Nobody can predict when the market will bottom, but Adam Alari and Jon Crossfield of Savills IM regard a correction as an opportunity to deploy capital, perhaps targeting assets that have been overpriced in the recent cycle.
By Adam Alari, head of living research & strategy, Europe, and Jon Crossfield, head of strategic partnerships and living
'The Living sector has provided stable yields and substantial capital growth for much of the past decade, fuelled by low interest rates, extreme demand/supply imbalances and increased private and institutional investment. As a result, European net initial yields have fallen sharply. But rising inflation and interest rates have brought this cycle to an abrupt end.
The gap between buyers’ offers and vendors asking prices is increasing, as buyers push for discounts to reflect the rising cost of their capital. The short-term outlook is therefore uncertain - capital values are falling and, as sentiment deteriorates, finance will remain scarce. An over-reaction by lenders to tighten criteria further could exclude many buyers from the market and exacerbate downwards re-pricing.
Multifamily is primarily a proposition for those in search of a stable yield, which has historically been the case (see yield chart below), but capital values in the multifamily space will inevitably be brought down, to some degree, by any widespread correction in the broader market. Looking at the spreads in the chart below, while we believe residential spreads will rise further, we do not believe they will widen to same extent as the logistics space, and are likely to be more resilient than the technologically-challenged office and retail sectors.
Difficult as the short-term environment will be for existing investors, it will provide a more attractive entry point for new investors, or those with a robust enough constitution to invest further, expanding their portfolios at lower prices and consequently higher yields. Equity buyers will also be at a substantial advantage as credit available for institutions may well also tighten until the outlook becomes more certain.
Nobody can predict when the market will bottom, but we remain bullish over the medium and certainly, longer-term view, and will regard a correction as an opportunity to deploy capital on a selective basis, targeting assets that have perhaps been overpriced in the recent cycle.
Importantly, the Living sector’s appealing fundamentals that we have highlighted before remain intact. In fact, they are arguably strengthening and, relatively, they are typically stronger than most commercial markets. Living assets produce higher risk-adjusted returns and are thus compelling for portfolio diversification.
Indeed, we also recognise that the depth of investor activity and experience in Living varies widely across countries and segments; some markets highly developed domestically (Germany, Netherlands, UK PBSA) and some more nascent (UK Multifamily, Spain, Italy) but few investors have diversified across the region as is common in commercial real estate.
The fundamentals for the Living sector:
· Putting a roof over one’s head is a necessity, this is not going to be dislocated by technological advances that adjust the way we buy goods, work in offices and so on, and the need for housing won’t adjust simply because the economies weaken. Yes, affordability might be challenged, but the need will not be.
· The current housing shortages show few signs of being addressed satisfactorily. Indeed construction levels are more likely to fall in the short term.
· We increasingly recognise that the quality of Europe’s housing stock is inadequate. It is typically quite old, not energy efficient, of the wrong size, and all of this is most acute in the cities where people most want to live.
· Demographic changes such as longer life spans and later family formation also exaggerate the need for smaller housing units, and this stretches the imbalances further.
· At the same, time prospective owner occupiers are constrained by their access to, and cost of, finance.
This all means that the tension for growth of Europe’s rents is of course, high. That’s potentially great for investors, but we must consider the impact on our communities. Quite obviously, affordability will be key and there is a clear risk to address, that being the rise and implications of various rent regulations.
We can only conclude that while the sector fundamentals are extremely robust, from a tactical point of view, the sector that is most compelling is affordable housing. With that in mind, the near-term pricing adjustment appears to be a timely opportunity to build up exposure.'
