The European real estate market environment remains incredibly uncertain. While the severity of the current recession is significantly worse than the global financial crisis, real estate markets have, at worst, been subdued.
Outright distress remains largely limited to the retail sector thus far, with rents and values falling significantly – particularly for out-of-town assets. However, this is increasingly occurring for some high-street locations also.
In other sectors, the full effect of the recession is yet to be felt, as tenants are being protected by a combination of short-term credit flows and generous employee retention scheme packages. But this cannot go on forever.
Similarly, when it comes to debt availability, lenders are understandably adopting a cautious approach. Lenders are delaying covenant tests and allowing short-term debt rollovers, rather than risking a widespread value correction by taking stronger action. Again, this cannot go on forever.
Despite the gloom, there are reasons for optimism. Interest rates remain low, which is supporting valuations, while we continue to report better-than-expected rent collection across most of our strategies. Throughout the market, investors have raised plenty of capital and have significant liquidity to deploy. The dilemma investors are facing now is whether to put the capital to work now or hold out for opportunities linked to a market correction that may never materialise.
Investors eyeing similar assets
It is clear a two-tier investment market is being established in Europe. Assets in resilient sectors, such as residential, or where there is long-term structural growth potential, such as logistics, continue to attract capital. Pricing in these areas has changed little from before the covid-19 outbreak.
In these sectors, particularly for assets that have tenants with strong covenants – or in countries such as Germany and the Netherlands, where the covid-19 impact has been lower – there is plenty of debt available and transaction volume is growing.
It is a different story when it comes to assets displaying a degree of uncertainty surrounding income generation, in struggling sectors such as retail or hotels – or those with risk on the leasing side, due to existing vacancy, short lease lengths or construction risk, for example. In such cases, debt is hard to access at higher loan-to-value levels and transaction volume is down sharply.
This means many investors are attempting to squeeze into a small segment of the market. Finding value in this environment is a tricky proposition.
A challenging office market
Finally, there is a lot of discussion about the future of offices in Europe. Across our major markets, office spaces are being reopened, but occupation rates remain subdued.
As such, uncertainty around the future of office space use – including costs that landlords and tenants may incur to meet evolving requirements related to covid-19 – remains high. Cities with an elevated reliance on public transport are likely to take some time to adjust back to some sort of normality.
Transacting in this sector will be challenging until there is increased clarity, or until we witness an adjustment in pricing that factors in the elevated risks.
Overall, it remains a tough real estate market environment in Europe, with numerous risks. The worst of the impact may be yet to come, so vigilance will be required. Nevertheless, opportunities are beginning to reappear, and we are evaluating where to effectively deploy the capital we have raised across our different strategies.
All investments involve risk, including the possible loss of capital. The comments, opinions and estimates contained herein are based on and/or derived from publicly available information from sources that PGIM Real Estate believes to be reliable. We do not guarantee the accuracy of such sources of information and have no obligation to provide updates or changes to these materials. This material is for informational purposes and sets forth our views as of the date of this presentation. The underlying assumptions and our views are subject to change.
Occurrences of epidemics, depending on their scale, may cause different degrees of damage to national and local economies that could affect the value of the investment. Economic conditions may be disrupted by widespread outbreaks of infectious or contagious diseases, and such disruption may adversely affect real estate valuations, the investments, and its potential returns. For example, the continuing spread of covid-19 (also known as novel coronavirus) may have an adverse effect on the value, operating results and financial condition of some or all of the investments, as well as the ability of the manager to source and execute target investments. The progress and outcome of the current covid-19 outbreak remains uncertain.
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