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Nick Spiro of London-based Lauressa Investments looks at why Europe鈥檚 commercial property investment market is a prime beneficiary of global institutional money.

There is no shortage of risks in global financial markets. The US Federal Reserve, the world鈥檚 most influential central bank whose monetary policies have a sweeping effect on asset prices, is preparing to raise interest rates - possibly as early as June - for the first time in nine years. If bond markets suddenly start to price in a more hawkish Fed, investor sentiment could deteriorate sharply.

Meanwhile, Greece鈥檚 membership of the eurozone still hangs in the balance, with potentially dire consequences for the rest of the bloc should it be forced to leave. Just because Spanish and Italian assets were not affected by the latest tensions between Greece and its creditors should not be construed as a sign that Europe鈥檚 ailing single currency area can manage a Greek exit (鈥楪rexit鈥�) without suffering too much collateral damage.

Yet despite all the uncertainties hanging over markets this year, investors鈥� appetite for risk shows no signs of being satiated - indeed quite the opposite.

Negative bond yields
In Europe, the demand for higher-yielding assets is being buoyed by one of the most remarkable developments in markets in recent times: the rapidly expanding universe of government bonds with negative yields (in other words loss-making if held to maturity). While some 5% of eurozone bond yields were negative as recently as last August, roughly one third of the bloc鈥檚 sovereign debt now trades at a negative yield. According to research from RBS, more than 50% of German, French, Dutch and Austrian bonds have negative yields.

There are a number of reasons for this. One of the main ones is that the European Central Bank (ECB) is moving in the opposite direction to the Fed and is about to embark on a programme of full-blown quantitative easing (QE) that has been driving down yields on government debt to historically low levels. Some investors even believe they can make money if they buy negative yielding debt on a temporary basis given that yields are likely to fall further as QE gets underway.

Many institutional investors, however, averse to suffering losses on sovereign debt, are moving up the risk curve. The appeal of higher-yielding assets is growing with each passing day.

Europe鈥檚 buoyant commercial property investment market is a prime beneficiary of money chasing yields across borders as well as across asset classes.

Core and peripheral
Higher risk product was already generating stronger interest a year or so ago. Plunging government bond yields - and the lower risk-adjusted returns and lack of available stock in the highly sought-after core markets - are encouraging investors to move into the secondary space in core countries and, more tellingly, back into the extremely fragile Southern European markets.

Last year, the eurozone鈥檚 still-vulnerable peripheral economies, together with secondary and tertiary locations in the UK and Germany, were among the areas that enjoyed the strongest surge in transaction activity, with investment volumes in Spain reaching their highest level since the peak of the market in 2007.

This should set alarm bells ringing.

Spain鈥檚 economy is hardly roaring back to life. Nearly four million jobs have been lost since the bursting of the country鈥檚 housing bubble in 2007, with youth unemployment still at a shockingly high 51% and the public debt burden having more than doubled since the crisis erupted to 100% of GDP. As the IMF rightly notes, Spain may have 鈥榯urned a corner鈥� but the legacy of the crisis persists.鈥�

This is not the time for investors in European commercial property to be losing their heads. Taking on more risk requires much greater discipline and knowledge of markets. Investors need to be more discerning and mindful of countries鈥� underlying fundamentals, their creditworthiness and, crucially, likely shifts in market sentiment.

The last time the Fed began raising interest rates was 11 years ago. Ultra-low borrowing costs (and the mispricing of risk which cheap money inevitably gives rise to) have become the norm for many investors and developers and are now dangerously hardwired into the global financial system. Complacency has become the biggest risk facing Europe鈥檚 real estate investment market - and indeed financial markets in general for that matter.

The further decline in borrowing costs raises the stakes for a European commercial property industry in which the thriving investment market has, for some time now, been dangerously detached from lacklustre occupational markets.

Considering that the growth prospects of Europe鈥檚 single currency area likely to remain subdued, to put it mildly, it鈥檚 important that the gap between 鈥淲all Street鈥� and 鈥淢ain Street鈥� doesn鈥檛 widen any further. Investors should proceed with caution.

Nicholas Spiro is managing director of London-based Lauressa Investments