Emerging Trends in Real Estate - Creating an impact Europe 2019
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Emerging Trends in Real Estate ® Creating an impact Europe 2019
Contents
30
Chapter 3
Markets to
watch
4
Chapter 1
Business
environment
2 18
Executive Chapter 2
summary Real estate
capital markets
Cover image: Royal Exchange building, City of London financial district, UK (Alexander Spatari)
2 Emerging Trends in Real Estate® Europe 2019
Emerging Trends in Real Estate®
Europe 2019
Creating an impact
A publication from PwC and
the Urban Land Institute
79
About the
survey
“Considering the environmental
impact of investments is absolutely
becoming important. The more
institutional the money, the greater
the pressure on these kinds of
issues. In five years’ time, the big
listed property companies will have
70 no non-environmentally labelled
real estate at all. Secondary real
Chapter 4 estate is going to have a much
Redefining more difficult time.”
value
Director, Scandinavian advisory firm
Emerging Trends in Real Estate® Europe 2019 1
Executive summary “Some investors are still looking at real estate in Europe as capital preservation. They are not looking for outsize returns, but security.” Director, pan-European investment bank 2 Emerging Trends in Real Estate® Europe 2019 Image: Warsaw, Poland (The World in HDR)
Executive summary
The search for secure, stable income in 2019 is paramount across Though there has been a lowering of
Europe’s real estate industry as it navigates the prevailing late- expectations around the availability of
equity and debt as the industry tries to
cycle market while embracing new ideas that seek to combine
assess the cycle, European real estate
long-term sustainability of financial performance with a greater remains highly liquid overall. More than
emphasis on its role in society. two thirds of survey respondents believe
investment from Asia will increase in
Though the industry remains positive 2019 – boosted by an expected influx
about business prospects the short-term of new capital from Japan.
outlook is more sober in most markets than
this time last year, if only because they However, with the price of core assets
are “one year further into the cycle and at record levels in many European cities,
one year closer to the end”. According to all investors face the challenge of how
Emerging Trends Europe, there is clearly to deploy capital effectively and achieve
a late-cycle edge to familiar concerns the “sustainable cash-flows” they cherish.
around historically high values and the Many are adopting “develop-to-core”
scarcity of suitable assets. strategies as a means of generating income,
while a growing proportion of the industry
“Environment and Interest rates have also moved on to the is looking beyond the cyclical mainstream.
industry watch-list following the European Alternative real estate and residential –
social values are definitely Central Bank’s decision to end quantitative in all its forms – dominate the sector
having an impact. In 50 easing by the end of 2018. The prospect preferences of survey respondents,
years’ time, it will be of modest rate rises is not considered a marking a remarkable shift in industry
threat to business in 2019 although real sentiment over the past few years.
inconceivable to not estate leaders acknowledge that might
have incorporated these change if there is a geopolitical shock In 2015, just 28 percent of survey
factors, because now to the monetary system. respondents said they would even consider
investing in alternatives. This year, almost
they are being measured.” Indeed, European and international political 60 percent of respondents are already
instability are among the key concerns for investing in alternatives in some way,
Director, pan-European investment manager
the industry, and in that context, Brexit and 66 percent wish to increase their
is uppermost in the minds of many as the holdings. Hotels, student housing and
due date of March 29, 2019 approaches flexible offices are the sectors where
without any clear idea of the outcome. current exposure is highest while student
Emerging Trends Europe reveals that housing tops the wish-list going forward.
global investors are less bothered by
Brexit than their European counterparts. Emerging Trends Europe reveals an
But the majority of interviewees and survey industry coming to terms with the
respondents nonetheless regard the operational risk of alternatives but
Eurozone as a safer investment destination also questioning traditional investment
than the UK in 2019. structures and looking at real estate in
a much broader context. Businesses
Given that the industry prizes the safety are taking a more “outcomes-focused”
of scale, liquidity and growing economies, approach to investment, breaking down
it is no surprise that German cities, the barriers between profit-driven
once again, dominate the top 10 picks decisions and environmental, social
for 2019 despite continuing high values. and governance issues.
Yet it is Lisbon that claims the Number 1
position for investment and development –
widely viewed as a strong, late-cycle play.
Emerging Trends in Real Estate® Europe 2019 3
Chapter 1 Business environment “The biggest challenge is finding quality assets. If anything, it’s getting harder as core assets, on the continent in particular, are tightly priced. The temptation to stray from quality assets in quality locations is there, but you have to stay disciplined.” Director, global investment manager 4 Emerging Trends in Real Estate® Europe 2019 Image: Vienna, Austria (nogreenabovetwothousand)
Chapter 1: Business environment
“We’re late cycle but that does not mean we’re at the precipice,” “As far as equity is concerned, there is
says a private equity investor. “It’s not late cycle 2007–08. We could still an over-allocation in global markets
to real estate. There is still a large amount
be at a plateau of valuations for quite some time.”
of that allocation coming to Europe,”
says the CEO of a pan-European
Europe’s real estate leaders remain consultancy.
optimistic about their business prospects
in 2019 albeit less confident than they The slightly more sober outlook for 2019
were a year ago as an air of late-cycle is symptomatic not so much of wavering
caution settles on the industry. confidence in the continental European
economy but of the unusually protracted
“There is still an over- Nearly half the property professionals property cycle and structural changes
surveyed by Emerging Trends Europe
allocation of equity in indicate that profits and headcounts will
discussed elsewhere in this report.
Some interviewees go as far to suggest
global markets to real be static, while the proportion of those the relative strength of the major European
estate. There is still a large thinking the business environment will economies – and with it, occupier demand
improve in the year ahead has gone down.
amount of that allocation – is prolonging the property cycle.
coming to Europe.” As has been the case over several years, Ten years on from the onset of the global
the primary concern for the industry is the financial crisis this late-cycle mood is
availability of suitable assets – cited by evident among all interviewees although
over two thirds of survey respondents some are more apprehensive than others.
this time – which serves only to underline
the enduring appeal of European real
estate on the global stage.
