It May Seem Bad, But Fund Manager Says UK Is Most Attractive Market In Europe
The UK is the European real estate market that should be most appealing to investors next year, a new forecast from a major global fund manager predicts.
AEW analysed the expected risk-adjusted returns on 168 European submarkets, finding the UK had 32 that remained either attractive or neutral. It said the UK looked more attractive for two reasons: Interest rates rose more quickly than in continental Europe, meaning pain for investors had arrived earlier and would be over sooner, and because Brexit meant yields had not dropped as far.
That doesn't mean real estate investment is now generally attractive on a risk-adjusted basis, however, AEW said, pointing to rising interest rates and yields that have not kept pace.
Five segments remain in the attractive category on a relative value analysis, according to the analysis: Paris light industrial, Berlin and Zurich logistics, and Stockholm and London shopping centres.
AEW’s new base-case scenario assumes the market is past the peak of inflation across the 20 countries covered. Inflation is expected to come back down to below the 2% target adopted by central banks by early 2024 after they hiked rates and initiated monetary tightening, according to Oxford Economics.
Despite low unemployment and a successfully managed rebound from pandemic lockdowns, AEW’s base-case scenario assumes higher bond yields as well as a short and shallow recession in Q4 2022 and most of 2023. Reflecting the heightened uncertainty, AEW’s downside scenario assumes a longer recession and higher or longer bond yields.
It expects 2022 full-year volumes in the European real estate market to land at €260B, with €218B invested in the first three quarters. That is a 38% drop on the 2021 record of €350B and reflects the effects on leveraged investors from the doubling in borrowing costs over the last 10 months.
A debt funding gap of €24B is estimated for the next three years in the UK, France and Germany, with refinancings of maturing loans expected to face issues from the decline in capital values and lenders’ reduced risk appetites leading to lower LTVs.
As in the post-Great Financial Crisis era, this presents an opportunity for equity and debt investors with capital to deploy, AEW said.
Projected returns for all property across Europe during 2023-27 remain positive, although yield widening has pushed forecast returns to 4% annually across all segments, down from 4.7% half year ago. This is mostly caused by higher government bond yields pushing up property yields and limiting capital value growth.
Logistics is expected to generate the highest returns of any sector over the next five years at 5.4% per annum as solid rental growth offsets yield widening.
Prime shopping centres are in second place with estimated returns of 5.1% per annum on the back of high current yields. Shopping centres are expected to be the top income-producing sector over the next five years, with base-case income return projections remaining relatively stable.
Negative capital returns are expected for the next three years across all sectors, with a cumulative capital value decline of -12% in the base-case scenario. That's less dramatic than the GFC, which saw a -20% cumulative loss during 2008-09.
Residential and logistics are the most resilient sectors for rental growth, per the analysis. The higher cost of debt financing and construction, as well as ESG regulations across all asset classes could further limit supply, protecting most from recessionary impacts that would bring demand for space down.
Only 8% more employees are working from home than before the pandemic, with the impact of work-from-home on office demand less significant than previously expected. Adjusted office employment growth for 2022-26 shows the strongest improvements in London, Amsterdam and The Hague over AEW’s previous forecasts.
