Embracing Change
2023 has been an “annus horribilis” for commercial real estate. In fact, the numbers for investment activity across Europe are indeed sobering; activity fell by 51% on average across the market. reaching €133bn, the lowest since 2010. Property values fell by 30% on average across Europe as the cost of debt rose sharply and demand for occupational space fell meaningfully, particularly in the office sector. These challenges may seem daunting but look deeper and there are pockets of opportunities now emerging for investors.
Offices: Turning Point
The uncertainty in the real estate market is most acute in this segment, which is going through profound changes on multiple fronts: price adjustment after the sharpest increase in debt cost in decades; working patterns that continue to
suggest reduced demand for space; and a regulatory framework that will increase obsolescence. These issues continue to weigh on the performance of the sector. But we believe there is light at the end of the tunnel now and most upheavals is now priced into
the sector. Nonetheless, increasingly investors are growing averse to offices and are therefore reducing their exposures. Going forward, this means we are likely to see a reduced share of offices in the overall investable commercial real estate universe.
Logistics: Inflexion point
Over the past few years, factors such as online spending and supply chain disruptions have boosted demand for logistic space across Europe. In 2023, growth in demand slowed in response to a more challenging global economy. However, rental growth
sustained as high-quality, energy efficient buildings were in short supply due to scarce land and low development finance. These rent hikes have been substantial in some markets and are affecting tenants unevenly. Going forward investors will have to reflect in their appraisals the possibility, at lease events, that tenants may seek a more affordable space and thereby creating a risk of void, even if
temporarily.
Retail: Renaissance
The retail sector has seen one of the most prolonged declines on record, driven by profound structural changes in shopping habits. The share of retail in European investment activity has fallen meaningfully over the years and consequently
pricing has adjusted significantly. The effect has been uneven in this broad sector. We think the down cycle may have reached the bottom as evidenced by the limited effect of the current interest rate cycle on pricing. Moreover, we are seeing pockets of
rental growth again, which could be consistent with a recovery for the sector. This leads us to wonder whether the sector is now worth an opportunistic play in a broader real estate portfolio.
Residential: Catch me if you can
This is a sector where movements in interest rates present a double edge sword. On the one hand, increasing debt costs make purchasing a home more difficult. As such, transaction volumes have fallen significantly on the back of the sharp rise in financing
rates. The flipside to this is increased demand for rental. This is one reason for growing institutional interest in residential allocations; demand for rental properties is increasing significantly across Europe. However, the rental segment faces two key
challenges that investors need to consider; both are in the regulatory space. Increased regulation on both rental controls and ESG requirements will heighten the operational risk that investors will need to factor into their expected return.
