After several prosperous years in real estate dictated by low interest rates and expansive monetary policy, last year turned out to be the abrupt end of it. Surging inflation in most European countries led Central Banks to quickly tighten financial conditions by increasing interest rates several times throughout the year. Consequently, European economic growth has slowed and is expected to weaken further. While most real estate occupier markets still show resilience with healthy demand and supply characteristics, higher interest rate levels have started to put upwards pressure on property yields and financing costs (Figure 1).
Relative attractiveness, which was key for the high influx of capital in the asset class, has melted away, at least in nominal terms.
Recent transaction market data shows, that net real estate yields have increased by 25 - 75 bps depending on region and sector. However, bifurcation between prime and all assets, including lower-quality properties, is becoming clearer while lower-quality assets are re-prized more extensively.
In Europe, the UK market is the one with the largest adjustment so far and is likely to peak first. However, most European markets will continue to see a correction in yields, and, consequently pricing, in 2023.
(Source: JLL, Green Street, CBRE)
At Club Estate, we believe that the correction in asset pricing has long been due. Even though the changing macro environment will be challenging to navigate, it will also offer attractive opportunities for capital-strong, flexible, and hands-on investors.
First of all, weaker real estate capital markets will unlock access to prime objects that have been hard to come by during the past years. Investors with capital to deploy will more likely be able to acquire high-quality assets in regions and sectors characterized by constrained supply and supporting structural trends. We anticipate attractive prime opportunities for example in London, UK. The turmoil in relation to pension funds in October, the rebalancing issues associated with it and the first indication of increased redemption in UK REITs suggest that UK intuitional investors will likely be forced to liquidate certain assets.
Secondly, the bifurcation of yields offers hands-on, value-add investors with extensive real estate expertise the opportunity to achieve attractive returns. Since low-quality assets have been re-priced more extensively than prime assets (i.e., due to transition risk), investors may acquire such assets at a relatively attractive price, refurbish or re-develop them to prime assets with a key focus on ESG performance and ultimately sell them at a prime yield premium.
Thirdly, in times of uncertainty, Switzerland offers an attractive investment case thanks to its overall stability. Furthermore, international investors from higher interest rate currencies can harvest additional yield by investing in lower interest rate currency and neutralizing FX risk. (More insights by our research partner Macro Real Estate AG: https://macrorealestate.com/2022/12/22/tricky-chf-appealing-swiss-cre-distribution-yields-from-fx-perspectives/?lang=en )
To sum up, the transition to a higher interest rate environment will continue in 2023. Despite all the challenges, we believe that attractive opportunities will present themselves along the way to the new “normal”. Investors that are having an anti-cyclical approach can benefit from attractive returns in the mid to long run.
Nicolas Voëlin on behalf of the entire Club Estate Team