Discussing what returns and risks to expect when buying property in Europe is emotive. It can inflame, many a seasoned professional. I like this, it demonstrates a little attitude. Which you will need to do well in the current economic climate. Although several European countries are still recovering from property and economic crises, international investors are still bullish about the European real estate market, driving further growth in several European property markets into 2018 - with the exception of the UK, which is experiencing a post-Brexit uncertainty. Brexit, is going to create trouble as sure as eggs is eggs guys. Yes, you may not agree with me, and that’s fine. But we are rarely wrong, live with it! Time will tell! Considering the uncertainty in the European property market, is buying property in Europe still attractive? And, more importantly, can investors expect a good return on their real estate investments in the current climate? Why are real estate investors still flocking to Europe? Just a few years ago, everyone was predicting the end of Europe - especially the end of continental Europe - but we have still seen ever-increasing property prices as investors flock to the markets, particularly in the main cities in Germany and, more recently, several Nordic locations. Real estate markets in Europe, whether commercial or residential, are actually very expensive. Are they a good investment? Some are very good. Some are not really that great. But any tangible investment which cannot be affected by the Brexit meltdown, and which is showing you a healthy return must beat leaving your pension / retirement money in an English bank account earning you almost nothing. Whoops. Sorry! Considering that prices are high and property assets are trading at incredibly low property yields, this makes the underlying value of properties very high. So how is it possible that a continent experiencing modest economic growth with a still-low inflation - though improving, albeit slowly - continues to attract investors from around the world? Yawn. Here comes the boring bit. 3rd Year University of Lincoln business studies anoraks at the ready please! The answer is simple: it’s all linked to the monetary policy of the European Central Bank (ECB), and it has nothing to do with real estate. With the ECB’s loose monetary policy of keeping interest rates artificially low - in early September 2017, in fact, the ECB decided to keep interest rates at 0.00% for an “extended period of time”, investors don’t see any other possibility than investing in real estate. Buying stocks can be too risky as they are volatile, and bonds are expensive considering yields are still hovering around very low levels. Even if it is expensive and the yields are not high, real estate still offers a cash yield or a net rental income of a few percent, which is a high return compared to zero interest offered on other assets. But, in a way, it is also dangerous that property prices are supported by this monetary policy of the ECB. The reality is that some emerging markets are in trouble with declining growth rates, turmoil, lower commodity prices and volatility in currencies. Rich investors from emerging markets are turning to Europe because they had to diversify due to such problems. For a continent that was a complete write-off less than a decade ago for investors, those same investors are now investing in Europe. Everything we have been predicting is the exact opposite: there are property markets performing well in general with lots of international capital flows. In essence, real estate is equivalent to a secured bond, especially if you buy in the prime property markets in Germany, for example. But anywhere in Europe, you still have the potential for a better economy and higher inflation positively influencing your investment. This is the main reason why real estate in continental Europe and recovering markets has performed so well. Should you worry about low inflation when buying property abroad? Some investors ask about the lack of inflation and whether it still matters. Understand that we have always sold real estate on the following argument: because of inflation, your investment will always be protected - it’s a hedge protection. But today we don’t have inflation or, if we do, it’s a mere few percent. When investors ask if it stills matters, the answer is yes. Inflation in Europe is currently at 1.48% in 2018, and is not expected to soar substantially in the coming years. If, for one reason or another, inflation was to recover further, real estate investors could benefit because, besides a potential rise in the value of their investments, rental contracts are generally indexed and reviewed upwards on a regular basis, as in the UK. A continuous, long-lasting lack of inflation would be bad news for a property investor. But in case of deflation, we also see a decrease of asset values, and that is no good news either. Inflation still matters, and we hope to have a return of a healthy inflation of 2% in the coming years — though, as ECB president Mario Draghi said, we must be patient. What will happen with interest rates in Europe? Higher interest rates have been predicted for years, but everyone was wrong. Interest rates are still very low - stabilising at best - but they are certainly not rising significantly. Europe is now in a situation with interest rates at around 1% or below. Without any