With healthy fundamentals and attractive valuations, European real estate securities are positioned to deliver meaningful relative real returns despite rising interest rates and slower growth.
By Rogier Quirijns, head of European real estate, Cohen & Steers.
Impact of Russia-Ukraine war on real estate so far limited
Russia’s invasion of Ukraine created a commodity supply shock that has driven up inflation and raised concerns over the pace of global growth in 2022. Continental Europe is particularly exposed, as those countries are more reliant than the U.S. or the U.K. on Russia-Ukraine commodities.
The European Central Bank has lowered its 2022 forecast for economic growth in the eurozone to 3.7% from 4.2%, reflecting the impact of the war on energy prices, consumer confidence and trade. If the disruptions to energy supplies and confidence last longer than expected, and global supply chains remain strained, regional growth could slow further to 2.5%, according to the ECB.
Because listed real estate can perform well relative to traditional asset classes in periods when economic growth is slowing and inflation is rising, the biggest upside risk to the outlook for European real estate, in our opinion, is recession. The chances of a eurozone recession depend largely on the flow of natural gas from Russia. While most European countries have created plans to dramatically cut back on their reliance on Russian gas, energy independence will take years to reach.
For real estate companies, the impact of the war is indirect, and hinges on the economy. We believe the crisis creates a unique buying opportunity, especially given the fact that the asset class still has short-term upside potential from the pandemic reopening trade.
The near- and long-term implications of the war for the economy may ripple across real estate sectors but at the same time the re-opening trade will likely have a short-term positive effect on some sectors.
For example, near term, consumers might spend less disposable income because of higher costs, potentially impacting the retail sector. However, retail sales data held up well through the Covid crisis and we expect them to remain so for the long term.
Longer term, migration and manufacturing trends could result in incremental logistics and housing demand in certain markets. Further deglobalization and investments in efforts to reduce Europe’s energy dependency could lead to structurally higher inflation and more on-shoring (Exhibit 1).
Learning from past crises
A look at the performance of real estate relative to equities in the aftermath of other significant crises such as the global financial crisis or the European debt crisis, can provide some perspective on the resiliency of real estate. Historically, European listed real estate securities have recovered in line or better than European stocks in the months after bottoming in the wake of global crises (Exhibit 2).
Real estate fundamentals remain sound
Despite the possible impact of slower growth and higher inflation on listed real estate securities, we believe real estate fundamentals in Europe remain healthy. Demand growth in certain sectors creates favorable supply-demand characteristics, which can allow developers to translate higher development costs into higher rental levels. In some areas, rising occupancy levels may allow landlords to raise rents.
Construction starts in many sectors have been delayed by labor shortages and higher costs for building materials, reducing supply pressures. This dynamic has allowed landlords to raise rents, leading to above-average cash flow growth (Exhibit 3). Meanwhile, listed real estate has continued to offer attractive levels of secure and long-dated inflation-linked income relative to traditional asset classes.