By Tom Leahy on June 5th, 2018
As we move into the later stages of the cycle in Europe, investors have to work harder to achieve required returns. The temptation is to move into smaller markets where they can achieve higher initial yields. However, there is a price to pay in the form of lower liquidity. Has the temptation lured investors so far?
Analysis of the RCA Capital Liquidity Scores and average transaction yields shows a clear relationship between the two metrics. To access stock in Europe’s most liquid markets – London, Paris, German A Cities and Tier 1 cities such as Madrid, Amsterdam and Stockholm – investors must pay a premium.
Data for 2017 shows that for every extra point of liquidity, investors can, on average, expect to take off 5 bps from their initial yield. Conversely, investors are rewarded with higher yields for taking on the risk of investing in less liquid markets. The question here is one of judgement: is the extra risk worth the extra yield?
So far, so good. The really striking finding, however, is that this relationship has changed. In comparison with 2014, investors are paying a higher liquidity premium. Clearly, in the later stages of the cycle, when liquidity becomes more of a concern, investors will pay more for it.
The higher premium also demonstrates some of the reluctance that many players have felt in moving beyond a small pool of more liquid markets. By concentrating on these markets they drive down yields and accept the trade-off of lower returns for the security blanket of greater liquidity.
European deal activity has gotten off to a slow start in 2018 as investors take stock of the market and work hard to find the right assets at a price they are willing to pay. It is unlikely that the pressure on pricing in the top markets will let up in the short term. And, with pressure to deploy capital and achieve target IRRs, we may see investors look at these less liquid markets in greater number, sacrificing some of that security to boost returns. As yet, we have not seen buyers invest in these markets in sufficient number to push down yields to the same extent that they have in liquid markets.
The latest RCA Capital Liquidity Scores report was released in April 2018. If you are an RCA client you can access the report and data file on the RCA website. To receive information about becoming an RCA client, please contact us.