With European countries set to exit pandemic-era restrictions and move into their ‘post-COVID’ phase by late summer, Europe’s real estate markets are well positioned to mount a robust recovery, despite the complications posed by the Delta variant. This is among the main findings of the mid-year 2021 edition of the Investment Strategy Annual (ISA), the client report published by global real estate investment manager LaSalle Investment Management.
LaSalle has identified four key factors that will have an outsized impact on individual property markets and sectors’ performance in the coming years. These drivers of performance will be particularly influential in the medium- to long-term, as the influence of Covid-19 gradually recedes and the divergent trajectories of infections within different countries become less important in determining the prospects for real estate in each market. These are:
Structural changes to European property sectors, especially office and retail, and how these vary across the region – with the UK office and residential markets more likely to be affected by the increased prevalence of remote working as a permanent trend than Continental European cities, and Southern European countries characterised by lagging e-commerce penetration rates.
Polarisation in capital markets between favoured sectors, such as logistics and residential, and unfavoured, including retail and offices. LaSalle continues to advocate for investors remaining active on both sides of this chasm, seeking higher risk-return propositions in the former category and value investments in the latter. But despite some structural challenges in the unfavoured sectors, office and retail’s dominance of Europe’s investable universe may drive pricing for these assets back up to pre-COVID price levels, due to the finite supply of opportunities, the firm says.
Inflation impacting borrowing costs and property yields if its current elevated levels across Europe become entrenched over the longer term. However, LaSalle foresees a lower risk in Europe than the US due to lower levels of stimulus and weaker underlying price pressures, with current metrics distorted by unusual year-on-year comparisons and the unwinding of supply chain idiosyncrasies.
Political complexity remains a risk factor, with pivotal national elections looming in Germany and France, while Brexit has moved from an acute to a chronic phase that may continue to drag on UK service sectors, and especially financial services.
Service sector workers’ ability to be productive remotely means that the boost from the reopening of European economies to the retail and leisure sector was muted in offices, but LaSalle does forecast a broad-based post-summer return. However, the reports finds that the fundamentals of the market have changed. Across Europe, a modest 1.2% rise in vacancy rates over the year to Q1 2021 obscures larger increases in key markets like London and Paris La Défense. The return to market of a still-to-be-determined quantity of second-hand space deemed surplus to post-pandemic requirements is expected to play out over the coming years. Nonetheless, physical office space will remain important to corporates, with ESG (notably sustainability and net-zero-carbon) and wellness set to drive occupier demand and bifurcation in pricing.
While government support schemes have averted a worse outcome for retail than initially envisaged, insolvencies and store closures continue to drive down rents – most notably in Germany, the Netherlands and the UK regions – though retail parks, supermarkets and other grocery-anchored retail have been resilient.
The success of logistics continued in H1 2021, and while the reopening of physical retail may soften new leasing activity, some of the shift online will remain – more so in the densely populated UK and Netherlands, less so in more cash-based Spain and Italy, LaSalle says. Last-mile urban logistics units also remain in demand and LaSalle foresees rental pressures persisting for several years.
The residential market also continues to perform, including both perennially strong cities (Munich and Berlin) and those that had experienced softness pre-Covid (Stockholm, Helsinki and London). Certain sub-segments faced challenges: care homes and student housing were directly impacted, although less than initially feared, while locations with high tenant mobility suffered occupancy declines as young professionals moved away from the office – a trend unlikely to reverse in amenity-poor submarkets only offering adjacency to office jobs.
Brian Klinksiek, Head of European Research and Global Portfolio Strategies at LaSalle Investment Management, said: “We have understandably been closely focused on how different European countries have performed in their response to the pandemic, with the UK and EU often appearing on divergent recovery paths because of mismatches in the pace of vaccine roll-outs, the resurgence of cases or the prevalence of new variants. But the broader economic path that matters to real estate performance is measured over quarters and years, not days and weeks, and the UK and Continental European markets now look to be approaching a ‘photo finish’ in terms of when they exit the pandemic. As the overwhelming short-term impact of Covid on real estate recedes, it will be other factors – namely, structural changes to real estate use cases, capital market polarisation, inflation and political complexity – that determine how different European sectors and geographies perform in the medium- and long-term.”
