Despite Europe-wide lockdowns deals have continued and a bounce back is expected.
The pandemic has shown how resilient real estate investors can be. Last year the market started on a high and then screeched to a halt in April and May, because of restrictions on movement and the economic shock, but it sprung back into life towards the end of the year.
“There are still deals being done now, despite the lockdowns,” says Tom Leahy, director of market analysis EMEA at Real Capital Analytics. “Real Estate investors have found a way of coping with the pandemic.”
Q1 2020 was the best since 2015, then it slowed down but it picked up again in Q4, when transactions were on a par with the first three months of the year, adds Leahy.
Transactions fell by 44% in the year, but December 2020 showed a year-end boost to deal flow, which augurs well for 2021.
Germany on top
Most of the capital went to Germany, far ahead of any other country in Europe, largely thanks to its strong domestic investor base, which accounted for two-thirds of transactions. In second place was the UK, where cross-border investors did most of the deals. France, the Netherlands and Sweden follow.
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Other countries performed well, albeit on a much smaller scale. “Norway, Switzerland and Denmark stand out, because they attracted a lot of capital and actually did better in 2020 than they had done the previous year,” says Leahy.
A sector-based hierarchy has emerged as a result of the pandemic. Hotels are at the bottom, with a drop of nearly 60%, retail and offices are in the middle and logistics, apartments and student housing are towards the top.
Top of the list is grocery retail, “the only part of the market that actually grew in 2020”, Leahy notes.
‘Distress tends to lag, as happened after the GFC. We expect there will be a pick-up in distressed sales later this year, especially in hotels and retail.’
Tom Leahy, Real Capital Analytics
The divergence plays out in pricing as well. Pre-Covid-19 prices of UK industrial and logistics were already going up, retail was going down and offices were in the middle, and these trends have been accelerated by the pandemic.
Surprisingly, distressed sales were only 1.2% of the market, less than in previous years, according to RCA data. But the worst is yet to come, warns Leahy: “Distress tends to lag, as happened after the GFC. We expect there will be a pick-up in distressed sales later this year, especially in hotels and retail.”
The short-term effect of the pandemic has been negative for offices, but longer term more space will be needed to guarantee social distancing while allowing people to go back to the cooperation, mentoring and social interaction that can only happen face to face.
“More attention will be paid to the quality of the building and to the health of tenants,” says Herman Kok, head of research at investment manager MARK. “It will become a differentiating factor, so there will be a lot of upgrading of buildings to adapt them to new, post-pandemic standards.”
When the lockdowns end and life returns to normal, people will want to go back to the office, but may not want to do long commutes anymore, preferring to work more locally. “I see a bright future for regional offices,” says Richard Pilkington, senior managing director, head of European real estate, at Cain International. “Out-of-town offices will be a winner on the back of the pandemic.”
In 2020 office transactions in Europe were worth €94.2 billion and investment declined by 35% compared to the previous year, according to new RCA figures. Despite last year’s upheaval, offices are still in the top three sectors as chosen by institutional investors.
“Demand for core properties seems robust and pricing hasn’t changed substantively, but the real test will be when secondary and tertiary assets come to market,” says Leahy.
Meanwhile, London is in limbo, but the real estate market is ready to spring back into life. The third lockdown at the beginning of the year has had a dampening effect on the market, but there are high hopes that the successful vaccination programme will lead to a bounce back in H2.
“London always reinvents itself, changing occupier profiles,” notes Vanessa Muscarà, director, head of research & strategy at Europa Capital. “It is driven by fundamentals and global relative value.”
Change of occupier
Tech and media companies have more than filled the gap left by some banks downsizing or relocating to mainland Europe because of Brexit.
“Financial services will continue to be important, of course, but London is no longer all about banks,” says Jamie Olley, principal, capital markets group, at Avison Young. “Since the GFC we’ve seen the financial sector reducing demand as an occupier and headcount reductions have been going on for a while.”
‘People see the light at the end of the tunnel but we don’t expect a huge amount of activity until the beginning of Q3.’
Richard Pilkington, Cain International
The mix of occupiers has changed, he says: “There are less banks but more professional services, including some very large US law firms, more tech, media, education and life sciences.”
Deutsche Bank used to have a 2 million sq ft campus, but now it has downsized to a 750,000 sq ft office. Amazon, on the other hand, “didn’t have a footprint at all but now have twice as much space as Deutsche Bank in interesting locations all over London”.
Deal brings certainty
The UK’s deal with the EU did not include financial services, but it has provided much-needed certainty to international investors, giving them another reason to commit. “There’s always capital looking at London,” adds Olley. “Last year investments were £9 billion, down from £13 billion in 2019, which is a pretty good figure, considering.”
H1 is expected to be slow, with little stock coming to market as investors wait for pandemic restrictions to end. But H2 could be a very different story. “It is encouraging to see so many investors looking at value-add and short-term opportunities,” continues Olley. “There’s also very strong demand for development sites in good locations.”
The market is ready to step up a gear but caution will be the watchword. “We’re seeing a real flight to quality,” says Olley. “Values and pricing will sharpen for the best assets and the longest income.”
Gateway cities will continue to play a big role, quality offices and core assets will be in demand, although there are concerns about the prices of beds and sheds.
‘London always reinvents itself, changing occupier profiles. It is driven by fundamentals and global relative value.’
Vanessa Muscarà, Europa Capital
There is also tension in the market between the eagerness to deploy capital and the need to tread cautiously.
“There is a lot of pent-up capital waiting to be deployed, but appetite is way down the risk curve’, says Cain International’s Pilkington. “People see the light at the end of the tunnel but we don’t expect a huge amount of activity until the beginning of Q3. It will take that long before investors feel confident enough to deploy their capital.”
Despite the slowdown due to the pandemic there is optimism and a sense that things are getting better. “Of course there are risks going forward, but there are also many reasons to be cheerful about Europe’s prospects,” says Oliver Kummerfeldt, European real estate analyst at Schroders. “It’s a land of opportunity, depending on access to product and your risk appetite.”
The list of positive factors includes the vaccination programme, leading to the hope that restrictions will be eased and consumption will drive growth again; and the signing of the Brexit deal, which is removing much uncertainty from the market.
Meanwhile, the ongoing recovery in Asia will help export-driven economies like Germany, Kummerfeldt says, the EU Recovery Fund is in place and there have been no major bankruptcies.