In its 2021 European real estate outlook, “After the Storm” AEW explores how investors can best navigate out of the current crisis.
Despite the recent news of a potential vaccine, 2021 looks to be a year characterised by a slow recovery hindered by both COVID-19’s impact on the wider economy together with the latent existing headwinds of unresolved trade frictions and political uncertainties.
The report highlights a return of non-performing loans (“NPL”) as the COVID-19 crisis drives a deterioration in consumer and corporate credit quality. As a result of upcoming NPL portfolio sales, AEW sees clear opportunities in mispriced, good quality secondary assets across the board. Prime retail should also prove attractive in 2021 following recent repricing and the pending shift to more sustainable turnover based rents.
Commenting on the report Hans Vrensen, Head of Research & Strategy at AEW, commented: “When we issued our “Calm before the Storm” outlook for 2020 we fully anticipated some form of catalyst to end real estate’s extended run. What we did not expect was that that volatility would be created in the form of a global pandemic that would cause unprecedented disruption to the way we all live and work. While worse than the GFC in its immediate economic impact, strong policy responses from governments have softened the repercussions, so far. However, we expect the related lower for longer interest rate environment to further increase investor appetite for real estate, underpinned by the long term asset backed income it offers.”
“As we emerge from the crisis, logistics and residential will continue to be our top picks. However we also expect to see opportunities in prime retail, as values bottom out and rents are rebased or restructured to become more sustainable. We also expect to see the re-emergence of NPL opportunities as they did post GFC, although to a lesser degree as lower supply and more conservative lending have reduced the downside risks.”
Rob Wilkinson, CEO of AEW, added: “The extent to which the real estate sector has evolved and been impacted by the COVID-19 crisis over the course of this year has surprised everyone. Our long term investments strategies such as logistics and residential have continued to perform well, as the pandemic has accelerated trends that were already prevalent, and we will continue to invest in these areas. With some light now at the end of the tunnel as we look towards 2021 we are also well placed to use our European network to deploy our clients’ capital into opportunities which we expect to emerge as markets adjust to the recent COVID-19-related volatility.”
Key findings of the report include:
– Increased universe of investment opportunities opening up in our base case risk-adjusted return scenario, with 90 of the 103 markets assessed now attractive or neutral for 2021-25, a significant improvement from the 77 attractive markets identified for 2020-24.
– 2020 should prove to be a year of re-pricing in both rents and yields, especially in retail where relative value improves after 2020 and more markets become attractive. The acceleration of structural changes arising from the pandemic will continue to increase e-commerce penetration and reduce retailers’ ability to pay rents. This should drive more leases to be agreed on turnover rents, particularly in the UK. The longer term upside of this shift is a more sustainable situation for both tenants and landlords.
– Logistics and office rents show continued resilience with the impact of working from home being exaggerated and AEW predicting office take-up recovering with economic growth, when the vaccine can be introduced in 2021.
– Regardless of the eventual speed of the economic recovery, rental growth and collections will be lower as many occupiers are likely to be slower to commit to expansion space and some might downsize or sub-let. Despite this negative impact on occupiers, our overall outlook remains positive as the new supply of space is reducing.
– While our debt funding gap analysis (AEW Research & Strategy Publication titled “COVID-19 triggers re-financing issues” ) confirms that refinancing issues will be less in the COVID-19 aftermath compared to post GFC. This is broadly consistent with the expected increase in NPL ratios due to a COVID-19 crisis led deterioration of consumer and corporate credit, with new highs being reached for NPL ratios in Italy, Spain, France and the Netherlands.
– The debt funding gap identifies a significant refinancing risk, particularly in UK retail.
– As a result of banks selling NPL portfolios to bridge the debt funding gap, there will be numerous value-add opportunities for good quality but mispriced collateral assets.
– The reversal in interest rate policy expectations is expected to keep prime property yields low and prime capital values stable for the next five years as the economic impact from the pandemic has locked central banks into keeping rates and government bond yields lower than previously expected and for much longer.
– Of the five largest European economies, Italy and the UK are expected to suffer the largest declines in both the base case and downside scenarios. This is even before the impact of a potential no-deal Brexit on the UK, which would likely be spread out over many years.
– Despite short term concerns being focused on the pandemic, climate change adaptation and mitigation has also moved up the agenda helped by better analytical tools(AEW Research & Strategy Publication titled “Managing & pricing climate risk”). The related risks to long term capital values continue to be underestimated based on currently available data.