Figure 1-1 Business prospects in 2019
2019 25 62 13 %
Business confidence
2018 42 50 7 %
2019 37 48 15 %
Business profitability
2018 51 39 10 %
2019 45 46 9 %
Business headcount
2018 49 43 8 %
Increase Stay the same Decrease
Source: Emerging Trends Europe survey 2019
Emerging Trends in Real Estate® Europe 2019 5
“The pricing for every asset class is now
Figure 1-2 Issues impacting business in 2019
at historic high levels so we are outside
the comfort zone. It is not a very healthy
environment. We have decided to slow 21 47 15 15 3 %
down our investments and are selling Availability of suitable assets/land for acquisition and development
more,” says one German institutional
investor. “We are at 97.5 percent 20 41 20 17 3 %
occupancy, so there is not a lot we can do
Construction costs
to drive returns even in a robust economy.”
For most interviewees, however, the issues 12 40 25 18 4 %
related to availability and pricing are Cybersecurity
tempered by the belief that the industry
is in good health and financial discipline 10 43 19 25 3 %
is in place – at least, for 2019. “The market Interest rate movements
is tough,” says a global investor, “and that’s
largely because valuations are very high
7 34 27 23 9 %
right now in most places. The good thing is
Currency volatility
that the occupier market is fundamentally
still quite healthy, and that positive is
underpinning that strong valuation; 6 42 28 21 3 %
that’s the key.” European economic growth
Though some express unease at rising 5 41 23 28 3 %
loan-to-value ratios in a particularly
Global economic growth
highly-priced German market, there are
no undue fears over leverage across
Europe as a whole. 5 23 32 33 7 %
Inflation
“Real estate has grown as a proportion of
the balance sheets of many institutional 4 15 12 43 26 %
investors because it has provided the yield Availability of finance
and returns that other asset types have
not. In that sense, they are more exposed. Very concerned Somewhat concerned Neither/nor
But the good thing is that if leverage levels Not very concerned Not at all concerned
remain modest, the debt providers really
Source: Emerging Trends Europe survey 2019
shouldn’t be bearing that much risk in the
next downturn. The equity providers will
be holding that risk, and that’s arguably
where the risk should be,” says one
global investment manager.
6 Emerging Trends in Real Estate® Europe 2019
Chapter 1: Business environment
“There is an enormous Some in the industry draw comfort from Indeed, the geopolitical backdrop to
a market with “more equity in the system” investment is hard to ignore. According to
amount of risk in the than at the previous peak and, equally one global investor: “There is an enormous
system. Geopolitical risk important, the restraint shown over amount of risk in the system. Geopolitical
is everywhere; there is speculative development during the risk is everywhere; there is no safe haven
past decade. “The market is balanced today.” Others see geopolitical events as
no safe haven today.” in most European countries,” says a putting a “periodic safety valve on the
Belgian interviewee. market that pulls everybody’s risk-tolerance
back”. That is certainly true of the UK where
The signs are that restraint will continue, Brexit remains a matter of growing concern
not least because the second biggest as the due date of March 29, 2019 draws
concern for 2019 is construction costs closer without any clearer sense of the
– labour and materials. According to one outcome. As a consequence, the UK
pan-European adviser: “Construction represents the one major exception to
capacity and construction prices are a the economic equilibrium ascribed to
major risk factor now for developers in Europe generally.
several countries. Capacity decreased
after the global financial crisis, and now Despite investment volumes holding up
more people want to build and material well in 2018, the industry believes the
costs are increasing.” UK economy is destined to underperform
the Eurozone following its departure
Here again, the late cycle is informing from the European Union (see page 13).
sentiment. As one German developer “That doesn’t mean it’s bad, just that it
explains: “In previous years you could underperforms,” says one private equity
be sure that your cost overruns would player. “Whether it’s 50 or 100 basis
have been compensated by higher points of GDP, that underperformance
sales pricing and yield compression. is significant. Therefore, in terms of
Going forward, that may not be the investment decisions and underwriting
case anymore. You have to watch in the UK, you’re looking at a relatively
construction costs more carefully.” weaker-performing economy.”
One pan-European fund manager
concludes: “For most of the bigger
markets we are one year further into
the cycle and one year closer to the end.
But I believe we have another good couple
of years to go until things correct and it
will not be a severe correction like the
financial crisis. The market has matured,
and you see the shift [by investors] from
sectors like office to residential. It will
not be too severe unless there is a major
geopolitical incident.”
Emerging Trends in Real Estate® Europe 2019 7
Political risk rises Figure 1-3 Social issues in 2019
Brexit is doubtless one reason why
European political instability is a key
20 60 12 6 2 %
social/political issue for the industry in
International political instability
2019, rating the second-highest level of
concern (69 percent) after international
stability. At the same time, the survey 16 30 16 24 13 %
indicates that national political instability National political instability
is not considered to be quite so acute
as previous years when there were
13 41 22 20 4 %
widespread fears over the threat of
Housing affordability
nationalism. Those fears have been
allayed – at least until the next round
of general elections – although the 12 57 15 14 3 %
interviews reveal lingering political European political instability
concerns, notably with the governments
of Italy and Turkey. “There are general
12 45 26 15 3 %
issues with political unrest around Europe
Environmental issues
and concerns over the viability of Italy in
the Eurozone,” says one pan-European
investment manager. “Turkey is a small 9 36 27 22 6 %
market and not really an investment Mass migration
destination for us, but it has the capacity
to be destabilising for Europe generally.” 7 34 28 23 8 %
Social equity/inequality
Others are pressing on, regardless of the
political noise. “In Italy we have a Milan- Very concerned Somewhat concerned Neither/nor
focused portfolio, and we are not seeing Not very concerned Not at all concerned
it being affected at all by the political
situation there,” says one global private Source: Emerging Trends Europe survey 2019
equity player. “We are selling assets in
Milan at sub-4 percent yields – there is
a huge buyer universe out there.” “There are significant risks if the trade Most interviewees believe a global trade
war escalates. You can see pockets of war is potentially damaging to business,
When it comes to social/political issues in
that effect already in certain trade flows,” but its impact is difficult to quantify at the
2019, however, the threat of international
says a global investment manager. Another moment and will most likely materialise
instability is by far the biggest concern
global manager adds: “We’re watching after 2019. Like Brexit, the uncertainty
among survey respondents, just as it
carefully to see what happens in the major over the outcome is the biggest frustration
was last year. This time, the interviews
ports – whether tariffs have an impact for the industry. “You need to have a little
were conducted in summer 2018 when
on the traffic coming in and out of ports. visibility, and it’s like being in the middle of
the imposition of tariffs between the US
The ports facilities also happen to be a storm,” says one French CEO. “I have
and China was high on the news agenda.
