By Max Clarke

Tougher regulations; Austerity Europe; the sovereign debt crisis; and a still-tight lending market will challenge Europe’s real estate industry in 2011, according to Emerging Trends in Real Estate 2011, published by PwC and the Urban Land Institute (ULI).

The highly regarded commercial real estate forecast, based on the opinions of 600 industry experts, predicts that 2011 will not be the turnaround year that the European real estate industry had hoped for, with a two-speed market likely to emerge that reflects a widening gap between investment hotspots and second-tier property markets. Respondents expect more industry downsizing across the continent.

John Forbes, partner with PwC and one of the report’s authors, said:

“In future years we may look back on 2011 as a transformational year for the property industry. Real estate professionals face a challenging time. Traditional sources of debt, for refinancing properties with vacancies or in need of refurbishment, will not be available, although new’ sources of lending are expected in the shape of sovereign wealth funds and insurance companies. A big theme will be the continued downsizing of the industry and the winners will be those who are best able to manage their assets, rather than those who make clever stock selections.

Patrick L. Phillips, chief executive officer of ULI, said:

Some of the trends we saw last year continue, such as a flight to quality and a bifurcated market, with strong interest in the best assets in the global gateway cities and little interest elsewhere. The real difference in this year’s report appears to be the perceived weakness in the government’s ability to spark demand or ameliorate the pain in the industry. Equally clear is the emphasis on the hard work of managing assets: repositioning properties to better meet market demand, creative approaches to maintaining and adding value, and effective and efficient property management.

Last year, the industry was concerned that the large amount of debt maturing across Europe over the next five years would prevent banks from undertaking new lending, but the new questions for 2011 are how much impact Basel III will have on the appetite of banks to lend to property and, when they do, how expensive this debt will be.

Respondents expressed serious concerns about areas outside prime regions, even within the same country. With capital so risk-averse, winning cities like Munich, London and Paris will continue to absorb investment as the only places where tenant demand will be robust. Other investor favourites are likely to be Istanbul, Stockholm, Berlin and Hamburg. Investors are expected to avoid Dublin, Athens, Lisbon and Budapest.

Even within the most favoured markets, investment will be drawn mainly to the prime buildings, the report predicts. The result is that values for secondary properties will remain at distressed levels and decline further in the months ahead.

The good news, the report says, is that improvements in the availability of real estate equity are anticipated this year. This is expected to come from an increasing number of investors from Asia Pacific and institutions such as insurance companies and private equity funds. But the consensus view is that even if new players do emerge, they will take a long while to do so and will only partially relieve congestion.

John Forbes said:

As is the case with so many positive trends today, they do not constitute unqualified good news. Equity, which is now choosier and more risk averse, will be funnelled towards a smaller slice of the industry, ensuring that the capital-raising environment is set to be tough for a good while yet.

While all property sectors show improved investment prospects in the quantitative part of the survey, central city offices, street retail and shopping centres were most frequently cited as offering the most promising prospects.

Interviewees anticipate that well-established firms with defensive strategies will fare best in the months ahead, while prospects are less bright for niche or new players. As firms prioritise resources in 2011, there will be those in the industry who find their skills in demand. The expected downsizing will reflect the dropping out of those who find themselves totally unequipped for the new climate.