After five consecutive years of transaction volume growth to a historic high of €11 billion in 2017, the country experienced a downward trend last year. This drop coincided with an unstable political environment and negative economic sentiment.
Italy’s Lega and Five Star Movement coalition government — the first populist administration to have gained power in a Western nation in the twenty-first century — has clashed with the EU over its plans to reduce public spending and debt prompting.
What’s more, confidence and new export orders fell in 2018. The trade war between the US and China acted as a trigger to pull Italy back into recession as Italian exports are sensitive to fluctuations in the world economy.
Nevertheless, Italy remains an attractive market for solid income investment in good quality real estate. Granted, it is not a growth market (and will not be one until reforms take place), but it has is a large economy, boasts a large consumer market, and has one of highest level of household net worth in Europe, according to the OECD. Further, it is also still recovering after the property slump caused by the financial and economic crisis. This means that investors can buy real estate in good locations — at favourable prices — compared with the rest of Europe.
Offices, particularly in Milan and Rome, offer good opportunities as supply is dwindling. Yields for office property in Milan at the end of 2018 were 3.4% in the city centre with a vacancy rate of between 2.8% and 4.4%. In Rome, the yield in comparably attractive locations was higher at 4.0% with a vacancy rate of 3.4 - 5.4%. But, of all Italy’s real estate sectors, it is logistics that stands out.
E-commerce logistics is developing
Having been a late adopter of e-commerce, only 3.4% of retail sales take place over the internet in the country, according to the Centre of Retail Research. It is not surprising, therefore, that Amazon has selected Italy as one of its principal expansion markets in Western Europe. The tech giant has taken up some 300,000 square metres of logistics space in the last 18 months.
Italy’s main distribution hubs lie around the Lombardy and Emilia Romagna regions. A warehouse in Milan can reach some 35 million people within a three- hour drive going west towards Turin, east towards Venice, and south towards Florence. At present, the general quality of existing stock is appallingly bad, making good quality logistics facilities relatively easy to let. Furthermore, land prices and construction costs are high — making it uneconomical to build speculatively. A good quality warehouse in Lombardy, for example, is therefore a solid asset.
To give some idea of returns, prime logistics net unlevered yields in Milan are about 5.5%, according to PMA, which is almost 150 basis points above the yields found in Munich or Frankfurt, for example. What’s more, Italy has local capital, which ensures liquidity. Over the last five years, annual transaction volumes of approximately €4 billion have come from domestic investors. Italian prime logistics, so long as assets are well located, of good quality and with modern specs, can represent good value for money, even in the current economic climate, making it a definite ‘hold’ in our house view.
Opportunities in value-add
Italy is also beginning to offer reasons to explore value-add and opportunistic strategies. Its vastly different real estate sectors have one common denominator — a scarcity of attractive assets. This lack of supply partly explains the recent significant drop in transaction volume and, as most investors remain concentrated in prime locations, has resulted in rising prices. This, in turn, has led to yields trending downward across Italy.
"Italy remains an attractive market for solid income investment in good quality real estate."
Given the scarcity of new assets in core segments, many investors who want to expand their exposure to the Italian market no longer focus exclusively on prime real estate but are increasingly considering value-add or opportunistic investments. In Rome, for example, the conversion of former offices into apartments and hotels has garnered significant interest. However, since the process of obtaining a building permit in Italy is complex and can take up to five years, especially for projects involving historic buildings in city centres, it is more advisable to engage in ongoing developments for which a permit has already been granted.
Nonperforming loans (NPLs) are also going to boost value-add and opportunistic deals in Italy. More than 30% of the NPLs recently acquired by specialised investors are secured by real estate, and more than 56% of those represent over €1 million worth of assets. Consequently, there will be an important stock of repossessed real estate assets that these investors will try to sell in the near future. Some of these will represent good locations where buildings could be refurbished or converted to create value.
And given the amount of capital in play — €130 billion worth of NPLs are still owned by the banks, with €70 billion already sold in the last two years — the effect on value-add and opportunistic deals could be hard to ignore.