some of the more tightly priced logistics no clue where it is headed, no clue.”
Not surprisingly, the threat of trade wars
assets. It’s easy to see how terrorism and
is now on the industry agenda, too.
As one German interviewee observes: or trade wars could impact the facilities.”
“It seems far away from continental Europe,
but it will have an impact in Germany as an
exporting country and may be quicker than
we think. It will affect general sentiment,
and general sentiment is the main condition
for a good business environment.”
8 Emerging Trends in Real Estate® Europe 2019Chapter 1: Business environment
Interest rate caution Figure 1-4 Interest rates and inflation in 2019
There is, at least, more clarity around
interest rates following confirmation by the 3% 3% 3% 4% 3% 7%
European Central Bank (ECB) that it will 16%
end its €2.5 trillion stimulus programme by 29%
the end of 2018 with the proviso that it will 33%
keep base rates at record lows until the Short-term Long-term
Inflation
middle of 2019. The decision had been interest rates interest rates
well-trailed, and unsurprisingly Europe’s
real estate industry overwhelmingly
61%
expects the loss of the quantitative 64%
easing prop to the economy to feed 74%
through to a rise in short- and long-term
Increase significantly Increase somewhat Stay the same
interest rates at some point in 2019.
Decrease somewhat Decrease significantly
Yet for most interviewees, the prospect Source: Emerging Trends Europe survey 2019
of mainland Europe following the UK and
the US and raising interest rates is not a
threat to business in 2019. Many believe
that increasing interest rates will be offset
In effect, interest rates have moved on to “We consider that an
the industry watch-list. Many interviewees
by growth in rents, or as one French agree that a geopolitical shock to the increase of another 200
interviewee puts it: “We consider that an system would accelerate rate rises basis points in interest
increase of another 200 basis points in
interest rates can be absorbed without a
and, as one German fund manager rates can be absorbed
acknowledges, “could cause some trouble
big hit on valuations.” so that alternative investments become without a big hit on
more attractive [than real estate] and valuations.”
In short, there is an expectation of modest, we see outflows of money”. At the same
containable rate increases. In that respect, time, some of the specialist bankers
Emerging Trends Europe reflects little canvassed this year report a brisk trade
change from last year’s report in its in prudent property clients refinancing
immediate outlook. Longer-term, loans at favourable rates while they can.
it is another matter. Some interviewees
ponder the idea of Europe charting a On an altogether bigger scale, one German
Japan-esque 10- or 20-year path of low banker warns: “I worry about the impact
inflation and low interest rates, but that of the ECB ending its bond-buying
is a minority view. Some 60 percent of programme. When that happens, countries
survey respondents believe interest like Spain, Portugal, Italy and Greece
rates and costs of finance will worsen will have to fund themselves in the
over the next five years. capital markets, which is something
they haven’t really done since 2008.
If they can’t sell bonds at interest rates of
less than 5 or 6 percent, then essentially,
they can’t fund themselves.”
Emerging Trends in Real Estate® Europe 2019 9Figure 1-5 Returns targeted in 2019 Figure 1-6 Time horizon for holding Figure 1-7 Returns targeted in 2019
compared to previous year investments
2%
9%
2% 2% 5% 21%
19%
30% 34% 19%
28%
48%
47% 0-5% 5-10%
34%
Significantly higher 10-15% 15-20%
1-3 years 3-5 years
Somewhat higher 20%+
5-10 years 10+ years
Same
Source: Emerging Trends Europe survey 2019
Somewhat lower Source: Emerging Trends Europe survey 2019
Significantly lower
Source: Emerging Trends Europe survey 2019
Searching for income One pan-European investment manager According to successive Emerging Trends
stresses the importance of “sustainable Europe surveys, return expectations have
The combination of the late property cycle,
cash-flows” and “ensuring we get the been progressively scaled down over
the geopolitical uncertainty and the rising
buying decisions right”, adding: “At this recent years, and once again, some 30
interest rate environment has reinforced
stage in the cycle, a lot of risks are on the percent of respondents say they are
the need for secure, long-term income.
downside, not the upside. The challenge targeting lower returns in 2019. In doing
For many, the search for income is the main,
now is assessing those risks and adding so, they still maintain that real estate
guiding narrative for European real estate
value, and so outweighing some of those has an edge over other investment asset
investment in 2019. “Many investors will
potential, wider market risks and the risk classes. But as one private equity investor
trade capital growth, which almost certainly
of rates increasing, yields moving out.” says: “We are just a little more cautious
is finished, for rental stability and growth,”
about where we are in the market cycle.
says one investment banker. “Any asset
Though there are “endless amounts What we don’t want to do is invest in the
getting a predictable level of income is
of money”, adds a German interviewee, final piece of the cycle with twice as much
in demand, and real estate is in that role.
investors are nonetheless careful about money and the same return targets.”
