There is resemblance of calm after the storm for the European economy and real estate markets.
Following significant repricing in 2022, we expect a smaller scale adjustment in yields this year. Moreover, the relative position of the different sectors remains in flux.
In recent months, we have seen significant improvement in major economic indicators around the world. The prevailing view is that the global economy may get away with a shallower and shorter period of economic contraction than had been expected six months ago, with most economies avoiding a recession altogether. Additionally, consumer and business confidence indices are edging back up in most European countries. One reason is that inflation in most economies appears to have peaked, thanks to reduced volatility in the energy market. This paves the way for monetary authorities to contemplate both what the terminal policy rate may look like and when that might be achieved. In our view, there is little justification for further significant rate rises before assessing the cumulative impact on the economy of the successive hikes already made.
The more interesting question is whether rates will return to their past lows and when might central banks start to cut them again. Answers to these questions will have significant implications for future performance of the real estate sector. The investment market has gone through a major adjustment over the past six months as policy rates tightened rapidly. Property yields have risen significantly across all sectors on the back of the increased cost of debt. Although most of the expected adjustments have already occurred, we think some further repricing is likely in 2023, however it is likely to vary between sectors. For investors, the race has been on to meet interest cover ratios rather than to protect return levels. As such, sectors that are able to generate higher levels of income, particularly via rental value growth, are likely to be better protected from further yield adjustments. These include logistics, where vacancy remains generally low; prime offices, driven by Environment, Social and Governance (ESG) requirements; and the alternative sector, particularly residential, where affordability issues and inflation are driving up rents.
This report looks in more detail at how these issues will affect the performance of European real estate over the next five years. In general, the Logistics and Shopping Centre sectors will provide the best annualised return over the next five years (respectively 6.9% and 6.7% estimated), albeit for very different reasons. In the case of logistics, this will be driven largely by rental growth amid limited yield decompression. Most of the yield increases occurred in 2022. Shopping centre yields have expanded considerably, making income return relatively high, even though rental growth is limited or even negative in some instances. For offices, the great divide between demand for prime and secondary assets will intensify as regulation begins to weigh on unsustainable buildings. In all, property is undergoing a short-term adjustment that does not alter the long-term relative position of the asset class in a broader investment strategy. However, the desirability of the different sectors remains in flux.
Download the full report below to find out more.
