According to a new report to be released later this month from global real estate adviser Cushman & Wakefield, “A total of €62.8 billion of commercial property was traded in Europe in the 3rd quarter 2007, 23% ahead of the same period in 2006.” The report warns, however, that despite strong activity and buoyant rental growth, a clear step change has now taken place with investment yields rising for the first time since 2003. The outlook is for a slowing in investment activity into 2008. As a result of strong investment activity to date, Cushman & Wakefield is expecting 2007 to be another record year and are forecasting that investment volumes will total €235-240bn (€236bn in 2006). David Hutchings, Head of European Research at Cushman & Wakefield commented; “The hard work in reaching this total was done during the first seven months of the year. While there was plenty of momentum spilling over into the third quarter, we saw the flow of new deals grinding to a halt in late August and September.” Cushman & Wakefield expects the final quarter of 2007 to be markedly slower, with a total deal volume of €54-58bn forecast, 8-10% down on the average of the previous three quarters and 30-35% below the record Q4 seen in 2006. “The ”credit crunch” has clearly had an impact on trading volumes and pricing.” said Michael Rhydderch, Head of the Cross Border Capital Markets team at Cushman & Wakefield, “Some areas of the credit market have been closed for business and, with uncertainty on pricing, activity stalled in August, with deals being renegotiated and some larger deals postponed. However, it is important to note that the whole market was not affected to the same extent. Outside the UK, many parts of Europe have remained quite robust, with well-financed investors still active and enjoying a better choice of property than for some time. Nonetheless, it is undeniable that buyers have shifted their views on pricing and stock quality. With a more demanding investor, only the best product will sell at anything like the pricing levels seen earlier this year.” Across Europe, yields rose in Q3 for the first time since early 2003, with office yields rising an average of 13 basis points, driven by a 20bp move in Western markets. Central & Eastern Europe bucked this trend, with yields stable or down, as strong buying demand and limited prime supply continued to force pricing higher. Conditions will remain more favourable for buyers than sellers into 2008 but there is no shortage of the former, with existing capital allocated to the market, new funds being raised and many investors recognising that currnet market conditions may offer a strong buying opportunity that will not last for long. The opening part of the year may nonetheless be quite volatile, with yields likely to edge up further. ”Yields should be rising at this stage in the market cycle”, commented Rhydderch, ”Since the perception of future rental growth which helped to drive yields down is now a reality in more markets. Moreover, given the level of investor caution, the potential for yields to over shoot cannot be ignored particularly if the real economy starts to falter.”. Looking at patterns of activity in the market, foreign investors remain dominant in many European markets, seeing their market share averaging 57% so far this year versus 44% in 2006. “Good demand is evident from a range of buyers,” said Rhydderch, “Notably, long-term equity or lowly-geared buyers from the Middle East, Australia and North America are particularly evident. German buyers also have a stronger presence and more UK interest is anticipated.” UK trading volumes were down on the previous quarter but the region’s other top markets, Germany and France, saw increases of 24% and 21% respectively over the first nine months of 2007. Other Western markets also saw strong buying activity, underlining investor’s interest in mature, lower risk markets, but at the same time, emerging markets enjoyed good growth as some investors sought out higher return opportunities. Central Europe was ahead by 15% and Eastern Europe by over 50% on the first 3 quarters of 2006, with Turkey, Romania, Bulgaria and Ukraine setting the pace. This trend looks set to continue in 2008, particularly as pricing in the Russian market becomes more accepted by international investors. The office sector has been the chief beneficiary of recent investment activity, with trading volumes up over 40% in the first 9 months of the year to €100bn and its share of total activity up from 50% in 2006 to 55% in the first three quarters of 2007. Retail by contrast has seen deal volumes rise 8% but its market share has fallen from nearly 28% to just less than 25%. “Results from the final quarter will be interesting and probably a mixed bag of positives and negatives.” speculated Hutchings, “However it is really the results from quarter 1 and perhaps quarter 2 next year, which will be most telling. The way ahead for property will not be clear until we see how the economy is reacting but we are still optimistic that current market conditions are actually bringing forward a correction in pricing and attitudes to risk which would have occurred anyway, rather than signalling the onset of a serious reversal. Nonetheless, the risk of a more adverse reaction, or over-reaction, will be with us for some time.”