Europe’s property sector is in the midst of a cyclical downturn that is coinciding with long-term structural changes in real estate, according to the 18th edition of the Emerging Trends in Real Estate® Europe report. However, real estate generally is seen as one of the few asset classes to generate acceptable returns at a time of low or negative interest rates.

The PwC and ULI survey of almost 1,000 industry leaders across Europe indicates that retail space and offices will be the sectors most affected because of widespread uncertainty related to rent collections amid the pandemic. This has led investors increasingly to assess the underlying operational risk of the occupiers and focus on their own strengths as operators of real estate to keep the income secured.

Capital flows into the sector are also altering how funds can be deployed, and a strong likelihood exists that domestic and European investors will play a much greater role in Europe. While a majority of those surveyed still expect the amount of Asian capital flowing into Europe to increase, this percentage is significantly lower than in previous years, with interviewees citing the inability of overseas investors to visit a property in Europe before buying it.

The challenges related to business travel and potential future lockdowns are raising concerns about deal sourcing. The industry had been working through a pipeline of deals originated pre-pandemic, subject to conventional due diligence and mostly with existing partners.

However, the assessment of new opportunities within restrictions and the difficulty of building new relationships in a Zoom era might significantly slow the transaction volume further going forward. At the same time, this situation could provide an advantage to those players with a larger footprint—those with resources in place on the ground in more countries—as well as the real estate markets in the bigger countries, such as Germany, that offer sufficient critical mass and the possibility to travel domestically and overcome some of the restrictions.

The “digital switch”—the increased pace of digitalization around the globe, boosted by COVID-19—is also affecting investors’ sector preferences, with logistics, data centers, and communications towers and fiber identified as having strong potential. In addition, life sciences and health care are being looked on favorably by investors, a trend accelerated by the pandemic, as is the residential sector.

“European real estate is at a turning point, trying to work out its future role in society while facing the cyclical challenges following the outbreak of the pandemic earlier this year and the ongoing uncertainty this creates,” said Lisette van Doorn, chief executive officer of ULI Europe. “COVID-19 has fast-forwarded a number of trends already started—for example, related to digitalization, remote work, and online shopping. But given the artificial environment amidst ongoing lockdowns and government support to employees and businesses, it remains hard to work out the long-term impact.

“The search for yield, which is now even more dominant than pre-COVID, continues to attract investors to real estate, especially core and income-generating, such as residential that continues to appeal to investors, in the ‘safest havens’ across Europe,” she said.

“The pandemic has amplified a number of previously identified structural trends,” said Gareth Lewis, real estate director at PwC U.K. “These include the uptick in e-commerce and remote working, causing investors and the industry at large to reexamine the historical risk-and-return profile for many types of real estate. It’s clear that at this time of significant uncertainty, investors continue to see Europe’s core cities as safer bets, and there remains cautious optimism.

“With London jumping up two places to second in the rankings—despite the challenges faced by all major cities—many investors see the long-term value. Further, central banks’ decisions to depress interest rates for the foreseeable [future] may [lead to] an uptick in investment activity as pent-up capital is deployed.”

“The uncertainty of this year has shifted priorities in the sector,” said Simon Hampton, real assets leader at PwC U.K. “We’ve seen a move away from the mainstay sectors of retail, hospitality and leisure; a pause in relation to office; and a strengthening demand for alternative sectors such as housing, data centers, life sciences/health, energy, and communications infrastructure, and a continued desire for industrial property and logistics warehouses—which all benefit from growing demand in this new environment.

“There’s a growing requirement to look more closely at the value that can be derived from these demand shifts and newer, emerging asset classes. Investors in the sector are therefore looking beyond real estate and into broader real assets—the built environment and infrastructure that surrounds us. These are all inextricably linked, not only to one another, but to how we live, work, consume, and spend our leisure time,” he said.

“The real estate industry faces a uniquely challenging period combining a potential recession in the immediate term and a series of structural challenges in the medium term,” said Angus Johnston, real estate leader at PwC U.K. “Both are likely to lead to changes to the use and value of our existing stock of real estate. How these challenges play out and how the industry responds to them will define the future shape of our sector.”

The report, published annually by ULI and PwC, is based on the opinions of 995 real estate professionals across Europe, including investors, developers, lenders, and advisers. 

Investing in Society 

Following COVID-19, environmental, social, and governance (ESG) strategies have gained the most interest. With many already committed to reducing the environmental impact of the built environment, executives surveyed now see a growing importance for the social aspects of their strategies.

Said Lewis, “2020 has also seen the real estate world begin to evaluate its wider role in society more seriously—from addressing diversity and inclusion in the workplace to a far greater emphasis on the environmental, social, and governance agenda. The social upheaval brought about by COVID-19 has the potential to accelerate the growth and prominence of impact investing in the built environment, with social impact increasingly being considered as part of an overall strategy rather than a specific investment strategy via specialist funds or products, although there is still a long way to go.”

European Cities Ranked for Investment and Development Prospects 

Some comfort is being taken from the fact there has not been a late-cycle development boom, meaning that ahead of potential business failures, European real estate supply and demand is broadly in balance. Stalwarts like Berlin, London, and Paris are still being backed for their long-term prospects.

The city rankings in this year’s report reflect both the caution and opportunities driving the market, with a focus on cities believed to offer liquidity and stability. Berlin tops the list as the overall favorite for prospects in 2021, with investors encouraged by the relatively strong performance in tackling COVID-19 by the country as a whole.

Real estate executives are cautious about the overall outlook. The interviews, conducted between July and September, show a marked decline in business confidence, with 28 percent of the participants seeing a drop in business confidence, compared with 13 percent in 2019.

In addition, 44 percent anticipate a decline in profitability, compared with 15 percent in 2019.  Epidemics or pandemics caused 88 percent of those polled to be “concerned” or “very concerned,” whereas international political stability caused 79 percent to say they are “concerned” or “very concerned.”

Those surveyed see better news in the prospect of central banks’ “lower for longer” interest rates, seeing reassuring levels of real estate investment activity even during the depths of Europe’s first lockdown, with many citing “pent-up capital” waiting to be deployed.

Capital Markets: A World Divided

Domestic investors are expected to come to the fore in 2021 in response to intercontinental travel being severely limited for North American and Middle Eastern investors.

A majority (53 percent) of respondents expect Asian investors, who are anticipated to recover first from the COVID-19 pandemic, to increase their investments in Europe in 2021, although this percentage is significantly lower than in previous years. About one-third expect European investors to increase their commitments next year, and a small majority expect investment to stay stable. However, 51 percent of respondents expect North American investors to reduce their investments into Europe.

Sector Prospects in 2021: Top 10

Three of the top four property types in the Emerging Trends Europe’s sector rankings are likely to benefit from the increased pace of digitalization around the globe, a change boosted by COVID-19, including data centers, communication towers and fiber, and logistics facilities.

Life sciences has also been cast in a new light by COVID-19, with many developers and investors scrambling to learn about a sector that traditionally has been highly specialized but where strong potential is seen, given long-term demographic trends and the anticyclical nature of the sector.

Though slightly less prominent than last year, the residential sector remains highly favored by investors, with three sectors in the top 10 representing some form of housing. Respondents did raise concerns about increased regulation.

Given the strong growth of remote work and uncertainty regarding how this trend may play out over the longer term and the future role of the workplace, no office sectors ranked in the top 10 this year. Even flexible/serviced and coworking space has slipped down the rankings as the industry takes a wait-and-see approach regarding how these developments will turn out in a post-pandemic world.

ULI members can access this report on Knowledge Finder.