High competition—and prices—in major markets have investors looking for returns from recovering markets, says the latest edition of Emerging Trends in Real Estate from ULI and PwC.

Competition for prime assets in Europe’s major real estate markets is leading investors to turn to recovering markets such as those in Ireland and Spain, regional cities, and secondary property in search of returns, according to the 2014 edition of Emerging Trends in Real Estate® Europe, a forecast published annually by ULI and PwC since 2003. It is based on the opinions of more than 500 internationally prominent real estate professionals, including investors, developers, lenders, agents, and consultants.

For the current year, 71 percent of respondents say they think that a shortage of suitable assets for acquisition will have a moderate or significant impact on their business. As a result of this increasing competition, 59 percent of respondents said they believe that prime property in Europe’s core markets has become overpriced.

Investors are becoming increasingly comfortable with taking more risk in search of returns, according to the report. One of the biggest beneficiaries of this change in comfort level is Dublin, which has risen dramatically in the city investment rankings, moving up from 20th in last year’s report to second this year. Dublin’s real estate market has been transformed from a “no-go” location among investors only two years ago, to being one of the hottest markets in Europe, with both domestic and international investors attracted by pricing levels and Ireland’s improving economic outlook. The report finds that 51 percent of respondents now see good buying opportunities in Ireland.

Top Ten European Cities for Existing Property Investments

 2014 Ranking2013 RankingChange

The weight of international capital is leading investors to turn to other recovering markets, such as Spain. The report reveals that 67 percent of respondents believe that there are now good buying opportunities in Spain, with the acquisition of the Parque Principado mall in Oviedo by Intu and the Canadian Pension Plan Investment Board for US$221 million highlighted as an indicator of mainstream interest in the market. However, skeptics argue that debt is hard to obtain and that Spain is a risky market to invest in before there are signs of growth.

Competition for core assets has also led to an increase in investors looking beyond prime assets in major European markets such as London, Munich, and Paris, and instead buying solid income-producing assets in secondary cities. For example, office investors in Munich can achieve yields of approximately 4 percent, but those willing to invest in smaller German markets such as Stuttgart can achieve up to 6.5 percent. Investors are also looking to acquire secondary properties in major markets, which have good existing income streams or which—with careful asset management—could be transformed into core assets.

Investors are increasingly considering development as a way of adding high-quality assets to their portfolios. The report says 71 percent of respondents believe that development is an attractive way to acquire prime property.

“The resurgence of investment in Ireland, and how far the Spanish real estate market recovers, will be two of the key stories in 2014,” says Joe Montgomery, chief executive of ULI Europe. “Investor appetite in Dublin has been growing over the past 12 months, with significant volumes of international capital chasing the best assets. Investor interest is now moving to Spain, where there are signs that opportunistic investors—who entered the market when Sareb opened for business last year—are now being followed by mainstream institutions. However, with limited signs of tenant demand and rental growth, questions remain as to how far the market recovery can go.”

Simon Hardwick, real estate partner at PwC Legal, says, “We believe the real estate investment market in 2014 will be dominated by a battle for assets. International capital will continue to flow into Europe, seeking to acquire prime assets in core locations. Intense competition for the limited supply of suitable property will inevitably continue to have an impact on prices—particularly in global gateway cities, including London. This will result in investors’ having to look at other opportunities and to accept more risk. This is reflected in the renewed interest in development, as well as the fast-improving outlook for ‘nonprime’ locations and properties. However, we are skeptical about whether the positive sentiment will lead to a headlong rush into the most risky markets. Investors’ interest remains focused primarily on sustainable returns from quality assets in good locations.”

There will be significant capital available in Europe’s real estate markets during 2014, with 71 percent of respondents saying there will be an increase in equity for refinancing or new investment this year. Although some of the equity will be domestic, significant investment is expected to continue to flow from sovereign wealth funds, especially those based in Asia. Nearly 80 percent of respondents expect capital from the Asia Pacific region to increase, with 67 percent of respondents saying that capital from the Americas will increase this year.