The demand side is still good; the ability
where to invest and at what level:
to satisfy that demand is more variable.”
“Capital is looking more on downturn
scenarios than ever before. Investors are
looking at assets which are replaceable,
where you have a high level of sustainability
in terms of prices and rents.”
10 Emerging Trends in Real Estate® Europe 2019Chapter 1: Business environment
Even so, many interviewees and survey Others favour allocating more capital to Broadening investment
respondents believe there are plenty of less cyclical alternative real estate sectors,
The interviews go further, indicating that
value-added opportunities around Europe which has been one of the significant
the coming five years will be a pivotal
– with ample debt finance available to trends of recent years and is clearly
period for the industry, the challenges
boot – although they are evidently not in gathering pace. “We see demand for
going much deeper than the conventional
the sustainable cash-flow camp. And at alternatives remaining very strong because
supply/demand dynamics of commercial
this stage in the game, according to one of yields, compared with the more mature
real estate, or even a market downturn.
pan-European institutional investment sectors,” says a pan-European institutional
manager, a value-added strategy risks investor. According to another institutional
Though social inequality is not the main
“promising the moon and delivering investor, higher returns may have been an
concern for 2019 in the survey, some
something different”. initial attraction of alternative real estate but
interviewees refer to it as one of the
more importantly “we have started to really
biggest issues facing the industry over
But if sustainable income is paramount understand the operational risk and we are
the medium term because it will set the
for the majority, there are numerous now more capable of analysing it properly”.
political agenda across Europe. Others
ways of achieving it. A growing number
cite the pressure on the built environment
of market players are what one global It used to be the custom that as each
brought on by urbanisation. Many refer
fund manager calls “exit yield agnostic”. market peak was passed, the enthusiasm
to the risk of obsolescence as real estate
They are focused entirely on income – for alternative sectors waned and investors
struggles to keep up with technology and
in other words, “the return component reverted to the traditional sectors: office,
rapidly changing consumer behaviour.
investors can control”. This approach retail and industrial. That no longer appears
implies investors will target good-quality tenable. All the signs are that the need
“Real estate provides the places where
assets – essentially sticking to core or for sustainable income and the push into
people work, live and play, receive
core-plus – with strong income streams, alternative real estate – or “demographic
education and healthcare. It’s the backbone
almost irrespective of pricing. investing” as some call it – will continue
of society, and it’s very difficult to get
long after 2019. Nearly half the survey
comfortable if society on the whole is
One investment manager with exposure respondents expect the availability of
on the verge of very significant changes,”
to logistics in Germany is less concerned suitable assets to worsen over the next
says one global fund manager. “How we
with the high prices in that sector – five years.
invest pension fund capital and get it
and in that country – than with the strength
to continue to grow is affected by all
of covenant. The argument here is that the
these things.”
equity and corporate bond yields in listed
logistics operators are still less than the “We see demand for
yields they produce as tenants. “But it’s alternatives remaining
the same counterparty. When clients think very strong because of
about allocating to real estate and what
they expect to get out of it, it’s much less yields, compared with
about the market going up and down and the more mature sectors.”
much more about what is the counterparty
risk? What is the cash-flow and am
I exposed to geopolitical risk?”
Emerging Trends in Real Estate® Europe 2019 11Figure 1-8 European business environment in the next 3–5 years
22 21 18 15 14 13 13 12 10
18
26
35 37
% 39 38
49 47
53
60
39 46 61
48 49
38 41
37
Inflation Interest
rate Construction
movements costs Cybersecurity Cost Availability Currency Global European
of of suitable volatility economic
finance assets/ economic
growth growth
land
Improve Stay the same Get worse
Source: Emerging Trends Europe survey 2019
One investment manager’s answer As one property company CEO concludes:
involves re-allocating capital “in a material “We have to make sure our buildings are
way towards social infrastructure, assets flexible enough to cope with whatever is
that are required by society and down- coming in 10 years’ time. We have no
weighting in conventional sectors, control over that, but it will drive what we
particularly retail, which is about trying to do. We have to look at the megatrends
be in highly desirable assets and avoiding that are driving human behaviour – ageing
assets that will become obsolete”. population, growing population, structural
shortage in housing, structural oversupply
If anything, the blurring of boundaries in retail property, a younger generation that
between traditional and alternative real is completely digitally enabled. We will
estate – as predicted in previous editions have to be much quicker in evolving our
of Emerging Trends Europe – is now a product. The future will be much more
fact of life in the industry. about mixed-use communities.”
12 Emerging Trends in Real Estate® Europe 2019Chapter 1: Business environment
UK faces Brexit reality check
More than 70 percent of Europe’s senior property professionals believe the UK’s ability to attract
international talent will fall following March 29, 2019, whether it is a soft, hard or no-deal Brexit.
As many as three quarters of survey
Figure 1-9 Business impact of Brexit in 2019
respondents believe that business
relocations will increase to continental
%
Europe in 2019 as a result of Brexit while
Business
similar numbers predict a decline in UK relocations
1 3 20 68 8
investment and values. to the rest
of Europe
For the UK, these are bleak numbers
given that the survey was conducted The UK’s ability
to attract
in mid-2018 when there was evidence international
18 53 26 3
that investment volumes and occupier talent
demand for offices in London were
holding up well.
Decrease Decrease Stay the Increase Increase
substantially somewhat same somewhat substantially
The interviews indicate that non-European
investors are less bothered by Brexit than Source: Emerging Trends Europe survey 2019
their European counterparts. Even so,
an overwhelming 83 percent of respondents
expect a divergence in economic growth
between the UK and the European Union Figure 1-10 Impact of Brexit on real estate in 2019
in 2019.
