The moderation in the outlook for real estate markets mirrors trends in the broader economy, PGIM says, adding:
“Forward-looking indicators, such as the PMI and the European Commission’s Economic Sentiment Indicator, are still at levels consistent with expansion, but have weakened over the past year. GDP growth has slowed, while lingering geopolitical risks – among them Brexit, protests in France and overspill from global trade conflicts – are weighing on the outlook.
“On the flipside, policymakers are adapting their approach to prevent a more severe downturn. Fiscal policy is being loosened – or at least being tightened less – in most major European countries, while the outlook is that interest rates stay lower for longer than previously anticipated.
“While 2019 was initially set to be the year that the ECB and other European central banks would start tightening, weaker signals on growth and inflation appear to have postponed interest rates increases for now, although QE is being scaled back. Real estate investors are concerned about yield levels, but loose monetary policy looks set to continue to provide support for pricing through 2019.”
Investment volumes tailing off
Set against this backdrop, there is significant ‘dry powder’ capital looking to get into European real estate, but stock in many markets remains restcited, curtailing investment volumes in H2 2018 through to H1 2019. This investment activity slowdown both reflects the downward shift in economic sentiment and is a function of country-specific factors, such a Brexit in the UK, which has caused capital flows to the UK from Continental European and global investors to fall sharply.
By contrast, France and Germany, Continental Europe’s two largest markets, are faring better. Driven by overseas demand for office assets, Germany recorded higher transaction volume than the UK in 2018, according to Real Capital Analytics, for only the second time since the global financial crisis. Meanwhile, France recorded a significant increase in deal volume last year – despite concerns about domestic politics and the pace of economic growth.
PGIM Real Estate picks up the trends:
“It is important to note that movements in wider economic sentiment only tell part of the story. Low yields in major markets mean that investors are finding deal underwriting more challenging, especially given recent downgrades to the growth outlook. According to RICS, up to 80% of investors view pricing in France and Germany as being expensive (see exhibit EU2). Low availability of stock – not all real estate is investable – is also a factor that continues to hold back activity.
“However, in a multi-asset context, real estate still offers attractive risk-adjusted returns. Income returns are low but remain elevated compared to, for example, fixed income assets, such as investment grade corporate bonds. According to INREV’s most recent survey, capital raised for European strategies remained above €30 billion in 2018, broadly in line with the total raised in 2017 and above the peak in 2007, prior to the global financial crisis.
“As a result, it looks like investors will still have plenty of capital to deploy throughout 2019. The paradox is that at the same time as investors have concerns about pricing, especially in major markets, several years of strong capital raising mean they are sitting on record levels of dry powder. If anything, the weight of capital available points to pressure on yields to fall further.
“With so much capital to deploy, if there were a downturn that caused a softening of pricing, it would likely quickly turn into a buy signal, especially with interest rates still at very low levels and the prospect of further QE if required. Unless liquidity dries up – or markets are hit by an unforeseen event – the risk of a sharp outward yield movement looks contained for now.”
PGIM Real Estate’s analysis continues tomorrow.