The outlook for real estate debt availability is also improving, with 51 percent of respondents expecting the availability of debt for refinancing or new investment to increase this year, with only 15 percent of respondents expecting it to become scarcer. However, respondents were not expecting dramatic improvements to pre-recession levels and there remain significant geographical differences in perspective. Respondents in the United Kingdom were the most upbeat on the prospects for debt, with nearly 90 percent expecting greater availability, while respondents in southern European and the Benelux countries were more cautious.

Top Investment Markets:

Munich. The city continues to benefit from Germany’s position as the economic powerhouse of Europe and from a young, expanding population. Munich remains popular with core investors who are attracted by low unemployment and a lack of high-quality office buildings. The city also has a busy retail market and a strong service-based economy. Munich is rated first for existing investment prospects and second for development prospects, but the outlook for new investments has fallen to seventh, likely because many investors think the city’s office market is too expensive. 

Dublin. The biggest winner in this year’s report, the capital of Ireland saw its ranking rise 18 places to second for existing investments and 14 places to become the top spot for new investments. Investors say that 2014 will mark Dublin’s comeback, driven by improving economic conditions, with unemployment at its lowest level since 2009 and with forecasted gross domestic product (GDP) growth of 2 percent this year. However, opportunities for investment will be limited due to the size of the market. Office prices have increased significantly over the past 12 to 18 months in prime locations such as the Docklands, and local investors are predicting a further rise of 10 percent in 2014. Survey respondents said there was significantly more equity available and that bank debt was becoming available again for the right assets and investors. The residential market is also recovering, with prices for well-located properties rising more than 20 percent last year. However, retail is still under pressure, with rents continuing to fall, albeit at a slower pace. 

Hamburg. Hamburg’s diversified economic base helps sustain a steady level of office demand, and there is considerable competition for core offices among investors, with yields now around 4.7 percent. Residential also has long-term momentum due to the city’s relatively high population growth, boosted by inward migration. Residential rents have risen an average of 5.7 percent annually since 2007, but they have started to plateau. The growing population, combined with an above-average level of disposable income and 10.6 million hotel reservations annually from tourist and business travelers, provides Hamburg with strong retail fundamentals. Limited new retail development has meant that the supply of prime space is now tight. HafenCity, Hamburg’s huge redevelopment of its former port, is midway through creating an entirely new quarter that will double the population of the city center. Due to be finished in 2025, it will also make Hamburg one of the most sustainable cities in Europe. 

Berlin. Berlin’s young population and its growing influence as a European media and technology hub continue to make it an investment hotspot. Prospects for the residential sector are strong, and rents in the capital of Germany have been rising steadily, especially in recently modernized buildings. House prices in certain areas of the city have doubled over the past year. Berlin’s office market is enjoying a mini-boom and is on most core investors’ target lists. The city’s economy and tenant base have become more diverse, and the demand for office space is set to grow as companies seek to expand. The retail sector also is experiencing good demand, with rents growing sharply in prime locations. 

London. A reputation as a safe haven for international capital means that London remains a favorite among investors seeking core and core-plus assets. Large amounts of sovereign capital from Asia and the Middle East continue to flow into the city, and very few deals or assets are now seen as unfundable. However, this popularity has led to price inflation, and there is concern that a bubble is now developing. Many respondents said they thought that London was fully priced, and as a result investors would look to other U.K. regions in search of returns or they would buy secondary assets that they could turn into core investments. Central London’s buoyant prime residential market also is attracting significant interest. The sector has not traditionally attracted institutional capital, but this is changing, and both U.K. and international investors are tentatively starting to develop and refurbish property, both for sale and for rent.

Peter Walker is ULI director of communications, based in London.

Register today for the 18th ULI Europe Annual Conference in Paris.  February 4-5.