Europe Part 2: What Should Investors Look for in These Challenging Conditions?
Feb 22, 2023
10 mins
As repricing linked to higher interest rates is taking place across all sectors and markets, investors should focus on two areas of opportunity where liquidity is playing a role. The first is where investment volume is showing some resilience and therefore pricing is expected to hold up better, while the second opportunity is to look for markets where investment volume has fallen quickly and the price correction has gone far enough.
The former is the case in the European living sector (Exhibit 3), where in the in the fourth quarter transactions in Germany and France only fell by small amounts, while they rose strongly in the UK, boosted by some large M&A student housing activity. A driver for living real estate investment appetite –and limiting the fall in investment volumes and the adjustment in yields –was that investors are still seeing a resilient rental growth story for example in apartments as supply shortages interact with rising demand for rental stock given high mortgage rates, which is expected to continue especially in the UK (Exhibit 3).
Exhibit 3: Living Investment Volume a Bright Spot Across Europe
The second opportunity is to look for markets where falling investment volumes have sped up the correction and pricing is approaching long-term fair value. Using our internal pricing model that factors in interest rates, risk premiums and expected rental growth, we’ve identified a target yield range expressing fair value (Exhibit 4). When yields reach that range, we are looking at opportunities on a long-term buy-and-hold basis.
Based on an analysis of major European markets across different sectors, taking into account the target yield ranges, our estimate is that the correction in pricing is already halfway done (Exhibit 4).
In some sectors, the adjustment is playing out more quickly, with the sharp drop in liquidity being an important contributing factor. After a quick pricing adjustment over the last two quarters and taking into account a still largely positive occupier market, logistics is already two-thirds of the way to adjusting to long-term fair value. The sector could soon turn into an attractive proposition again, in particular as positive medium-term demand drivers linked to online spending and supply chain expansion remain in place.
Our expectation is that investors with capital available to deploy will quickly see a window of opportunity opening upfor new transactions at more attractive yield levels, either where resilient transaction volume is limiting the expected rise in yields or wheredrying up liquidity is leading to prices adjusting quickly toward long-term fair value. These target yield levels could be reached as early as in the middle part of this year.
