Valuations Mostly Down in Europe But Vacancy Remaining Low

Limited supply of real estate assets—particularly properties which have the high environmental standards being demanded by occupiers—as well as the boost provided to rental income by inflation are positives amid persistent uncertainty in the European real estate market, according to a panel of executives during the 2023 ULI Europe Conference.

Europe’s real estate market is struggling with a subdued investment market and a decrease in values owing to dramatic increases in financing costs. Investment in property during the first quarter of 2023 fell to its lowest level in 11 years, data provider MSCI Real Assets said in April.

But inflation—which was 6.1 percent in May—is increasing rental income for investors, helping to offset price declines in the industry, reported the panel, which convened during the four-day event in Madrid in June to explore “New Highs Amid Uncertain Times.”

Brad Hyler, managing partner, real estate and head of real estate in Europe for Brookfield Asset Management, added that there had been no discernible slowdown in tenant demand, with occupancy rates “extremely high across pretty much all asset classes,” helped by index-linked leases.

“We keep waiting to see some deceleration, particularly in the hospitality segment, where we have potentially more price-conscious consumers, but we just haven’t seen it yet,” Hyler explained, adding: “We are seeing real rental growth, double-digit [growth] in some asset classes like student housing and logistics.”

Annette Kroger, chief executive office, Europe for real estate manager PIMCO Real Estate, said that the company was witnessing an inflation hedge in real estate and that is a “positive for the industry”.

The value of the region’s commercial real estate fell 10.8 percent in the year to March 2022, according to MSCI. Kroger, however, said lack of supply would help the market given the likelihood of a continued slowdown in development due to soaring construction and borrowing costs.

This lack of supply, combined with strong employment was also providing resilience for some offices, said Hyler: “In many markets [we invest in] class A offices, which I would certainly differentiate from class B offices, and supply is very tight, rents are growing,” he reported.

Green Offices

The panel went on to say that despite wider issues for the office sector, an opportunity existed to create a new breed of offices that are being demanded in a post-covid era—and confirmed debt finance was available for this.

Hyler explained. “One of the most important equations in real estate is supply and demand and there isn’t enough supply of class A buildings that have been renovated, which are sustainable and have the amenities that occupiers want.”

Kroger added that PIMCO is targeting outdated assets in good locations that could be brought up to the latest environmental standards, and decarbonisation to maintain values is a “high strategic priority”.

She explained: “I think this will be a big theme going forward as that pressure continues to be in the market. It seems there is slightly less focus on ESG in the U.S. these days but in Europe, that is absolutely not the case. E.U. regulation is putting pressure on investors but equally, it is the sustainability agenda of corporate occupiers, owners and investment managers that will trigger continued investment.”

Rohan Sikri, senior partner of The Xander Group, which heads the firm’s real estate investment program in Asia, also said sustainability was “very high on the agenda” in India, where it has invested $5 billion since 2005.

Renewable Energy

Sikri explained: “It is actually economically rewarding to implement sustainability, especially in terms of [energy]. India is a big importer of energy, which means costs, especially for commercial and industrial are quite high. If you have the ability to go green [firm’s can] actually bring down costs by 50 percent.”

Hyler confirmed that investment in renewable energy was also an area of opportunity for Brookfield in Europe. In May, the company, which invests in renewable power assets, agreed a 15-year power purchasing agreement with Canary Wharf Group, owner of London’s Canary Wharf estate.

The project will support the construction of a wind farm and provide retail, office occupiers and residents across the 150-acres estate with electricity. “As the marginal cost of developing renewables has come down, there is an opportunity to reduce operating expense by procuring renewable power. It [also] gives you that security of a power supply.