Real estate investors that recently moved up the risk curve to ‘chase yield’ could suffer disappointment as the fallout of the Coronavirus pandemic prompts repricing across the asset class.
According to INREV’s annual investment intentions survey, institutional investors on aggregate have been favouring value-add strategies over core strategies since 2016. However, core investments are expected to perform better under a transformed outlook for the global economy and real estate markets.
“I would expect that core strategies are likely to perform better at least for the next year or two years… than riskier strategies,” said Gunnar Herm, head of research and strategy for Europe at UBS Asset Management Real Estate & Private Markets.
This is particularly the case in continental European where the yield differential between core and non-core assets in some office markets has fallen to 10-20bps. “I would expect this is going to change,” Herm said. “With the uncertainties and, probably, an upcoming global recession, [we will] probably see more outward yield movement for riskier strategies”.
According to a research report published by UBS Asset Management this week, European the lack of supply in European office markets should support fundamentals and occupation levels should remain steady “unless there is a major downturn”. It said: “Very low vacancy and a limited pipeline (which may shrink further) will support rents even with weaker demand.”
Herm, one of the authors of the report, said: “Only if you have a really severe and long-lasting economic downturn, we would get a serious pressure on office markets. But today we are coming from vacancy rates in many markets of sub-4%; CBD locations are getting closer to between 1% and 2%.”
But rental growth forecasts need to be revised down, and this could affect pricing. “The pricing pre-Coronavirus reflected expected future rental growth, [which was] in some markets – in particular, continental Europe – quite decent rental growth,” he said. “We suspect that, with the lower rental growth expectations, investors are likely to ask for slightly higher yields more or less across all sectors.”
The retail sector, which has been weakening in recent years, is expected to be hit hardest. “With the more-or-less shutdown of the European economies, where retailers cannot open anymore, that will have a very immediate effect on the performance of retail assets – also considering that in many case retail leases are linked to turnover,” Herm said.
But while investors had previously tipped certain segments of the retail sector to perform well in the age of online commerce, the current crisis is likely to damage the performance of all assets.
“At least in the short term, probably more or less all retail is likely to suffer like all real estate, because of much lower liquidity in the market,” Herm said.
“Obviously, food-related should perform relatively well compared to others. But in previous economic crises there was always the view that luxury retail is likely to continue to perform well. With the global travel restrictions we are having at the moment, those locations are likely to be affected… in the past, the luxury retail has always been the exception.”