European property should be considered for yield-hungry investors such as family offices, the author of this article asserts.

Where in a world of low or even negative interest rates can yield be found? That remains a burning question for wealth managers of all descriptions. One option, so the author of this article argues, is European property. Giles Fuchs, who is chief executive of Office Space In Town, argues that family offices – often direct investors in property – should look at Europe’s real estate market. Office Space In Town is a serviced office company. The editors of this news service are happy to share these comments with readers; they don’t necessarily endorse all the views expressed and invite readers to respond. (To see another example of a guest article arguing the case for European property, see here.)

A difficult macroeconomic climate is stifling institutional investors all over the world, from pension funds and insurance companies to family offices. In the hunt for yield, one sector in particular stands out for its strong and consistent returns: European real estate.

This year family offices have increased their real estate allocations to 15 per cent – up from 13 per cent in 2015 – with more than 10 per cent of total real estate investment flowing into the UK. But with the ramifications of Brexit and the need for diversification, family offices are adopting new strategies to protect their investment. While the UK – and especially London – remain attractive, other European cities are increasingly coming under the spotlight. 

Real estate was one of the only bright spots for family offices last year, outperforming most other asset classes, according to the 2016 Global Family Office report by UBS. The report also showed that Europe produced the strongest returns globally, surpassing North America, Asia-Pacific and Emerging markets.

One note of caution is that after almost €250 billion ($266.5 billion) was poured into European real estate by investors last year, concerns were naturally raised about inflated valuations. Consequently, overall investment in commercial property has fallen by 47 per cent in the UK, 35 per cent in Germany and 32 per cent in France. 

Yet the outlook for the sector remains attractive in a largely insipid investment climate. Around four-fifths of institutional investors across Europe plan to increase their European real estate portfolios over the next two years. Building upon recent trends, family offices are likely to be at the forefront of this.

While there are still compelling reasons to look to the UK, Brexit has presented fresh challenges, as well as opportunities. Following the unexpected decision, as many as 40 per cent of commercial property deals stalled – with some commercial property buyers invoking "Brexit clauses" written into contracts agreed before the vote. For example, Germany’s Union Investment pulled out of its £465 million purchase of Cannon Place, a landmark City of London Office block, while the Danish pension scheme ATP – the fourth largest in Europe – halted its investment in the UK and eliminated its exposure to sterling.

As a result, family offices are increasingly diversifying their assets and turning their attention to other European cities in addition to London. Surveys show that 38 per cent per cent of institutional investors still cite London as the most attractive destination for real estate investment. But in a recent survey of overall investment prospects, Berlin and Hamburg – Germany’s most populous cities – were ranked top, followed closely by Dublin, Madrid and Copenhagen. London came in below Istanbul and Budapest – which, despite their political volatility, ranked highly because of their favourable demographics. 

Despite Brexit, in the first half of 2016, close to £23 billion ($23.64 billion) flowed into UK real estate, well over 10 per cent of all transactions worldwide. Overseas investors – who still regard the UK as among the world’s safest destinations for real estate investment because of its strong legal system and stable regulatory climate – accounted for some 40 per cent of capital flows. 

And that strong overseas demand is set to continue: tellingly, reports indicate that international investors made up nearly four-fifths of the £2.2 billion of commercial property deals in London in the three months following the Brexit vote.

Whilst London remains dominant on investors’ horizons, at Office Space in Town, we are seeing family offices considering new strategies to boost their investments: in particular, towards regions which were traditionally overlooked and thus undervalued. In 2015 investors spent $25 billion on property outside of London. 

Going forward, we still expect the London commercial property market to be the prime recipient of overseas family office investment, due to its strong liquidity, depth of opportunity and variety of projects and developments.

Investors from the Middle East comprise a significant proportion of this group. Among Middle Eastern family offices, there is a strong preference for wealth preservation and high income-producing assets with typically a decade long investment horizon.

Moreover, with the recent fall in sterling, UK property is up to 20 per cent cheaper for many overseas family offices. Another positive is the UK’s favourable policy environment: the Bank of England is encouraging investment by cutting interest rates to historic lows, while government policy offers robust fundamentals for property investments.

In terms of type of assets, family offices are beginning to diversify their strategies. Yields can be bolstered by combining commercial and residential real estate: anticipated yields from commuter investments average 4.4 per cent per year – and are rising. 

Two sectors which offer promising yields are industrials and logistics warehouses. In these asset classes, refurbishment projects offer returns which average 14 per cent. There is also strong demand for sectors which provide additional revenue streams over and above the standard rental income they generate, such as hotels, serviced offices and student accommodation. 

These are often undervalued because of misconceptions about the stability and breakdown of their income, and inadequate valuation methodologies.

The key point is that family offices tend to be long-term strategists who look beyond short term market volatility when investing. The uncertainty around Brexit has encouraged them to diversify their assets to European cities outside the UK and strong performing asset classes. While London may have lost some of its shine, international investors in particular will continue to be attracted to its political stability and cultural influence. 

European real estate will remain a core focus, with the UK likely the most favoured and London remaining the capital choice for overseas family offices for many decades to come.