What’s Next for the European Property Markets?

Author: John Scott - Head Of Institutional Investments @ NdG

COVID-19’s impact on investment capital flows into the European private real estate market reflects unprecedented uncertainties for both buyers and sellers. As cross-border travel restrictions have impeded the ability of investors to conduct due diligence and to complete deals, institutional property transaction volumes have declined ~ 30% y/y.

Despite the current wait-and-see investor attitude, forward-transactions encompassing a development or value-add component have increased. A recent PERE survey indicates that 70% of the capital raised in 2Q20 for private equity real estate has been earmarked for opportunistic investment strategies … an indication that a subset of forward-looking investors, who believe that COVID-19 disruptions will eventually prove to be cyclical, are attracted to projects possessing attractive J-curve return attributes.

forward-looking investors, who believe that COVID-19 disruptions will eventually prove to be cyclical, are attracted to projects possessing attractive J-curve return attributes.

Despite understandable investor concerns about the pandemic’s magnitude and duration, the logistics sector has demonstrated continuing resilience. Indeed, prior to the COVID crisis, investment volumes in the European logistics sector had risen from the prior market trough in 2009 of ~ €7 billion to ~ €35 billion in 2019.

E-commerce has been the key demand driver of this sector which has benefited from the broadening acceptance of the online shopping channel. In our opinion, continuing changes in consumer behavior, which have accelerated due to the pandemic, will further the demand for logistics properties ranging from large-scale distribution centers to urban delivery hubs in inner city areas.

In our opinion, continuing changes in consumer behavior, which have accelerated due to the pandemic, will further the demand for logistics properties ranging from large-scale distribution centers to urban delivery hubs in inner city areas.

The remarkable growth in the consumer adoption of e-commerce in the decade preceding COVID-19 reflects an underlying secular growth trend for on-line shopping. Indeed, this increasing acceptance by shoppers appears to be the ‘new normal’ as consumer preferences for online shopping further accelerates the well-established shift from “bricks-to-clicks.” Within this context, on-line retailers have expanded their existing logistics capacity while legacy retailers and supermarkets have endeavored to preserve their business model continuity with belated e-commerce capabilities.

As e-commerce further erodes the franchises of traditional retailers and lessens their requisite floorspace volumes, it is difficult to see how the sector’s growing oversupply of stores, excess square footage and structural vacancy rates will be ameliorated. The financial pressures attributable to an increased willingness of landlords to re-negotiate leases and the subsequent decline in rents have accentuated the retail industry’s systemic financial pressures. Importantly, these operational difficulties call into question the sustainability of retail floorspace capital values. Within this context, the conversion or re-purposing of large-scale retail parks and shopping centers appears to be economically unviable. Accordingly, investors have legitimate, challenging and yet- to-be answered questions about the appropriate valuation benchmarks for retail sector properties. Investors have legitimate, challenging and yet- to-be answered questions about the appropriate valuation benchmarks for retail sector properties.

Investors have legitimate, challenging and yet- to-be answered questions about the appropriate valuation benchmarks for retail sector properties.

Finally, with regard to pandemic related imbalances in the office sector, industry observers are understandably concerned about the dislocations attributable to the work- from-home (WFH) trend. Investors are asking, “Will office properties become the new retail sector?” In our opinion, it is unlikely. Historically, the office market has proven to be more adaptable than the retail sector to changing demand trends. In prior cycles, for example, when office markets have become structurally oversupplied, conversion to alternative uses has been a viable re-purposing alternative … especially in undersupplied residential markets which currently characterizes many major European cities.