inflation, yields or potential profits will not rise. Despite this, investors know that if they buy today, they benefit from financing at a very low cost of borrowing. This trend is seen almost everywhere in the world - housing markets are very popular, as everybody is trying to finance or refinance their mortgage to acquire a home while mortgage rates are so low. Many investors ask about the artificially low interest rates: how long will they last? Another year, two or maybe three? Nobody knows for sure, but we do know that interest rates will rise again. We may then have a serious market problem - if you bought property, whether commercial or residential, with low yields of 3 %, even a 1-2% rise in interest can have a serious influence on your profit return. When financing your real estate, it should be done at fixed rates. Buyers shouldn’t consider financing at floating rates, because besides being dangerous, with interest rates so low, why consider a floating rate? This is no longer necessary. Even if interest rates were to later rise, your cost of borrowing would be fixed. Additionally, if inflation rises, your cost of borrowing stays capped while your rental income can potentially rise in line with inflation - this is how real estate investors can make money in the future. What kinds of returns can European real estate investors expect? In the core markets of Europe, it can be expected that returns will be positive but on the low side. You may not make 10–15% a year, but you might have a few percent a year cash return. In reality, the focus of investors should be on cash, not on capital gains, because core residential markets are already expensive. But if you were to buy in troubled markets such as Spain (though recovering very rapidly) or Greece, you may have a chance of making capital gains if the economies continue to improve. The commercial market is similar: either you buy in the established office and retail markets and expect a cash return of around 4-6% with limited capital gains, or you buy in recovering markets - southern and central Europe, perhaps Ireland and Central Europe and the more regional cities in European countries - and the returns could be higher though with much higher risks. The euro is regaining strength after falling to record lows beginning in 2014, though still not as strong as it once was - properties are still essentially cheaper for foreigners, and investors could benefit as the euro continues to strengthen. European real estate is in extremely high demand, and it’s an interesting asset class. Still, investors should not overestimate their return expectations they should ‘be realistic and carry on’, as I like to say. Risky versus stable real estate: where are the best places to invest in real estate? On one hand, we have the core, established property markets that hardly saw any crisis. On the other hand, real estate was perceived as a safe haven in main European capitals, such as London and Paris. The UK, France and Germany, for example, had taken the bulk of investment volume accounting for more than 70% of transactions prior to 2016–17. Certain neighbouring countries in southern Europe, as well as some countries in the north and in central Europe, have not performed well in the past years, having suffered severe property crises. Germany is now regarded as one of the best countries to invest in for 2018, with major cities Berlin, Hamburg, Frankfurt and Munich making the top-ten lists of best places to invest in real estate. The focus is on cities rather than countries, and Nordic locations such as Stockholm, Oslo and Helsinki are gaining favour. An investor now has the possibility to either invest in very expensive property in established European markets - but it is a secured investment at a low return - or to invest in those markets where prices have fallen but are recovering. Investors who are willing to take a bit more risk could have a higher return but not without taking a gamble. Europe’s capital in Belgium is in the middle of everything - but it’s not performing like the German markets. Brussels has not participated in the huge property boom, because both rents and values have been relatively stable — this is why Brussels is rather ‘boring’ in terms of property markets. The Brussels commercial and office markets have not been in such great shape, though it is improving. You have areas close to the EU institutions that perform well thanks to EU occupancy, as well as other areas only 3-5km away where vacancy rates can reach as high as 15%. Because UK locations are falling out of favour thanks to the uncertainty of Brexit and rent prices may come under pressure, other European markets are poised to take hold. Europe is now offering opportunities both to defensive and opportunistic investors. We see a mix of investors; those who are investing in the core markets with an expectation of a few percent return, and those who are investing in European countries to benefit from the property market recoveries. Should you consider a high- risk investment over a stable one? Spain is still a popular country in which to buy property - housing prices fell by 30-40% compared to peaks recorded in 2007, and they are now rising quickly. Investors from Belgium and France are buying apartments in Spain in droves - it is a popular holiday destination, and many investors get swept away while vacationing in the country. But you need to