There is still support for pricing in the form of a significant weight of available capital and low interest rates, fewer markets are reporting yield compression, reflecting investor perceptions about elevated pricing in many markets, says PGIM Real Estate.
With income returns at a low level and rental growth still sluggish, returns – for much of the cycle driven by sustained yield compression – continue to decelerate.
Greg Kane, Executive Director, Head of European Research at PGIM Real Estate, explains:
“In terms of pricing trends, there are differences across sectors. The clearest exception to the pattern is in the logistics sector, where investors continue to bid up pricing, both as a rotation away from retail and on its own merits, owing to improving occupier fundamentals. Rising demand among retailers and third-party logistics providers, while supply growth remains contained, points to improving prospects for rental growth.
“Office yields are increasingly stable across markets – with non-CBDs still reporting some compression as existing yield gaps narrow – while retail momentum is weaker owing to challenging occupier conditions. Uncertainty about future cashflow generation potential for bricks and mortar retail units is putting upward pressure on the risk premium for retail assets, most notably for out of town retail formats, such as retail warehousing and regional shopping centers.
“The upshot is that although pressure on yields to rise may remain contained, the era of returns being repeatedly boosted by yield impact is coming to an end. Performance through the next phase of the cycle looks set to instead be dominated by real estate operating fundamentals. European investors are set for a period of lower returns and an environment in which they will have to work harder to achieve outperformance.”
The increasing importance of income in the returns mix in the coming years, has renewed the cyclical focus once again back to the outlook for occupier markets. PGIM says while rents are, on average, above previous peaks, particularly in major core markets such as Berlin, Munich and Paris but there is still justification for an optimistic outlook.
According to PGIM, reasons for optimism include:
- development activity remains contained, compared to in the past;
- in office markets, vacancy is now at its lowest level since 2002, with several markets that had been struggling with oversupply since the late-1990s – including Amsterdam, Berlin, and Frankfurt – now reporting much lower availability, an effect of low supply growth, tighter planning and conversions of existing space to other uses; and
- office supply pipeline remains contained, although there are differences by geography.
PGIM Real Estate’s analysis continues tomorrow.