%
One private equity player suggests that
until Brexit, the UK represented 25 percent UK 22 56 17 5
of European GDP while attracting a Real estate
investment
disproportionate 40 percent-plus of capital Rest
2 9 46 41 3
flows. “We’ve just said to our clients, of EU
that’s gone now. The UK has lost a big
piece of its competitive advantage.”
According to most pan-European UK 14 63 19 3
investment managers canvassed for Real estate
values
this report, their institutional clients are Rest
1 6 63 29 1
“nervous about their allocations to the of EU
UK” going forward, despite capital and
rental growth. “They just look at the UK
and think it’s fraught with risk,” says one. Decrease Decrease Stay the Increase Increase
substantially somewhat same somewhat substantially
A good number of interviewees equate
Source: Emerging Trends Europe survey 2019
such risk with opportunity. For the majority,
however, the Eurozone is seen as a safer
and more fruitful investment destination
than the UK in 2019.
Emerging Trends in Real Estate® Europe 2019 13Top trends
Working around In response, the industry is seeking its “The late cycle could
“sustainable cash-flows” in a variety of
income creation ways. Many of those who are sticking go some time still.
This late in the cycle and with commercial with commercial real estate have adopted But in terms of any cap
real estate values already very high, the
common goal for many in the European
a build-to-core strategy. Debt is increasingly rate or yield shift, that
regarded as a sound, defensive means
property industry is secure income. of exposure to the sector. There is also is no longer going to be
a marked shift of capital into residential what drives real estate
Interviewees are reflecting much more on
the “downside risks” than in last year’s
and alternatives – the late cycle lending values, and so we’re
an urgency to long-term demographic
Emerging Trends Europe although the influences. going to work around
mood is lightened by a widespread belief income creation.”
that supply and demand at the occupier It seems highly likely the interest in
level remain balanced in most cities. residential and alternatives will grow,
given the pricing and availability of suitable
“The late cycle could go some time still,” core assets. “There is still an opportunity
says one pan-European private equity to buy under-managed real estate,” says
partner. “But in terms of any cap rate or one pan-European fund manager. “It is
yield shift, that is no longer going to be about how quickly interest rates rise and
what drives real estate values, and so we’re how robustly rents grow at the same time.
going to work around income creation.” There will be growth on the rental side,
but the best may now be behind us.”
Another pan-European player is more
cautious: “Capital growth has mostly played
out, and the areas that are performing in the
UK now are being driven by income growth.
We will increasingly see that in continental
Europe too. In some segments,
decompression in yields will moderate
returns over the next 18 months.”
14 Emerging Trends in Real Estate® Europe 2019Chapter 1: Business environment
Where’s the risk? Others are going down the value-added, “The biggest change
build-to-core or development route.
The consensus from Europe’s real estate
“What we are doing more of, is things that we have to
industry is that it is coming towards the
end of a good run: almost all of its major
that are growth-orientated and taking accommodate will be
markets have recovered from their
development risk or lease-up risk in the end of substantial
markets where supply is tight and rents
2008–2009 downturn; for their commercial
are growing so we can make returns by quantitative easing,
property, supply and demand are pretty
much in balance, if not tight; and investors
taking on risk,” says a global investor. negative interest rates
and lenders do not appear to be heading and high liquidity,
Development in certain sectors is definitely
for a feeding frenzy, piling large amount
on the increase – JLL's forecasts indicate which have boosted
of debt on slim equity underpinnings.
that office completions over 24 European all asset classes in
So where is the risk hiding? Investors
cities will increase significantly in 2019 the last few years.”
and 2020 before dropping back in 2021.
complain that quality, core assets are
hard to come by and point to “over-priced”
But the risk is hard to judge. As a percentage
markets. But the signals from our
of existing stock, the supply coming in the
interviews are that European real estate
next few years is not, in most major markets,
leaders are treading cautiously and
overwhelming: mostly in the 1-2 percent
resisting the temptation to continue
range. Interviewees say that banks have
bidding up prices. Indeed, some have
been reluctant to fund speculative projects,
been selling – to an increasing array of
insisting on pre-lets. Alternative lenders
non-European investors with different
may be more open-handed, but they are
return/risk criteria.
still a minor part of the debt market.
But the search for yield and income is now
“The ability to find value and deploy
edging the industry out of its core comfort
capital is extremely challenging,” says a
zone. Some are moving into alternative or
pan-European investor with a stellar track
niche areas, like student accommodation,
record of calling the market’s twists and
which require more operational expertise.
turns. “The biggest change that we have to
“If you're not able to raise the income on
accommodate will be the end of substantial
your asset and yields blow out you’re
quantitative easing, negative interest rates
exposed. If you have assets where you
and high liquidity, which have boosted all
can grow the income, or you’re in a sector
asset classes in the last few years.”
where income is growing then you’re less
exposed,” says a global investor.
Emerging Trends in Real Estate® Europe 2019 15Affordable housing The fundamentals look even better against
the cyclical uncertainty surrounding
in demand commercial real estate. As one global
“Every major city in Europe has the same investor says: “We are focusing on those
issue: lack of affordable housing, lack of sectors where we think income might be
social housing and lack of senior care … more resilient, which is often residential,
the problem is just getting worse and student housing or senior living.”
worse,” says a partner with a pan-European
private equity firm. Housing is also integral to the industry
discussion around mobility of companies
“We are spending an For many in the real estate industry, and their employees. In Munich, for instance,
the corollary of this widespread problem one investment manager says: “Residential
increasing amount of is a reallocation of capital to residential, prices are so high that it becomes hard for
our time on residential which has been reflected in Emerging companies to relocate there, they can’t
around the world, and Trends Europe for some time. But this year, find the workers. That is a real issue.”
the interest in housing has reached a
that includes Europe – higher level. So far, the very specific response to
anywhere we can get demand from the millennial generation has
access to housing at scale. The same private equity partner believes come in the form of micro-apartments and
Europe’s private rented sector (PRS) has co-living – the latter, says a German fund
The fundamentals in these undergone “a critical change from niche manager, is “one way for people to afford
markets are good.” to institutional” – in other words, similar to live in the biggest cities”.
to the US multi-family sector.
