SPR/IPF European Outlook Seminar
Schroders, 20 September 2023

Waiting for a window of opportunity

The darkest hour is often just before the dawn. Likewise, after a period of real estate market crisis, the best investment vintages often emerge, stressed Oliver Kummerfeldt of Schroders Capital, who spoke at this event.  In a presentation that looked for the brighter spots in what was a generally gloomy outlook for Europe, he proposed that the yield decompression seen in 2022-23 was now slowing, with the possibility that pricing could stabilise in the next few months.  Furthermore, global managers have been left with a lot of ‘dry powder’ from more prosperous times that they will still need to invest.

Innes McFee of Oxford Economics, who gave the opening macroeconomic view at this joint SPR/IPF event, agreed that 2024 would be a year of weaker economic growth in Europe, with inflation continuing at elevated levels and interest rates therefore needing to remain higher than historically. However, Kummerfeldt mentioned that his own organisation’s view is for rates to start coming down later in 2024, although he admitted that this was somewhat ‘off consensus’. McFee stressed that the link between wages and inflation had been strengthened, particularly in the UK, meaning that price rises were in danger of becoming entrenched.

Turning to real estate, McFee saw signs of recovery in valuation-based indices but noted that these did not seem to be borne out in the marketplace. Meanwhile market sentiment was extremely weak, while the current cost of debt implied a further price reduction of around 10% before prime offices in London or Stockholm would be affordable for leveraged buyers. However, one advantage of the high cost of debt was that development was no longer viable, meaning that the supply of space was static, giving values a foundation from which to come back relatively quickly.

Kummerfeldt emphasised the lack of development taking place in European offices, particularly due to high construction costs.  Leasing activity had been slowing but there was still activity from occupiers searching for more modern space, and this was resulting in a very polarised market.  The situation is very different to the US where occupancy has been much lower since the pandemic, due to the unattractive nature of many office locations, relatively long commutes, and more spacious domestic housing, he proposed. There is also a huge opportunity to upgrade European stock to be ESG compliant, given its comparatively old age.

Also on the plus side, he noted that European logistics are seeing low vacancy with supply remaining restricted, while many tenants have been strengthening their supply chains by onshoring and nearshoring, as well as diversifying their supply sources geographically, all of which have bolstered the demand for space.  And despite the overwhelming impact of inflation on consumers, there are some patches of light in the retail sector, for instance in the growth of discounting.

In the panel discussion that followed, led by Alan Dalgliesh, chair of the Property Research Trust, Kummerfeldt noted that there had been little distress in the market as yet, with investors largely selling assets selectively rather than being forced to sell, although the need would increase if markets continued to stagnate. The speakers agreed that some of the biggest downside risks – apart from inflation – now stemmed from geopolitics; what Kummerfeldt described as ‘interesting times.’ China was a big worry, but it would be important for real estate investors to distinguish between short-term ‘noise’ and longer-term influences. And he stressed that Europe still has advantages such as transparency, liquidity and (relative!) political stability which should continue to attract investment in its real estate  – and there would be many opportunities opening up to provide for an ageing population, for example.

Tim Horsey