Outlook for offices improves with emphasis on ‘prime’: AEW

New investments in prime offices are now projected to generate the highest returns of any sector at 9.6% pa over the next five years, according to real estate asset manager AEW.

This is attributable to the extent of the sector’s re-pricing, which was bigger than anticipated in both 2023 and Q1 2024, and is set to continue into Q2 2024, the firm said. A stronger rebound is expected for offices compared to other sectors after repricing in the sector which was sharper than other sectors.

AEW said in a statement that the precise timing of the rebound in offices remains uncertain as offices still attract negative sentiment and there are still refinancing challenges for the asset class. There also remains a clear distinction between prime and secondary offices.

AEW published the findings in its 2024 Mid-Year European Outlook in which it also states that because inflation has reduced and is close to targets, central banks are widely expected to begin reversing some of the rate increases during the second half of the year, on the assumption that inflation, bond yields and real estate borrowing costs further reduce.

“Even with the continued global geopolitical risks, our latest outlook confirms that the recent improvement in investor sentiment is justified,” AEW’s head of research and strategy Europe Hans Vrensen said. “Despite lingering concerns towards the sector, our return projections for new investments into prime offices have now pushed it into the top slot. It should allow more investors to take a selective, yet more proactive approach to investment in European real estate and liquidity to return to the market. With the cost of debt expected to come down, this should allow much of the remaining debt funding gap to be resolved in the next few years.”

He added that the relative attractiveness of real estate has improved and is in line with the 25-year average.

AEW’s latest relative value assessment indicates that over 93% of the 168 covered European markets classified as attractive (101) or neutral (55), based on its updated forecasts.

In terms of countries, Germany remains top in terms of relative value with the most attractive markets. On an individual market basis, UK prime residential ranks top, with Spanish and Belgian prime logistics, and Dutch and German prime offices coming out top in their respective sectors.

The relative value analysis incorporates AEW’s latest rent and return projections. AEW’s base case forecast shows a small reduction in its average prime rental growth estimate to 2.1% p.a. for 2024-28 from 2.2% in the firm’s 2024 Outlook, published in November 2023. At 2.7% and 2.5% pa logistics and residential remain the top performing sectors for prime rental growth, with offices at 2.2% and retail at 1.6% pa.

European real estate investment volumes dropped to €150 billion in 2023, which was just over half of 2022’s total volume. AEW expects 2024 European investment volumes to come in only slightly ahead of that at €160 billion as bid-ask spreads between sellers and buyers remain high. With re-pricing expected to continue until mid-2024 and AEW’s base case scenario assuming lower projected bond yields, the firm’s predication that prime property yields will move in by 20 to 65 bps across all sectors over the next five years remains unchanged. However, as yields widened more than previously anticipated in H2 2023, this yield tightening is from a higher level than before.