However, the lasting solution to housing
At the same time, more than half of the affordability will surely come simply from
survey respondents are concerned about building many more homes of all types.
housing affordability as a significant social According to Emerging Trends Europe,
issue in 2019, which is around the same the industry is ready and willing.
proportion as previous years. Yet as
each year goes by without any tangible “The last few years have seen an
improvement in housing affordability, increasing institutionalised investment
so the supply/demand dynamics seem market in the accommodation space,”
more compelling to the industry. adds one pan-European private equity
player. “It includes multi-family, student,
“We are spending an increasing amount and senior. It is a big market, but it is in
of our time on residential around the its infancy, and it is not capitalised with
world, and that includes Europe – the right long-term capital. So, it’s a
anywhere we can get access to housing trend that has started but will continue.”
at scale,” says one global private equity
player. “The fundamentals in these
markets are good.”
16 Emerging Trends in Real Estate® Europe 2019Chapter 1: Business environment
As it turns out, the survey puts health
Figure 1-11 Factors influencing real estate strategies over the next 3–5 years
and wellbeing almost on a par with such
long-established influences on the industry
14 43 36 7 % as sustainability and energy efficiency.
Shorter and more flexible leases
But importantly, the driver here is not
regulatory force but occupier demand.
14 41 38 8 %
For many interviewees, occupier
Technology readiness – broadband capacity and performance wellbeing falls into their Environmental
and Social Governance policy. It is also
12 31 49 9 % an example of property as a service,
Promoting health and wellbeing which Emerging Trends Europe has
highlighted in recent years.
11 37 45 7 %
“Occupier views on health and wellbeing
Improving sustainability/energy efficiency/reducing carbon emissions
are increasingly important,” says a fund
manager. “They are certainly a feature of
7 23 53 17 % our investment decision-making process.”
Certification of digital infrastructure
Many of the interviewees talk about the
6 22 53 19 % “demand for more flexibility” among
Implications of International Financial Reporting Standard 16 (tenants capitalising lease liabilities)
occupiers so that they, in turn, can
respond to the needs of their workforce.
Very significant impact Significant impact Moderate impact No impact “If people are not happy and satisfied with
their business environment,” says a global
Source: Emerging Trends Europe survey 2019 institutional player, “then it becomes
difficult for the companies that are the
tenants. Then they can make the decision
to leave, and when the notice comes,
Happy tenants it’s too late. That’s where intensive asset
“We have to be ahead Not so long ago, the idea of promoting management is very important.”
health and wellbeing would have been
of the game as far as dismissed as irrelevant to the real estate Another global player concludes: “You’ve
possible in thinking industry, yet nearly half the survey got to stay ahead of the trends and respond
about the happiness respondents believe it will have a to them. Fundamentally what it means is
moderate impact on strategies over the that you need to invest more. The days of
of tenants. In the end, coming five years. More tellingly, perhaps, buying real estate, holding it for 20 years
they pay the rent and we 43 percent acknowledge it will have a and doing nothing, are long gone.”
want to find the highest significant impact.
rent and the most loyal “We have to be ahead of the game as far
tenant in the long term.” as possible in thinking about the happiness
of tenants,” suggests one pan-European
fund manager. “In the end, they pay the
rent and we want to find the highest rent
and the most loyal tenant in the long term.
And then the cap rate is the outcome.”
Emerging Trends in Real Estate® Europe 2019 17Chapter 2 Real estate capital markets “Investors are lowering their risk-adjusted returns or keeping them the same, and everybody is trying to get longer-dated, annuity-style products out there. Bonds still look unattractive, stock markets are volatile, you’re getting nothing on your cash, and you are getting a decent yield on real estate.” Director, pan-European investment manager 18 Emerging Trends in Real Estate® Europe 2019 Image: Hamburg, Germany (Alexander Spatari)
Chapter 2: Real estate capital markets
“There remains a significant Figure 2-1 Availability of equity and debt in 2019
amount of capital interested in
property in all shapes and sizes,” Equity for refinancing or new investment
says one global investment Decrease significantly 1% Increase significantly 1%
manager. “The biggest challenge Decrease somewhat 17%
is finding quality assets and Increase somewhat 27%
portfolios in which to invest.
If anything, it’s getting harder
as core assets, on the continent
in particular, are tightly priced.”
This is a common sentiment among
Emerging Trends Europe’s survey Stay the same 54%
respondents and interviewees, reflecting
the fierce competition for assets arising
from the sheer weight of capital bearing Debt for refinancing or new investment
down on European real estate. Decrease significantly 1% Increase significantly 2%
Decrease somewhat 21%
Against that backdrop, the outlook for
capital markets in Europe in 2019 remains Increase somewhat 30%
positive although there has been a lowering
of expectations around the availability of
equity and debt as the industry tries to
read the cycle.
Some 28 percent of survey respondents
believe the amount of equity available
for refinancing or new investment will Stay the same 46%
increase, compared with 50 percent last
year. The figures are similar for debt. Debt for development
Decrease significantly 4% Increase significantly 3%
While that indicates less confidence in the
capital markets than last year, it is coming
off a very high base. With few exceptions Decrease somewhat 23%
– notably retail in the UK – real estate Increase somewhat 31%
markets remain highly liquid despite some
nervousness that pricing of prime assets
is high by historic standards.
