FUNDAMENTALS REMAIN STRONG IN BOTH PUBLIC AND PRIVATE EQUITY MARKETS
PRIVATE EQUITY
Despite a slowdown in EMEA commercial real estate transaction volume in Q2 2020, the private equity market remained robust, with ample dry powder. Preqin data show that fund raising targeting EU real estate investment neared €17 billion in H1 2020, on par with 2019’s annual total of €34.5 billion. The period from March-May 2020 saw significant flight to value-add and opportunistic funds, resulting in a 27% y-o-y increase in aggregate funds raised. Activity was led by Blackstone’s closing of its sixth European Opportunistic fund, with an eventual US$9.8 billion in potential capital allocation.
Although the volume of funds raised would have been less impressive had this particular close not been reached, such activity by large institutional investors is now the market norm, and remains the optimal route for individuals seeking exposure to commercial real estate, especially during periods of economic uncertainty. In the medium-term, CBRE expects to see the continued raising of funds, led by a few large market players and characterised by heavier portfolio allotment to value-add and opportunistic strategies.
PUBLIC EQUITY
The public equity real estate market closely paralleled wider global benchmarks, registering massive corrections heading into Q2 2020. The subsequent recovery across major global stock indices has yet to be fully observed in the publicly traded real estate market. EPRA indices revealed gains of around 5.5% during Q2 2020 and slight losses so far in Q3 2020, trailing behind the 17.7% climb in the DJI average.
CBRE therefore has a nuanced outlook for publicly traded real estate. On the one hand, as REITS have lagged major global indices, investors may flock to open ended funds as they seek opportunities during the economic downturn. On the other hand, calls for
redemptions may force funds to sell at a discount.
Intensification of NAV discounts for European REITS, the six largest of which had already been trading at a discount of -22% going into Q2 2020, could have implications for distressed selling. In the short- to medium-term, value in public equity markets will be impacted by future developments related to the pandemic, such as the likelihood of a second wave or the successful development of a vaccine.
FIGURE 7: FUNDS RAISED BY EUROPEAN FOCUSED FUNDS, Q2 2020
Source: Pregin.
FIGURE 8: REAL ESTATE VERSUS WIDER EQUITY MARKET PERFORMANCE, H1 2020
Source: EPR, Macrobond.
RETAIL AND HOTEL YIELDS MOST AFFECTED
YIELD OUTLOOK
The pandemic continued to weigh on European commercial real estate yields in Q2 2020.
The retail and hotel sectors have been the most affected, with yields for prime shopping centres and hotels (leased) softening in the region of 25 – 75 bps across several locations since Q4 2019. In certain categories, such as secondary retail in the U.K., the variation has been much more pronounced. In the office sector, prime yields, which were compressing in the quarters leading up to the onset of the pandemic, have slightly altered course, either by remaining stable or marginally softening.
Multifamily and logistics yields have been stable and are well positioned to recover. CBRE expects investor appetite for commercial real estate to strengthen in the coming quarters as investors are lured by the spread on the risk-free rate and low long-term interest rates. Yields for most sectors, aside from retail, specifically shopping centres and high streets, will harden. This could happen as early as H2 2020 for logistics, core offices and multifamily. Hospitality will likely take longer to recover due to the profound impact of the pandemic on business travel and tourism.
FIGURE 9: PRIME YIELDS SECTOR COMPARISON
Source: CBRE Research, 2020.
EUROPEAN COMMERCIAL REAL ESTATE INVESTMENT VOLUME LIKELY TO APPROACH PRE-PANDEMIC LEVELS BY 2022
INVESTMENT OUTLOOK
Following the best first quarter on record in terms of investment volume, activity in Q2 2020 was significantly reduced by the pandemic. CBRE transaction data indicates a –39% y-o-y drop in European investment volume over the quarter. However, this figure nevertheless exceeded CBRE’s initial estimates of a two-thirds drop, thanks to deal activity picking up in June.
Countries that emerged relatively quickly from lockdowns, including Austria, Germany, and the Netherlands, outperformed other markets in terms of investment volume, and are poised to lead the recovery. However, most deals sized over EUR100 million completed in Q2 2020 were initiated well before the onset of the pandemic, and the weak pipeline may drag on investment volume in the coming quarter. Other concerns include a slowdown in foreign capital inflows into Europe, particularly those from Asia, which typically represent 5% of aggregate investment.
CBRE expects aggregate European commercial real estate investment to fall by between 30-40% y-o-y in 2020. Provided occupier markets do not worsen further, investment activity will return to pre-pandemic levels by 2022.
FIGURE 10: GLOBAL INVESTMENT VOLUME FORECAST
INVESTORS FOCUS ON VALUE-ADD AND ALTERNATIVE STRATEGIES
VALUATION OUTLOOKDownward pressure on rental income is expected to weigh on capital values in the short- to medium-term. Cap rates should therefore expand over the same timeframe, a trend that to some extent is already supported by market evidence. Repricing of around - 25% has been observed in value-add secondary office locations as well as value-add investments in traditional sectors. However, cap rates in core markets, especially those for logistics and office assets, have generally remained stable.
While an abundance of capital is ready to be deployed through private equity channels, transactions in the near term are contingent upon repricing. The pause in private debt markets in Q2 2020 has led to an increased cost of borrowing, estimated at around 50 bps in Europe. This development, coupled with lenders implementing lower LTVs, will continue to affect underwriting in the short- to medium-term – a trend that will benefit equity firms and investors. Repricing across the retail, hotel and selected alternative sectors, as well as value-add strategies across traditional sectors, may intensify in the short-term.
INVESTMENT STRATEGY OUTLOOK
Rapid ecommerce growth and a drive to shore up domestic supply chains will provide a solid foundation for logistics markets. Multifamily investment, also defensive in nature, offers reliable income streams and stable capital values. Those seeking exposure to this sector, which many currently consider to be trading at a premium, may wish to pursue opportunities in specialised sub-sectors, such as student housing. Therefore, investment in REITs, particularly those with selective alternative investments, may have strong growth potential, especially considering their attractive discounts.
Positive sentiment in continental European occupier markets, reflected by the gradual return of office-based employees to their workplaces and increased footfall in retail, is also likely to support core investment in the coming quarters. Investors seeking higher yields and possessing a greater risk appetite may wish to consider heavier portfolio allocation to alternatives, core retail and value-add strategies in traditional sectors, all of which are in the midst of repricing.
FIGURE 11: EMEA CAP RATE SURVEY – Q1: 'What was the change in asking prices / asset valuation this month compared to that immediately prior to the COVID-19 outbreak?'
Source: CBRE Research 2020. Survey sent to CBRE EMEA Capital Market Professionals.
Key Takeaways
-
While investment volumes dipped by 39% in Q2 2020, there remains ample unallocated capital and pent up demand for European prime property.
-
Public real estate markets will remain volatile in the short-term but may ultimately make up ground with global stock indices. Given current levels of market liquidity, the future course of the pandemic will be a major factor in returns.
-
Yields and pricing for core logistics and office assets should remain stable in the near term.
-
Although contingent on repricing, investors are displaying renewed appetite for value-add and core plus investments.
-
Other opportunities include multifamily, logistics and selective investment in REITS with exposure to alternatives.