There was a definite air of positivity in European real estate markets in January and February 2022.
COVID restrictions had largely been lifted across Europe and the investment
community was optimistic about the strength of the real estate market –
fundamentals were solid, the occupational market was robust and there was a
realistic level of achievable returns. And then late February arrived along with the
invasion of Ukraine which, not in isolation, but led to the remainder of the year
fraught with uncertainty.
And so, 2023 will be a year with a lingering layer of uncertainty attached to
it. Investors are increasingly risk averse even though parts of the real estate
market continue to support both income and growth, underpinned by robust
structural drivers such as the continue march of online consumption and the
lack of supply of quality housing at rent levels that are affordable. Preserving
value will be at the epicentre and the forefront of investor intentions.
With energy costs having soared across Europe since March 2022
and interest rates following suit, this has refocused minds at
several levels, where preserving and creating value for the future
have really risen to the fore. Along with this, despite the fragility
of some economies in Europe and the wait-and-see approach
adopted by a number of real estate investors, there will also be
opportunities. In times of more restrained capital growth, with
income becoming a greater proportion of overall returns for the next
few years a yield advantage strategy, combined with a top-down
strategic approach, could lead to additional outperformance.
It is worth remembering for those with a vested interest in real
estate that they need to try and look through the short-term haze
and deploy strategies that answer to longer-term trends such as
hybrid working and the continued shift of some consumption to
online or the lack of the right sort of housing in the right areas.
There is perhaps a misguided expectation that we are heading
toward some ‘fixed state’. But real estate markets are always
moving, and trends will continue to evolve and impact real estate,
and the solutions the sector can deliver. It is often the years after a
recession or significant upheaval that the real estate sector delivers
and has the potential to offer the best vintage of investments.
Performance will vary, quality is key
As the price correction, that is already underway, continues to unfold
there will be varied performance across portfolios which will largely
depend on the quality of assets and the breadth of sectors those
assets are in. As more and more occupiers look to secure space
that provides them with higher levels of efficiency not solely in a bid
to reduce costs, but also to attract and retain talent that are aligned
to greener credentials. And this will increasingly come at the cost
of brown discounts needed for older stock as green premiums
for new stock is seen more and more as the norm and over time
will not attract a premium but rather be expected – the balance of
power continues to shift to occupiers. The resilience seen within
the occupational sector over the last 12 months will lead to longer
term capital preservation for landlords as they look to secure good
quality space and it seems willing and able to pay for it.
Opportunities exist not only in retrofitting older stock if the balance
between cost of doing so and potential income streams can be
made to stack up given the inflated cost of materials and labour at
the moment, but also in identifying overlooked areas with growth
potential. Quality, be it immediately acquired in standing stock or
realised through refurbishment and repositioning is the way forward,
regenerating and/or strengthening city centres and urban areas.
Location
But location is important too, more so now than ever before. But
what defines a ‘good’ location will vary depending on the sector.
Offices for example, continue to go through the impact of the
structural shift to hybrid working. Whilst the story has not yet ended
and corporates continue to assess and test what strategy is best for
them in a one-size-does-not-fit all world, what is increasingly obvious
is that well-located offices that are accessible from a transport
perspective, play a role in their communities with amenities in
close proximity will be the ones that succeed and this will be at the
expense of lower quality stock and lesser appealing locations.
Well-located leans to the urban centres and not just for offices.
Urban centres are the hub of infrastructure such as schools and
hospitals, roads and public transport networks, all of which have
a role to play in a community and thus continue to be a draw for
people, all of whom need somewhere to live. And this plays into
the hands of the transition of the living sector from an alternative
real estate class to a mainstream one. The sector has proven to
be more resilient over the last 12 to 24 months. Housing is in high
demand countered by low levels of supply and even lower levels of
quality supply. Investors are prime placed to help bridge the supply
gap while creating a positive social impact at the same time and
capture both income and growth.
As the E in Environmental, Social, and Governance (ESG) becomes
more a given than a nice-to-have, and is regularly embedded into
the capex programme, attention is, and will, continue to be given
to the social component of the equation, a large impact of which
can be achieved through placemaking and delivering well thoughtout mixed-use developments. For example, if proposed regulation
in terms of Energy Performance Certificate (EPC) ratings comes to
fruition, there will be large swathes of residential stock that does
not qualify to be let and is often in the hands of private landlords.
This leaves opportunity in the market for investors to step in and
not only upgrade parts of this stock though decarbonisation and
digitisation but use the opportunity to create and influence the
development of communities by not replacing a like for like, but
instead perhaps replacing with a mixed-use development helping
to create healthy, sustainable communities with a breadth of
employment and growth potential.
So, in 2023 whilst we don’t have all the answers, the direction of
travel is clearer.