Stay the same 39%
Source: Emerging Trends Europe survey 2019
Emerging Trends in Real Estate® Europe 2019 19“There’s just so much money in the world
Figure 2-2 Real estate investment in European countries Q4 2017–Q3 2018 (€ bn)
that has to get invested, so as soon as
something falls in value, everyone piles in
Other and that raises the price again,” says one
4 Norway Finland investment banker.
4
Sweden 7
11
UK “A lot of sovereign wealth funds but also a
68
Denmark
Russia lot of wealthy individuals see a generational
6 2
Ireland
5 opportunity to buy a trophy asset and take
Germany Poland a very long-term view,” one agent adds,
65
Netherlands 7
4 21 picking up on a big theme this year –
France Belgium increasing inflows of equity from wealthy
39 1
Czech
Republic
2
individuals rather than just institutions.
Luxembourg 4 1
5 Austria Hungary
Switzerland
“The interesting thing we’re seeing –
and Asia is a part of this – is increasing
Spain Italy
7 capital from high-net-worth individuals,
19
Portugal not only directly into real estate trophies
3 but into funds and real estate across the
board,” says one private equity investor.
“We’re seeing an increased flow from
high-net-worth or super-wealthy individuals
Source: Real Capital Analytics
Note: Figures are provisional as at 22nd October 2018 who view the equity and bond markets
as no longer offering them return and are
therefore looking at real estate as a place
to get return. It’s pretty significant.”
Figure 2-3 Eurozone property yields and interest rates, 2009–2018
As for the lowering of expectations
6 around capital availability, the difficulty
in putting money to work at this point in the
5
cycle is clearly a factor. “With this kind of
4 investing environment, raising capital for
3
new funds is certainly not getting easier,
% because investors aren’t stupid,” says one
2 global fund manager. “They see what’s
1 going on in the underlying market and how
challenging it is to find good investments.
0
So, they’re more cautious about where
-1 they want to commit their money.”
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
EURIBOR Eurozone bond yields Eurozone property yields Five-year swap rate At the same time, there is very little fear
that debt will precipitate another downturn
Source: CBRE, Datastream, European Central Bank
in the short or medium term.
20 Emerging Trends in Real Estate® Europe 2019Chapter 2: Real estate capital markets
“Financing is stable and supportive
Figure 2-4 UK property yields and interest rates, 2009–2018
of transactions without posing a risk,”
one global private equity investor says.
8
“The pricing of debt, both senior and
mezzanine, feels appropriate,” another says. 7
“One thing that happened in the previous 6
crisis is that debt became very mispriced.
5
We think the returns you can generate are
% 4
appropriate for the amount of risk you
have to take. We don’t see a credit bubble, 3
and we are in a functioning market.” 2
1
About the same proportion of survey
0
respondents think debt for development 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
will increase as those who think it will
increase for refinancing and new investment, LIBOR UK Government bond yields UK property yields Five-year swap rate
34 percent versus 32 percent, and this Source: CBRE, Datastream
figure is down from 46 percent last year.
By contrast, interviewees report more
caution about deploying equity and debt in Prime assets are over-priced
the UK compared with major continental
European markets, given the uncertainty
around Brexit. 24% 46% 20% 9% 1%
Strongly
Direct investors from Asia and the UK Disagree disagree
Strongly Neither agree
are still buying core property, and the agree Agree nor disagree
UK saw the highest investment volumes
of anywhere in Europe in the first half
of 2018, according to Real Capital
Analytics. But for anything below prime “One thing that happened
property, the situation is less easy to in the previous crisis is
justify, with economic fundamentals
weaker but asking prices still high.
that debt became very
mispriced. We think the
“We’re not doing anything in the UK returns you can generate
at the moment,” one investment advisor
reports. “There are some capital raises
are appropriate for the
going on, but they will find it hard. It would amount of risk you have
be difficult for us to take on a value-added to take. We don’t see a
fund in the UK. Speaking to managers
that deal with core-plus vehicles, they’ve
credit bubble.”
had a hell of a job finding opportunities
because the pricing is so hot, still,
which amazes me.”
Emerging Trends in Real Estate® Europe 2019 21Debt evolution Figure 2-5 Sources of debt in 2019
The debt world is evolving in terms of the
sources that borrowers can tap. Banks still
18 55 22 4 1 %
play a significant part in the market, but
this is diminishing while alternative lenders Alternative lending platforms
continue to grow.
13 45 34 6 1 %
In the UK, for instance, data from Cass Debt funds / Other non-bank lenders
Business School show that banks now
hold 74 percent of the £164 billion of
9 52 30 8 1 %
debt outstanding against commercial real
Non-bank institutions
estate, compared with 98 percent in 2007.
This shift is likely to continue. Some 55 3 35 50 10 1 %
percent of survey respondents believe Commercial mortgage-backed securities
lending from non-traditional debt providers
will increase in 2019. Just 27 percent 2 25 44 26 3 %
predict lending from banks will rise,
Banks
compared with 42 percent last year,
while 29 percent forecast a fall. Increase significantly Increase somewhat Stay the same
Decrease somewhat Decrease significantly
For insurance companies and institutional
Source: Emerging Trends Europe survey 2019
investors, debt is increasingly viewed as
a way of investing defensively at the top of
the cycle, whether it is being undertaken
directly or through investments with debt “There is a lot of liquidity targeting the “I see us being far more
fund managers. market, which creates risk, and loan-to-
values (LTVs) are increasing, and we don’t conservative on the equity
“I see us being far more conservative on really want to increase our LTVs too much,” side and far more focused
the equity side and far more focused on one banker says. “We are holding firm on income return, and that
income return, and that takes us down the on our LTVs and our pricing. A lot of our
debt route as a debt provider,” one global competitors are not, so we are losing takes us down the debt
institutional investor says. “This year, business, but we don’t want to take on route as a debt provider.”
more than 70 percent of our flows will more risk.”
be in commercial real estate debt.”
