A report by the European Research Group of the Cushman & Wakefield (C&W), a leading global property solutions company, says that Europe’s economy is at last showing signs of improvement.
While not enough to trigger significant short-term rental growth, a firming in the business environment should signal a further good year ahead for real estate.
With yields already compressed to at least a 25-year low, some are questioning whether recent performance can be sustained. However, in C&W’s opinion, given the level of demand and reducing property risk premium, yields will in fact fall further.
Following a total return of 15 per cent in 2005 for prime Western European property, performance may ease in 2006, but modest rental growth and further yield compression should ensure it still beats its historic average.
The strongest area of growth in 2005 was retail, but current performance is more uniform - with offices showing the better rental growth and industrial the sharpest yield falls.
Western Europe is expected to show faster short-term rental growth in 2006, of four per cent versus three per cent in 2005, with offices leading retail by a narrow margin.
The drivers for the market will be a mix of low interest rates (albeit rising), higher building and material costs, a slow uplift in economic activity, ongoing margin pressures and occupier and investor interest in new markets.
C&W has found that the medium term outlook for the Central and Eastern Europe (CEE) markets is good, albeit that short term growth will be constrained as they continue to adjust to new supply.
The research group believes that there are several key macroeconomic factors that are boosting the performance of the region. Those include the gradual though not significant fall in unemployment, the gradual decrease of inflation to realistic levels close to the ones in the European Union, as well as increasing consumer spending on the back of lending and income growth. But, most importantly, the CEE region has seen in the past few years gross domestic product growth, which is above the one registered in Western Europe.
About two billion euro was invested in CEE institutional property in the first half of 2005, an increase of about 40 per cent year-on-year. After a strong first half of the year, the property investment markets in CEE were expected to exceed by the end of 2005 the record 4.1 billion euro that was invested in 2004. 
Almost 10.5 billion euro has been invested into CEE institutional property since 1998, with more than 80 per cent of the total volume being invested since the beginning of 2003 alone. More than 85 per cent of the total invested volume in CEE consists of office and retail (shopping centre) property. Office transactions have been primarily centred in the capital cities, while retail (shopping centre) and industrial transactions have been finalised in regional cities as well.
Almost all properties sold in CEE in 2005 were office buildings and shopping centres. Retail continues to make up a significant portion of the total investment volume. In fact, retail transactions account for about 50 per cent of the total volume in 2005, the same as in 2004.
Based on three main factors, namely macro figures (including EU accession, politics, economic and foreign investment), property market activity (maturity, occupier and investment activity and values), and property market structure (transparency, foreign ownership, leases, property taxes and costs, legal structure and planning), C&W has made a ranking of Emerging Europe’s top commercial property markets.
The ranking is led by the Czech Republic, which was the top location for a second year in a row, followed by Hungary, Poland, Slovakia and Estonia, forming the top five destinations for the commercial property developers. Next in the ranking is Russia (the absolute giant among the countries of the region), Latvia, Lithuania, Romania, Bulgaria (firmly occupying 10th place), followed by Croatia, Slovenia and Turkey.
In terms of the economic growth, which is the most important factor boosting the property market, it is Latvia and Estonia that are on top of the chain (with seven per cent and more GDP growth in 2005), followed by Lithuania and Slovakia, as well as Bulgaria, Russia, Romania and Turkey (all with more than five per cent GDP growth in 2005).
The flow of new funds and indirect vehicles in Europe shows few signs of slowing, with a growing presence of diversified open and closed ended funds. While emerging markets remain a focus, a growing number of funds are concentrating on core locations due to investors’ aversion to risk as well as the greater size and liquidity of these markets.
Key targets remain France, Sweden and Spain as well as the CEE region, with very strong demand growth in Romania for example, but interest is increasingly global, with Asia of growing interest due to its diversification benefits.
The key investors in CEE meanwhile are more diverse than in the recent past. German and US money is highly significant but Dutch, Irish and UK buyers are strongly evident, as is money from the Middle East, mainly Israel. Danish, Norwegian and French investors are also extremely active.
In the first half of 2005 (a process which evidently was preserved in the second half of the year too), 97 per cent of the total invested volume in CEE property was concentrated in the core CEE markets - the Czech Republic, Hungary, and Poland. However, a gradual increase is observed in activity in markets such as Bulgaria, Romania, Russia and Slovakia, with most of the transactions in these markets finalised during the past two years. Bulgaria, for example, witnessed its first institutional investment transactions in 2005.
Prime yields in CEE are constantly under downward pressure due to a shortage of available product and ever-increasing demand. Prime office yields are now approximately 7.25 per cent in the Czech Republic, Hungary and Poland. Analysts expect that prime yields will continue to fall in 2006, with prime office yields in the core Central European markets quickly approaching seven per cent and below.
The investment markets began to emerge first in Romania and Russia in 2003 followed by a very active year in Slovakia in 2004. Bulgaria joined the ranks in the first half of 2005, with several institutional transactions being finalised, including the sale of Bulgaria’s first modern shopping centre - the Mall of Sofia.
