COVID-19 is accelerating bifurcation in European real estate market – LaSalle Investment Strategy Annual

The most successful investors in European property in 2021 will be those who can be active on both sides of a growing chasm between favoured sectors such as logistics and residential, and less favoured property types including retail and office assets, according to the 2021 edition of the Investment Strategy Annual, the annual client report published by LaSalle Investment Management, the global real estate investment manager.

While so-called ‘shed and bed’ assets are benefiting from a number of compelling secular trends including e-commerce growth, urbanisation and a growing investable stock, investors must choose assets carefully to avoid overpaying in these highly competitive segments of the market. Moreover, investors should cautiously take advantage of mispriced assets as they emerge in the retail and office sectors.

The ISA finds that the pandemic has accelerated the long-term process of investors rebalancing their portfolios away from traditional sectors such as office and retail into logistics, residential assets and niche sectors including healthcare properties and self-storage facilities. While this trend is global, the starting point in Europe is more extreme. Office and retail still account for around 72 per cent of core portfolios in Europe, compared to about 49 per cent in the US, according to MSCI data, but this proportion is expected to fall more rapidly as the bifurcation in the market gains momentum.

While the office sector faces an uncertain period as tenants review their requirements in the wake of the pandemic, particularly in cities with higher-density floorplans and longer commutes, the importance of in-person collaboration means the overall depth of tenant demand from a wide variety of sectors and companies’ preference for high-quality office space in accessible locations are both expected to persist.

In terms of retail, LaSalle expects to see the bottom of the current cycle for prime retail pricing in 2021, while lesser-quality retail may take longer to find a floor. Retail locations surrounded by residential rooftops and catering to daily necessities are expected to remain most resilient.

The report also reflected on the degree to which COVID-19 has subdued investment activity across the region. European commercial real estate investment volumes dropped by 17% year on year to their lowest level since 2014 – albeit faring slightly better than in North America or Asia Pacific – as the lack of in-person meetings and an inability to visit sites disrupted cross-border capital flows.

Germany, Europe’s largest investment market, outperformed the regional average, with transaction activity falling “only” by 15 per cent in the first nine months of 2020. The main factors supporting Germany’s relative resilience are its safe-haven status; the size, scale and sophistication of the domestic investor base; its more effective response to the COVID-19 pandemic; and its strong public finances. By contrast, countries harder hit by COVID and its economic fallout have seen bigger drops in investment. In the UK, the second largest investment market in Europe, volumes were down 30% over the same period; volumes also declined substantially in France, Spain, Italy, and the Netherlands.

In terms of lending, LaSalle remains bullish for the private debt market, as traditional lenders continue to favour core, stabilised assets with lower loan-to-value ratios. Mezzanine, higher-leverage whole loan strategies and transitional financing will also likely play an increasingly important role in the liquidity of the real estate market.

Brian Klinksiek, Head of European Research and Global Portfolio Strategies at LaSalle Investment Management, said: “The trends driving the growth in the logistics and residential sectors have only been accelerated by the pandemic. With concerns about the future of offices adding to longer-standing worries about retail, ‘TINA’ (There is No Alternative) has joined ‘FOMO’ (Fear of Missing Out) as reasons investors are targeting European ‘sheds and beds’. This has created a chasm between logistics and residential on the favoured side of a great divide, and office and retail on the unfavoured side. In our view, the investors in European property that will be most successful in 2021 will be those who can be active on both sides of the chasm.”

Also included in the ISA report is LaSalle’s European Regional Economic Growth Index (“E-REGI”) for 2020, which ranks European cities and regions based on their medium-term economic growth prospects, level of human capital and wealth and the quality of the business environment, relative to the European average.

For the fourth year in a row, London topped the index, despite ongoing Brexit uncertainty, indicating that the UK capital remains Europe’s leading market for real estate as measured by estimated occupier demand. Also placed prominently in the 21st annual E-REGI Index were Paris (2nd place), Luxembourg (3rd), Stockholm (4th) and Munich (5th).

Jacques Gordon, Global Head of Research and Strategy at LaSalle, said: “In the 2021 edition of the ISA, our advice for investors is to hold the course. On the other side of the pandemic lies a landscape that real estate investors will recognize, even if it will also be different in surprising ways. The strength of the post-vaccine recovery could be one of those surprises. The secular trends we follow have been simultaneously accelerated and interrupted, and as a result, we undertake a global look at the future of the mainline property types, while also focusing on the rise of viable alternatives.”