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DWS: investor demand and weak deal flow mismatch driven by lack of product and markets trading at capacity

Investment volumes were down 25% year-on-year during the first three months of 2019, resulting in the weakest quarter for five years. Although preliminary data suggest that second-quarter volumes returned to the stronger ground, half-year volumes are still well down on last year. However, overall investor sentiment towards European real estate jumped to a five year high in the first quarter of the year, according to the PMA, with 70% seeing an improvement in investment intentions.

Simon Wallace, Head of Research, Europe, at DWS, explains:

“We could also see a lagged impact from the stronger demand, as anecdotal evidence suggests that activity is picking up notably going into the second half of the year. Nevertheless, while a gradual rise in new completions will provide additional investment stock, some investors are reluctant to adjust hurdle rates too far downwards, meaning that current pricing levels at the prime end of the market may still be difficult to justify for some.

“Although overall activity is down, a number of markets are still seeing significant momentum. Last year, Spanish volumes were very close to the previous year’s record total, and in the first half of this year volumes were up by almost 40% compared to the same period a year ago. Elsewhere, the Nordic region and parts of the CE region have also seen strong demand so far this year, although demand for UK property continues to fall, with volumes down by more than 30% year-on-year in the first six months of the year.

“While the investment slowdown has been relatively widespread so far, it is the retail sector that has borne the brunt of the fall. Sentiment towards retail investment has also dropped to the lowest level since at least 2001. Sentiment towards the office sector remains positive, with investors attracted by rising rents and occupancy rates, and logistics sentiment is close to a post-GFC high.

“Nevertheless, despite the structural drivers supporting the logistics sector, concerns over rising construction volumes are beginning to creep in, leading to a modest decline in sentiment in the early part of this year.

“One area that continues to attract significant interest is the living sector, encompassing hotels and residential, where investment activity has so far matched the 2018 year-to-date total. At this stage in the cycle, there is often a temptation to drift up the risk curve, but many investors are still looking for defensive assets that offer some protection against wider economic risks.

“While no sector can be immune to the economic cycle, hotels offer some international diversification, benefitting from visitor flows and structural growth in international tourist numbers. At the same time, residential occupancy rates are often higher than those for commercial space, while rents tend to be more resilient to a market downturn.”

james.wallace@realassetmedia.com