Pricing Through the Cycle in Europe

We created a model based on a measure of "cyclical fair value" in order to understand why yields of commercial real estate properties in Europe peaked below their long-term averages during the most recent recession.

Executive Summary

• Investors believe that European property markets are not completely efficient. Property prices and values don’t always move in concert with fundamentals, giving rise to opportunities to profit from mispricing.
  
• Yields in most European office markets, which fell to historical lows in
  2007, rose during the most recent economic downturn. However, they appear to have peaked below their long-term averages.
  
• Traditional pricing models have a difficult time explaining why yields didn’t increase more, given the severity of the global recession and its impact on commercial real estate fundamentals.
  
• To understand the discrepancy – and to evaluate whether market pricing at any given moment is consistent with investors long-term property return expectations – we have devised a measure for “cyclical fair value” that takes the property cycle explicitly into account.
  
• The results of our analysis show that capital-growth driven markets, which recorded the most significant corrections during the recession, now appear to be most attractively priced, although these markets carry additional upside yield risk.
  
• Stable, income-driven markets look more expensive, but they have limited upside for yields, making them suitable targets for defensive, long-term investment strategies.