be careful - Spain’s supply of vacant residential properties has risen to over three million. Additionally, if you buy in Spain, you have to think about the paperwork and ensure that the buyer - or better, a lawyer - checks the documents, as a Spanish notary is not obliged by law to disclose all information. You must be careful that there’s no mortgage on the property, that building permit is valid, and that you’re aware of any other costs and shared responsibilities, such as a pool or elevator in a housing community. It is true that prices are very low; you can sometimes buy a three-bedroom house with a pool and a garden for €250,000 in a rather nice location. In comparison, for example, in Belgium, it is complicated to find a 60sqm apartment for that price. Properties in recovering markets can be cheaper, but there is some primary work that should be done before acquiring any property in any foreign country. What should you know before buying property in Europe? Every country will have fiscal implications you need to check: • What local taxes you have to pay • If you are subject to pay capital gains • What happens to the property in the event in death Whether you need to pay inheritance taxes Your net returns on property investments will likely decrease in the coming years as it’s reasonable to assume that taxes, charges and costs will rise in many countries across Europe. Taxes are, in fact, going up - the UK is charging among the highest - and some mortgage relief measures are diminishing, e.g. in the Netherlands. This should not be a reason to abstain from buying property in Europe; so far, investors have not been discouraged to buy property despite higher taxes, even in the UK, where, since April 2015, they have had to pay capital gains tax. It can, however, eat into your return, and investors should know that in advance. Still, the negative impact of these fiscal issues is offset by the very low cost of borrowing. This appears to be one of the main reasons why, in many stable European countries, housing prices have either stabilised or went up a great deal, as in Germany and a number of other markets. Another difference to be aware of lies between continental Europe and Anglo-Saxon Europe, such as the UK: in continental Europe, where tenants are more protected, if you have a problem and go to court it can be a very lengthy process. For example, it can be difficult in continental Europe to evict a tenant if they stop paying rent, unlike in the US and to a lesser extent in the UK. What types of properties in Europe should investors consider for better returns? A major trend in the European housing market is buyers seeking out smaller houses - they are no longer interested in acquiring grand villas, which are not only expensive to buy but to maintain. The elderly in particular are the ones with money, but they often don’t have the capability to maintain such huge houses. Younger people, on the other hand, don’t have the money but are also not willing to spend the time maintaining large properties. Therefore, we see the luxury segment has more vacancies and large villas dominate the market. Instead, senior citizens would rather sell their houses and reinvest in smaller luxury apartments with a view. They are willing to put a lot of money in a five-star apartment without too much work. Even when younger people don’t have enough money, parents are often willing to help out - if they simply put it in the bank, for example, they will get little return since interest rates are around zero. If parents want to help their children, they might consider investing in smaller, more affordable housing - this is now key in our society. This is not only a financial trend but a social one, and property developers and investors should consider houses and apartments of a medium size or smaller, as well as those that are energy efficient, which is obviously big business almost anywhere in the world. This ‘small trend’ will even accelerate in the coming years. Even in Dubai, which always strives to have the best, tallest and longest buildings, new apartments and houses are being built smaller. What about buy-to-let investments? This trend has accelerated in the past few years, as real estate is increasingly considered as an investment object. Even families are buying property in Europe as a second home with the idea to find a tenant. If you do rent out a buy-to-let property, you might have a rental yield of 2-4% net after charges. This is not too high as a return - it is even on the low side - but today, everything is relative. If we compare this to a 1% yield on a long-term corporate bond, at least a buy-to- let property allows investors to potentially cash in on higher yields. You need to be careful, though, because a tenant can walk away or decide not to stop paying — which, as mentioned, can be problematic in continental Europe — so those rental streams are not necessarily guaranteed. But if you buy the right house in the right location, and you find a tenant with a good salary, you can make a better return compared to bonds or other asset classes - and people today are doing just that. This trend will accelerate - unless interest rates were to rise suddenly - as even at BNP Paribas Fortis, we have increasingly seen cases where new loans are given to families to finance a second home. If you want to have a chat with Toby Taylor, call him on 01832 864020. Back to Articles