The yearly ULI PwC Emerging Trends in Real Estate Europe report is published today (Thursday) in what amounts to a hard-hitting state-of-the market review that in some places makes for grim reading on the investment front at least.
Nearly three quarters of survey respondents believe Europe will move into recession before 2023.
One Irish property leader went as far as to tell the report authors, ‘Europe is in for a very grim winter.’
Now in its 20th year, the report contains a look back at key trends in the European real estate plus ESG focus pieces, but with interest rates putting pressure on existing borrowers, rampant inflation, politcal issues, and a cost of living crisis to name just four things, it is what happens next that is uppermost in people’s minds.
‘There will be a change in valuations driven by higher interest rates and a change in relative pricing between prime and secondary real estate,’ suggested a head of investment strategy of a pan-European investor.
The report authors say the listed sector is already bearing the brunt as discounts to net asset value (NAV) continue to deepen, with a number of firms exploring the take private route.
Lisette van Doorn, ULI Europe CEO, says the market has shifted rapidly over the last few months with the outlook becoming more negative.
‘Since we conducted the survey and interviews over the summer, which already showed highlighted deep concerns, the industry has become even more worried.’
‘But there is still a lot of capital available to invest and mostly not in a hurry, waiting for the right opportunities to arise. For the industry to weather the storm, stock selection is key, in addition to a strong ESG focus, operational skillset and customer focus.’
In a sign of the times, new energy infrastructure tops the sector rankings in the report for the second successive year, partly reflecting historically high energy prices and the prospect of shortages over winter.
This sector covers a wide range of real assets, such as solar, wind, energy storage and electric transport infrastructure. Its top ranking is also part of a wider, longer-term trend in which investors rebalance holdings away from mainstream real estate towards alternative sectors that will benefit from the megatrends of demographics, climate change and technology.
However, generally speaking a fall in values is inevitable in European property, according to survey respondents.
Meanwhile, expectations around the availability of equity and debt has sunk to their lowest level since the global financial crisis of 2008.
In parallel, real estate business confidence and expectations of profitability have dropped to a low level, reflecting widespread industry concerns across an array of indicators for the business, political and real estate environments.
Findings in the report are based on the views of around 900 real estate leaders from across Europe. Some 91% are concerned about inflation, closely followed by interest rate movements (89%) and European economic growth (88%). Political uncertainty at the global, regional and national levels are of high concern as well.
In the longer term, the levels of concern drop. In five years’ time, only 13% see inflation being a problem, while interest rates (73%) and growth (76%) remain medium term concerns. But as of now, there are grave concerns about construction costs and availability of resources, with 92% concerned about costs and 84% harbouring fears about resources in 2023.
Germany, the UK and the Netherlands look unlikely to escape recession, while France seems more insulated, largely due to how it sources energy. Recession is likely before 2023 for 83% of respondents in Germany, 82% in the UK, 79% in the Netherlands and 68% in Spain. French (45%) respondents are more sanguine.
Confidence in the availability of debt and equity has not been this low since 2012 and 2009 respectively. Respondents believe capital coming into Europe from every part of the world is more likely to decrease than increase. Respondents are most negative about the prospects for debt (70% expect decrease) and equity (63% expect decrease) for development and debt for refinancing or new investment (64% expect decrease).
Interviewee responses point to values dropping in 2023. But this could present a great buying opportunity for core and all-equity investors that are still under-allocated to real estate.
There is much talk about distress or at least special situations in the market. But the ULI Europe PwC report says the consensus view is that distress is unlikely to reach anything like the proportions of the global financial crisis. That said, the rise in interest rates will nonetheless create stress, for example related to the need to repair banking covenant breaches if values decline, significantly higher refinancing costs and the potential requirement to sell assets in response to redemption requests for listed open-end funds.
The fact that distress is not quite as acute as during the global financial crisis might prompt banks to push for sales more quickly, encouraged by the Bank of England’s slotting regulation and Basel III European banking rules. Such sales could crystallise price falls.
From the development perspective, interviews indicate that projects slated for 2023 might be pushed back into 2024 or shelved entirely. This lack of new development is seen by some as a positive for existing assets and their owners.
The report also takes a look at the fortunes of Europe’s cities.
Gareth Lewis, director at PwC, said: ‘Though the same cities remain in the top three, the overall investment and development prospects for all 30 cities have declined. London is first for the second successive year, followed by Paris and then Berlin, swapping places from last year. Cities that have risen in the rankings most significantly this year are Madrid, Lisbon and Copenhagen.’
‘Various forms of housing dominate the top 10, varying from retirement/senior living to social and affordable housing. Interestingly, there is also more concern about housing, with the increasing political uncertainty around policy.’