But it is also a secular trend, the result
“We have finished raising capital for a of regulation that is designed to limit
[pan-European] mezzanine debt fund,” systemic risk in the banking sector as
a global fund manager says. “We closed prices in real estate markets increase.
that with a little over $1 billion of
commitments, and it could have been “The European Central Bank regulates
more. My preferred investments in this kind this market very heavily, every lender
of market are debt and develop-to-core. has to fulfil strict capital criteria and hold
That’s where I see, from the investment more equity against real estate loans,”
side, the best risk-reward balance.” another banker says. “As values get
higher you have to put aside more equity,
For banks, that reduction, if it comes to so those requirements will always limit
pass, will be partly attributable to not the volume of new loans.”
wanting to be burned again, with the
memory of 2008 still fresh.
22 Emerging Trends in Real Estate® Europe 2019Chapter 2: Real estate capital markets
Pricing problems Figure 2-6 Access to senior debt in 2019
With the price of core assets at record
highs in almost every market bar those
6 29 47 16 1 %
with major macro issues like Moscow
or Istanbul, investors are presented with Value-added real estate
the challenge of how to hit return targets.
For some in the industry, this means 6 27 58 8 1 %
targeting value-added real estate, and Core real estate
indeed marginally more survey respondents
(35 percent) expect to be able to secure
4 30 53 12 1 %
senior debt here than for core assets
New investment
(33 percent). However, twice as many
people think debt for value-added will
decrease compared with core – 16 percent 4 25 50 18 2 %
against 8 percent – and so this is a mixed Development finance
picture. It is worth noting that in interviews,
the value-added contingent say they do 2 20 66 11 1 %
not want to take on too much extra risk.
Refinancing
A key element here is the move of core Increase significantly Increase somewhat Stay the same
investors towards “develop-to-core” or Decrease somewhat Decrease significantly
“manage-to-core” strategies. Rather than
Source: Emerging Trends Europe survey 2019
heading to secondary markets or buying
in secondary locations, such investors are
increasingly comfortable taking leasing risk
in strong locations in core markets, either Investors are taking on more risk to achieve target returns
through refurbishment or even ground-up
development. The develop-to-core
movement helps explain the relatively high
29 percent of respondents who believe 26% 53% 11% 9% 1%
Strongly
access to development finance will Neither agree Disagree disagree
increase in 2019. Strongly nor disagree
agree Agree
“The build-to-core idea applies almost
universally, and it is a function of the
fact that development financing has (Re)development is the most attractive way to acquire prime assets
been restricted – more so in Europe
than in the US,” one global fund manager
says. “There just hasn’t been enough
development to satisfy demand. It depends
22% 48% 21% 9% 0%
Strongly
on which pot of money, but a good chunk Disagree disagree
Strongly Neither agree
of our value-added money is going into agree Agree nor disagree
refurbishment of older assets. We’re also
doing ground-up development in Europe.”
Emerging Trends in Real Estate® Europe 2019 23Figure 2-7 Cross-border capital into European real estate in 2019
2% 4% 8% 3% 1% 5% 9% 1%
15% 18%
33% 27%
32%
22%
The Americas Europe Middle East Asia Pacific
and Africa 38%
56% 40%
51%
34%
Increase significantly Increase somewhat Stay the same
Decrease somewhat Decrease significantly
Source: Emerging Trends Europe survey 2019
New sources of equity “The Japanese are coming; that door Liquidity is expected to remain high from
has just opened, mandates have been this domestic investor cohort, with more
When it comes to equity, European real
awarded,” one global fund manager says. than half of survey respondents expecting
estate is like a busy nightclub – as soon
“But for most Japanese institutional them to maintain current levels but a third
as one group leaves, another seems to
investors they are not investing directly predicting an increase in 2019.
be ready to take its place.
but via funds and multi-managers.
Most market participants won’t see it The third largest investor group is North
Chinese capital has been severely reduced
as Japanese capital, but just in deals Americans with €20 billion invested over
because of capital controls introduced by
by investment managers. But it is very the same period, and again survey
the government to control capital flight –
significant in volume and will help mitigate respondents expect this to continue,
as highlighted in last year’s Emerging Trends
the fall in volumes from Chinese investors.” with a third expecting levels to increase.
Europe. But the expectation is that Asian
Though US investors have focused on
investment into European real estate as a
Another says: “They are increasingly opportunistic and value-added assets in
whole will continue to grow – 69 percent
showing up on managers’ radars. Europe, interviewees say they are now
of survey respondents think investment
They have a lot of capital to deploy.” moving down the risk curve.
from Asia will increase, the highest
proportion of any region.
However, there may be something of a “Some of the opportunistic US investors
gap between perception and reality with are now looking at European core, which
Koreans and Singaporeans are investing
capital flows. Asian investors might grab is quite unusual because they’ve always
now, but there is a lot of excitement among
the headlines, but they only accounted said they wanted a premium in Europe,
interviewees about an influx of capital from
for €9 billion of the €124 billion invested to offset currency and tax,” one US-
Japanese pension funds, notably Japan’s
in Europe up until mid-September 2018, backed fund manager says. “But I think
Government Pension Investment Fund
according to Real Capital Analytics that’s now going away, and because
(GPIF), which has $1.2 trillion of assets.
although this does not take into we’re late cycle they want to de-risk.”
GPIF has been permitted to invest in
account commitments to funds,
global real estate for the first time and
only direct investment. “We’ve had a significant increase in
has recently awarded its first real estate
interest from the US in our core-plus
fund of funds mandate. Japan Post,
Western European players were by far the product,” one pan-European fund
which has more than $500 billion of assets,
largest group, investing €63 billion, followed manager adds. “US investors still need
is also looking to diversify beyond its
by UK investors, who deployed €21 billion, something for currency risk because it
domestic market.
albeit mostly in their home market. costs to hedge that risk, but they don’t
need 500-700 basis points of incremental
return over core.”
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