We’re now halfway through 2021, and it’s time to look at the current state of European commercial property and at the longer-term implications of the pandemic’s impact on it.
While we were perhaps hoping to be clearer by now regarding economic recovery, the pandemic continues to interrupt European economic projections. The global economy is growing, but there are still many challenges that make it difficult to predict with any certainty when we can consider full recovery underway.
In terms of property investment, the market continues to be led by European investors and I think we will see more investors begin to take more risks in the second half of the year. Let’s look at it all in more detail.
How much has commercial property in Europe been affected by the pandemic
The European economy is responding more strongly than some predicted. This is due to support from the European Central Bank (ECB) boosting the Pandemic Emergency Purchase Programme (PEPP) in order to stimulate economic growth.
However, according to Focus Economics, inflation is set to stay low (below 2%) well into 2025. This means that further policy changes will probably be needed, and interest rates could be lowered below zero. As the vaccination programmes continue to ramp up, we can expect to see a strong bounceback by the end of the year.
The Euro continues to hold at the strongest level against the US dollar since the first half 2018 and we will continue to see increased trade between the US and Europe thanks to a new President.
Real estate market activity is increasingly driven by European investors. In 2020, according to Preqin, the number of real estate funds that closed was the lowest in a decade. Furthermore, there has been an increase in the number of funding vehicles targeting European real estate. This is up to more than 25% in 2021, from 18% in 2020. This is a strong indicator of investor confidence in European real estate of all kinds, including commercial and industrial.
Competition within industrial and logistics is strong
Prime yields can be expected particularly in logistics and industrial commercial property. Competition in this area is strong, particularly in logistics found in key distribution hubs across Europe. It’s likely that there will be increased yields within the retail sector thanks to the uptick in activity within food and beverages.
We are now seeing owners becoming more realistic and pragmatic with their investments. Some investors are starting to commit to new developments, as they want to catch the investment cycle firmly within the recovery phase. Developers across Europe are looking for alternative funding.
Office vacancy rates are still historically low, due to the proliferation of lockdowns and remote working patterns since the pandemic began. There is a growing demand for more logistics property and for purpose-built high spec office space. The pandemic is changing the attitude of developers and buyers regarding office space, green credentials, retrofitting to become environmentally viable and wellness within the workplace. These are all boost demand for new spaces that fulfil all of these criteria.
Investment opportunities are also increasing in redevelopment or repurposing projects. For example, the conversion of defunct retail space to local fulfilments centres or for storage areas for vaccinations are underway in many regions. Similarly, offices that are no longer in use could be converted into residential space and empty malls to mixed-use commercial, residential and community spaces. These kinds of investments will deliver returns as the economy fully recovers, and it’s possible for investors to capitalise on the rental market cycle at just the right time.
Office occupation levels are still uncertain in the long term
Decisions regarding office occupation are still cautious even as we head into the second half of the year. While most corporations haven’t made definitive changes to their office space footprint quite yet, they are certainly considering their options. Layout plans will change, as will the space deemed necessary for a healthy office space.
It’s likely that there will be a continuing rise in office vacancy rates as some companies decide to shift to remote working permanently, and others close down. Vacancy rates for offices across Europe are hovering around historic lows. However, vaccinations continue to rollout at an impressive pace, and this could mean people going back to offices sooner rather than later. However, the world is contending with new variants all the time, and it’s likely that there will be a need for vaccine boosters even as early as the end of 2021.
The role of the office will always be important for collaboration purposes. According to a survey by Savills, 89% of employees consider the office to be important in their working life. I think there will be a surge in demand for high quality offices, potentially in mixed use spaces. Connectivity and location will be the most important factors for the employees, who will probably want to mix working from home with a couple of days in the office per week.
Venture Capital investment flowing into major European cities
Core cities in Europe (Berlin, Paris, London) will continue to attract the highest level of venture capital investment. By December 2020, 42 billion Euros worth of VC funding had been raised. This was split 14 billion Euros to the UK, 5.4 billion to France and 7.4 billion to Germany. Collectively, this marks an increase of 11% on 2019, driven by life sciences, fintech and mobile tech. All of these will continue to drive demand for occupancy over the next couple of years.
I think that the next six months up to Christmas 2021 are a good time for occupiers to strike rental deals. Rents are likely to adjust, but it’s likely that vacancy rates won’t rise significantly across core markets. Older office space will suffer the most, and could be repurposed to other uses, such as industrial or residential.
For the logistics subsector, I expect competition to remain fierce. Urban logistics and big box sites are in demand by landlords who are keen to move quickly into this sector. Traditionally, it’s only been responsible for about 11% of investment volumes, but this is set to change. The enormous consumer shift towards online shopping directly because of the pandemic has led to a sharp rise in the need for storage, warehousing, logistics and delivery hubs.
Availability of warehouse space in most of the core markets is quite limited, and a small number of businesses control the supply. This could mean positive rental growth for some retailers in some locations. Any second-hand space that returns to the market duet to companies failing will most likely be repurposed by e-commerce companies.
The relative lack of product will mean investors fund more new developments within this subsector. Investors should look out for hotspots in vacancy rates as these are likely to offer the best growth prospects for rental income. According to Capital Economics, we’ll see the strongest rental growth within logistics in the Benelux and Nordics markets by 2026.
|Sarem Eddie Kerman is Investment Director at London-based Pelican Partners, a private equity and real estate investment firm.|