ANNUS HORRIBILIS GIVES WAY TO HOPE IN 2023
The biggest interest rate surge in decades led to significant re-rating of property, even as the occupier market remained solid. It was real estate’s worst year since the GFC. All the sectors saw major shifts in yields, some more so than others. However, the biggest implication for the asset class is that investors are re-weighting the different sectors amid structural changes.
Offices – modern life
Post COVID-19, the profound changes to the way we work continues to echo throughout the office sector. It is now clear that hybrid working is here to stay and companies are working through what this means for their office space demand. Moreover, increased energy costs have pushed energy efficiency and ESG issues to the fore. As a result, there is now regulatory momentum to prescribe a minimum energy efficiency level, such as the MEES regulation in the UK, for leasing a building. Many buildings may not meet the new standards, which come into play as early as April 2023, and others may be viable only if construction costs fall enough to support refurbishment. Either way, this will continue to polarise the performance of modern and secondary buildings.
Logistics – a sector of two halves
Demand for logistics space remained high across Europe in 2022. Rents have seen two years of sharp increases on the back of low vacancy rates. Meanwhile, geopolitical upheaval has prompted an even sharper focus on supply chains and the European reshoring trend has gathered pace. These events underline the robustness of the logistics occupier market. Sadly, the strength of the occupier market has not carried into the investment market. Yields adjusted by far more than the other sectors, due to the jump in the cost of debt. The relatively strong yield expansion mirrors the sharp yield contraction of recent years. We see further adjustment in 2023 even as the occupier market strengthens, creating a truly two-tier market in the sector.
Retail – are we there yet?
2022 was supposed to be a year of recovery for the retail sector, after a prolonged period of structural change that left it under-performing the other sectors. However, the invasion of Ukraine and widespread inflation in the wake of soaring energy costs dashed such hopes. We expect 2023 to be pivotal for retail recovery. Footfall keeps improving, as international visitor numbers increase, and the figures are close to pre-pandemic levels, with Spain and the UK still a little behind. We see this as supportive for occupier demand in European retail space, which should stabilise. Retail yields offer a compelling opportunity relative to other sectors.
Residential – cost push
Affordability is being challenged significantly by the sudden increase in household mortgage rates across Europe. This is sharply increasing demand for rental accommodation in big cities. Moreover, we see a significant imbalance between supply and demand in the rental sector made worse by regulatory challenges, particularly in the area of energy ratings for lettable buildings. These have contributed to a dramatic reduction in the rental stock, notably in Berlin, Barcelona, and Valencia, manifesting in sharp rental increases.