively strong. 

Although rental growth will be subdued across Europe for 2008 and 2009, we expect Germany’s office, retail and warehousing sectors to be among the top growth markets over the next five years. We played this conviction through with our recent purchase of a newly-constructed office building close to Frankfurt airport. 

German cities, with the exception of Berlin, look attractive, with returns at or above the average for the European retail sector despite slower consumer spending. Retailer demand and competition for the best high streets also remain healthy, with international fashion houses such as H&M, Inditex (Zara, Massimo Dutti) and TK Maxx expanding significantly in Germany.

Over the next five years, we expect the industrial sector in Hamburg and Frankfurt to have the largest prime rental growth at 1.9% and 1.7% per annum respectively. These cities benefit from more restricted land supply and the rapid distribution opportunities that their seaports and airports afford to international operators.

Read more next week in the second part of the article on the UK market. Also learn more about Roberts conclusion on European commercial real estate.

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*) Robert Matthews is Head of International Property & Strategy at Scottish Widows Investment Partnership (SWIP). As a part of Lloyds TSB Group, Scottish Widows Investment Partnership (SWIP) holds more than 116bn Euros* in funds under management. SWIP invests in a broad range of asset classes. The real estate team is 26 specialists strong, with an average of 15 years of experience in the industry. SWIP currently manages 7.8bn Euros* in direct commercial property assets. (* as of 31 July 2008)