Europe: the rise of the secondary city

International investors have long coveted exposure to Europe’s largest property markets such as London, Paris, Berlin and Amsterdam.  Yet, there are numerous barriers to entry that mean gaining access to these markets is difficult and there are relatively limited opportunities compared with the high levels of interest. Furthermore, following extended periods of rapid capital value growth, acquiring a significant portfolio of residential units in these major cities is likely to require a significant level of investment.

The success and capital growth exhibited by these cities have also resulted in strong yield compression over the past decade. This, among other factors, has turned the heads of many potential suitors to Europe’s secondary cities. This classification does not necessarily mean that these cities aren’t capital cities or large markets but rather, cities within Europe that are yet to receive the same levels of capital pouring in.

Before we delve into the reasons of secondary city investment, it’s important to understand why yields have been compressed.

Residential property in Europe has outperformed other real estate sectors and buyers have targeted large scale investment opportunities across the continent’s principal cities, not only in search of high returns but also as a hedging instrument used to diversify a wider portfolio.  The recovery from the 2008 worldwide recession has been relatively sluggish with investors struggling to achieve returns that once would have been considered moderate. On top of this, the current global macroeconomic picture is plighted with uncertainty amid concerns of the slowdown of the Chinese economy. This clearly indicates demand for residential shows no signs of letting up.

The relatively weak Euro over the past few years has encouraged investment from overseas but it would be foolish to assert that prices have only risen due to increased inward flows of capital from international investors with deep pockets.

Rising urbanisation across the continent and inward migration from other parts of the world have driven up demand for housing. Furthermore, most of Europe’s largest residential markets face the same substantial conundrum: chronic undersupply of residential construction. The consequence of these two factors has caused prices for the existing housing stock to soar.

The ECB’s monetary response to the 2008 recession has also played its part in yield compression across residential property throughout the continent. Both conventional and non-conventional monetary policies – Quantitative Easing and record-low interest rates – were designed to stimulate the economy in the short term in order to grow. However, a significant by-product of this policy is that growing numbers of European citizens are not only buying property to inhabit but also in search of investment returns they can no longer earn from their savings investments.

Investment in these secondary city locations can not only result in higher rental yields but improve geographical diversification and allow buyers to acquire units in greater scale.

As illustrated by Grainger’s recent acquisition of Clippers Quay [see box], there are sufficient opportunities for investors to create a geographically diversified portfolio outside of Europe’s primary cities, with recent investment in Edinburgh, Dublin and Kiel in Germany also proving particularly noteworthy.

The emergence of Europe’s secondary cities provides food for thought as this story of yield compression is part of a much wider trend that indicates migration to these secondary cities is as strong, or in some cases stronger than to Europe’s major capitals.

JLL’s European City Momentum Index tracks a city’s short-term socio-economic and real estate momentum in combination with measures of whether a city has the longer-term foundations for success. The index’s top 12 European cities includes Dublin, Manchester, Edinburgh and Barcelona, all historically less fancied residential investment locations that are now going through something of a renaissance.

Increased infrastructure investment, the creation of high-skilled jobs and high levels of foreign direct investment are all characteristics that define the aforementioned cities. As such, residential investment in these cities may not solely be about maximising returns but establishing a foothold in cities with high growth prospects.

It is not in question that the region’s primary cities will continue to be the focus for the greatest amount of capital in the sector. But it is clear as residential investment grows, so will its geographic scope for a number of pertinent reasons.

Recent investment examples in Europe’s primary and secondary cities



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