The UK has been ranked the most attractive location for property investors on a relative value basis over the next five years in AEW’s European Annual Outlook for 2023.
Out of 168 market segments covered by the outlook the UK came out on top for the second year in a row, but AEW cautioned that the European property investment market will experience some cooling due to a short, shallow recession in Q4 this year and throughout most of next year.
AEW estimates full-year investment volumes in the European real estate market will hit the €260bn mark this year, compared with the record €350bn racked up last year. This fall largely reflects the effects on leveraged investors from the doubling in borrowing costs over the last 10 months.
It estimates there will be a debt funding gap of €24bn for the next three years in the UK, France and Germany as ‘re-financings of maturing loans are expected to face issues from the decline in capital values and lenders’ reduced risk appetites pushing for lower LTVs’.
In AEW’s relative value analysis, only five markets are considered ‘attractive’ – Paris light industrial, Berlin and Zurich logistics, and Stockholm and London shopping centres – while 47 are classified as ‘neutral’ out of the 168 market segments covered, with projected returns for all property across Europe during 2023-27 remaining positive, although yield widening has pushed forecast returns to 4.0% per annum across all segments, down from 4.7% half a year ago
Unsurprisingly, logistics is expected to generate the highest returns of any sector over the next five years at 5.4% per annum, with solid rental growth offsetting yield widening. Prime shopping centres came in second place with returns of 5.1% per annum on the back of high current yields. AEW believes shopping centres will be the top income producing sector over the next five years, with base case income return projections remaining relatively stable.
Hans Vrensen, managing director, head of research and strategy Europe at AEW, said: “The first European-cross border war in 80 years has pushed inflation to record levels. Whilst we believe the peak of inflation has now passed in our base case scenario, the economic backdrop and higher borrowing costs have significantly altered the outlook for real estate investment to the downside. Real estate investors face a more challenging market environment.
“However, our research shows that opportunities do remain for investors, who are well positioned with capital to deploy. Also, the last few years have taught us that the macro-environment can change quickly. Our forecasts cover a five-year forward view, but we think investors need to be more prepared in the current volatile environment as the situation may change on the upside or negatively.”
He added: “Unsurprisingly logistics, despite the largest expected yield expansion, continues to be the most attractive sector given the anticipated rental growth. We also project positive prospects for income growth in residential. Prime shopping sectors remain attractive on a total returns basis, whilst the impact from working from home on offices is less severe than previously anticipated. What’s significant, however, is that the real estate market continues to experience supply limiting factors, such as rising debt financing and construction costs, across the board. We expect these supply limitations to counter the negative impact on demand from wider economic headwinds.”
