Electoral law, GDP growth, supply shortage seen compressing Italian office yields

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Helped by a new electoral law, GDP growth momentum and a supply shortage, Italian office sector dynamism is picking up and should produce rental increases and further yield compression, particularly in Milan, according to the listed Coima Res group.

Head of Investment Management Gabriele Bonfiglioli says nationwide office investment transaction volume rose 31% in the first nine months to over €7bn in volume while yields continued a steady drop that started in 2013. Grade A office yields are around 3.50%, down some 35bp over 12 months. This compares to a 10bp fall in retail yields to 3.15%, and 25bp in logistics to 5.90%

"The investment market remains strong so there is a trend growth of over 30% in volume so far this year," Bonfiglioli told a company conference call on Thursday. Around 70% of the volume was done by foreign buyers but, "also Italian investors are back... Milan has fully participated in the convergence of prime yields across major European cities." Top grade Milan yields are now roughly in line with London and Frankfurt, albeit not yet at the 3.0% seen in some parts of Paris CBD.

Coima Res, an Italian REIT/SIIQ founded in 2015, focuses on Milan, which is Italy's most important office market with 49% of volumes this year so far which and acts as a gateway to the national marketplace, he said. However capital values in the city, averaging some €14,670 per sqm, are still well below London prices - which are more than double - or Paris.

"The important element is dynamics," he said. "Milan has had one of the fastest-growing rental rates in Europe in the last few months at 9%, and we expect this to continue." Coima's flagship development Porta Nuova should outpace even the city's CBD, with rents projected to rise by 18.5% in the coming three years. The prediction, made by US-based research group Green Street Advisors, is outstripped only by Berlin and Madrid among the major European conurbations.

But one key element in Milan has been a shortage of Grade A office space, where vacancy rates are below 2% as compared to a city-wide average of some 12% including Grades B and C. Over the next three years however, demand for top-grade office in the city is forecast at some 207,000 sqm, while supply is seen at just 87,000, so that there is roughly a 120,000 sqm shortfall.

Coima Res CEO Manfredi Catella added that the absence of supply is what differentiates Milan from, for instance, Madrid and Barcelona. "What we are seeing is tenant demand picking up quite considerably, for example from companies consolidating their space," he said. Allianz and Generali have now moved into the CityLife development for this reason. Another trend is that tenants normally located outside the city such as big US tech names, have all moved into the Porto Nuova area. "This has created a tech districit which did not exist in Milan before."

The third trend is employment growth among consultancy groups such as PwC and Accenture. "They are significantly increasing employees and creating a need for more modern spaces and also for places that more easily attract talent," Catella told the call. "They are prepared to spend a bit more in rents to get a good location but not one that is necessarily central... We expect more supply to be produced but of a very different nature. Several buildings used in the past will become obsolete and this will create increase in vacancy in some subsectors of the market."

Bonfiglioli added that one major lease negotiation is taking place at €600 sqm, around 10% above the peak office rent seen in Milan so far. "Capital markets remain strong and steady inflows into Milan will put pressure on yields so that they are not only falling in the city centre but also in secondary locations," he forecast. "Rents are increasing and will continue to increase in next 24 months, additionally boosted by a lack of quality space. This will characterise the market in the coming years."

Business Immo