Despite the relative turmoil in liquid asset classes, occupational markets for European real estate remained relatively sanguine in 2Q22, says Zachary Gauge, head of real estate research at UBS Asset Management.
Office take-up continued to recover from the pandemic trough as occupiers switch to a hybrid working pattern, says Gauge. “To facilitate this change there is a clear preference for better quality space, with prime rents in all the main German markets, Italy and some of the regional Dutch and UK markets reporting positive growth in 2Q22. However, we continue to have significant concerns over the secondary market and peripheral assets.”
According to Gauge, the initial impact was felt in a number of high-profile deals falling through, as buyers’ and sellers’ expectations moved further apart. “Leveraged buyers generally adjusted the entry yield to make debt accretive, but without sell-side pressure many vendors have opted to hold out for improved market conditions. Quarterly investment volumes for Europe fell by 25% on the previous quarter. Evidence is still fairly thin on the ground, but there is an acceptance that a re-pricing is necessary, with some markets already reporting outward yield shift and more set to follow in the second half of 2022.”
Reversal in sentiment should lead to opportunities, says Gauge. “At the end of 1Q22, many real estate investors remained in a bullish mood despite the narrowing spread to bond yields and the economic headwinds stemming from the war in Ukraine. What has been quite surprising is the pace at which sentiment turned – almost in a matter of weeks early in June. A key driver of this has been the rapid increase in swap rates which had the direct impact of preventing leveraged buyers transacting for most core income producing assets.”
“Interestingly”, says Gauge, “it is some of the most popular sectors of the past few years that are seeing the quickest outward movements in pricing. Logistics is the clearest example, with prime yields in 2Q22 moving out across a wide number of European markets, despite being high up investors’ wish lists just a few months ago. Part of the reason behind this, is that the most popular sectors (generally the beds and sheds assets) saw the strongest yield compression. These exceptionally low yields are now fully exposed to rising debt costs and the narrowing spread between government bonds and income producing real estate.”
According to Gauge, the key question now is, at what point these sectors will become good value again. “The positive supply-demand dynamics which pushed so many investors towards these sectors are generally still in place. Using logistics again as an example, there were several markets that saw yields move out at the same time as reporting positive rental growth. This is not unheard of, but it is uncommon. And with supply-side levels remaining very favorable and development financing becoming increasingly hard to obtain at a level that stacks up, the rental growth outlook for existing stock remains pretty positive.”
Here you'll find the complete white paper from UBS Asset Management