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LONDON-Scottish Widows Investment Partnership is betting the European market to outperform the UK over the next five years. The pension fund researched the European commercial property market and concluded that it is likely to produce average total returns in excess of 8%, compared with forecast returns of around 7% from the UK commercial property market.

SWIP expects the warehousing sector to provide the strongest performance over the next five years–with annual returns topping 10%–followed by retail and then the office sector, although the gap between retail and office returns is narrowing. This is in contrast to the UK market, where office property is expected to lead the market over the next five years.

Over the short-term, Central Europe, Spain, the Nordic markets and France are forecast to see the fastest rental growth. The Central European warehousing market saw particularly strong demand last year with take-up in some markets up by almost 50% from 2004 to 2005.Total returns for the retail sector are forecast to moderate at around 6% to 10% a year in Western Europe and from 10% to 14% a year in Central Europe. Consumer confidence has improved since the end of 2005 and is now stronger than last year and above the long-term average. Investor demand for retail real estate also remains very strong, and a significant inward yield shift over the past year continues to drive capital value growth.

High returns in the office sector are unlikely to be reciprocated in the medium term since most European office markets have already witnessed significant yield compression. However, moderate rental growth and stable yield profiles should result in healthy returns in most office markets. SWIP expects total returns in the European office sector to be around 8% to 10% a year between 2006 and 2010, as rental growth replaces yield compression as the principal driver of returns. Among the major markets, Hamburg, Helsinki, Dusseldorf, and Munich are expected to show strong returns.

“Over the medium term, we expect returns in the European market to be driven by rental growth,” says Ian Hally, head of property research at SWIP. “Improved transparency and the harmonizing of legal and reporting regimes across Europe have improved the accessibility of the real estate market. As a result, investors are looking increasingly at Europe as a single real estate market with convergent return prospects.”

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