After nearly ten years of high premiums on real estate yields compared with government bonds, the return of inflation and rises in interest rates have caused spreads to contract sharply in the last three years. With borrowing costs skyrocketing, credit requirements have tightened, leading to a drop in transaction volumes since 2022. As liquidity is unlikely to recover to the levels seen in the past six years, investors in the sector will be looking at longer holding periods and could turn to private lenders to increase their risk-adjusted returns.
Some longer-term trends have been at work too, affecting the different segments of the real estate market differently. These include falling margins in e-commerce, an increase in remote working, a changing tourism landscape, and the expansion of the digital data-driven economy.
Having dominated the market for decades, office space is expected to give up some of its market share to other segments of the real estate market:
- Despite some pressure from e-commerce and the effects of credit tightening, retail has shown unexpected resilience, especially in luxury. The omnichannel model has emerged as more successful than pure online, and demand for retail parks and grocery stores remains robust.
- While housing (residential) faces difficulties due to the surge in mortgage rates and refinancing costs, as well as stricter regulations on energy ratings, the need for renovations and the secular undersupply should open up value-add opportunities for investors with capital to spend.
- Hospitality has picked up vigorously since travel restrictions were lifted. Also, a large proportion of hotels in Europe are unbranded and operated by independent owners, many of which are short of capital to cover expenditures. This creates opportunities for value-add investors.
- As enrolments in Europe’s universities increase, the student accommodation market is being fuelled by increasing rents, low vacancy rates, acute undersupply and demand for higher-quality, institutionally managed residences.
- The boom in e-commerce in the past decade, with record volumes during the pandemic, has benefited the real estate logistics segment. With occupiers of warehouses and the like concerned about lack of supply, investors are looking at strong rental growth prospects.
- Data centres are supported by multiple growth drivers in 5G, artificial intelligence, the Internet of Tings, gaming and e-commerce. With a 32% capacity increase and hyperscale developments in the pipeline, exposure to this segment in investors’ portfolios is bound to increase in the coming years.
Despite current disruptions across many sectors, the outlook for real estate is firm. An actively managed real estate allocation has an important role to play in investors’ portfolios, no longer as an alternative to fixed income, but as a source of value creation until the market reaches a new equilibrium.
Pierre Escande
Geoffroy Troesch