Invesco Real Estate
H2
Economic growth in Europe is showing the first clear signs of recovery in the course of H2 2024 and 2025. In addition, the ECB made a first interest rate cut at the beginning of June. Market expectations regarding the ECB’s interest rate hikes were withdrawn in the course of H1 2024, but at least one further cut is expected in H2 2024 and subsequent interest rate hikes in the course of 2025. From a real estate perspective, it is particularly important that the medium-term interest rate outlook has remained largely unchanged.
In Europe, real estate investment markets have now adapted to the changing interest rate environment, with real estate yields remaining largely stable over the course of Q2 2024. In addition, the fundamental situation in the real estate industry remains robust in most sectors, as sustained rental demand meets limited space supply, resulting in upward pressure on rents. Our strategic outlook is aligned with solid long-term value drivers that drive both space demand and rental growth generate. We concentrate on a few key topics and present our The main focus is on high-yield investment opportunities in markets with a scarce supply of space.
In our view, European property valuations have already bottomed out. With GDP recovery and falling interest rates, the outlook for real estate is positive.
Positive survey data suggest that eurozone GDP is likely to emerge from the general stagnation of 2023 and accelerate again in 2024 and 2025, even if growth remains uneven across countries, curbing the overall recovery. For real estate, this environment of steady but uneven growth will lead to differentiated rental demand. Our investment strategies aim to
identify those investment opportunities that we believe will benefit from stronger rental demand and continued liquidity in the investment market. We therefore continue to focus on those real estate sectors where demand is supported by three key long-term growth drivers:
- Demand due to demographic change and urbanization
- Positioning of properties with regard to stricter efficiency and
sustainability requirements - Technological progress
We continue to focus on deep value investment opportunities as market values stabilize after recent dislocations.
Investment Outlook H2 2024
European property yields saw a significant correction between the beginning of 2022 and Q1 2024, but market evidence suggests that the price adjustment is now complete and that property yields were much more stable in the second quarter of 2024. For those markets that are IRE’s investment focus, CBRE’s market returns showed an average upward movement of 107 basis points between January 2022 and June 2024, although almost 10% of these markets already have some compression, indicating an overcorrection. Markets with yield increases of 100 basis points or more are sometimes markets that showed the lowest yields at the outset, second-tier properties, or sectors where the income profile has changed significantly, such as housing markets where rent caps have been introduced or adjusted.
While prime yields experienced a negative, valuation-driven shift in yields in 2023, rents in most sectors remained remarkably robust. Activity on the tenant side continues to be strong, as demand for the best quality space has led to prime rents continuing to rise or, in the worst case, remaining stable.
View
Looking ahead, our House View is based on the expectation that real estate returns will experience a period of stability following the recent market correction.
The current price levels correspond to the historical ranges on the European markets, but are at the lower end. Therefore, we expect a downward movement in yields to play a smaller role in the appreciation of real estate, at least as long as long-term interest rates do not fall further than currently expected, so that spreads move closer to the long-term average.
European real estate capital markets have suffered a significant shock over the past 24 months, but the situation in rental markets has remained robust in most markets and sectors. This is the result of a still
solid demand for space and an overall limited supply. Increasing confidence, as shown, for example, by the OECD’s composite headline indicator, will further support demand for high-quality space and thus rent levels and growth. In addition, it should be noted that rental price growth across Europe has been lower than headline inflation (or construction cost inflation) over the past two years, even for the highest quality space, so affordability for occupiers remains in real terms.
In order to achieve the best total returns compared to the respective local market environment, it is therefore necessary to focus on increasing rental income and being supported by secular demand drivers that can cushion a weakening of the economic cycle. In addition, due to the large historical discrepancy between the best and worst performing markets, it is necessary to achieve positive differentiation in performance through market selection. Our House View for the year 2025 therefore includes four key points:
- Yields have adjusted to the cost of financing, but capital demand remains an area to watch. In the baseline scenario, we expect yields to stabilize after the recent correction. Nevertheless, it should be noted that the adjustment to date reflects the evolution of borrowing costs rather than longer-term imbalances in capital availability. A further price correction could occur if there is a mismatch between the profile of the capital we want to invest in real estate and the type of properties that are put on the market.
- Stable returns require income growth as a driver of returns. A period of slower economic growth means that not all real estate sectors are experiencing the
same demand. We therefore rely on the long-term growth drivers mentioned earlier, which can provide structural tailwinds to increase incomes. As long as consumer confidence is weak, we will avoid industries and sectors that depend on discretionary spending in the mass market. - Growing regulatory pressure on sustainability is creating opportunities and risks. The demand for energy-efficient space with sustainability certificates is increasing, while the supply is low. We therefore try to develop corresponding properties in markets to compensate for bottlenecks. In the medium term, the risk of “stranded” properties will lead to the repositioning of properties in difficulty – especially those of owners who are suffering from the increased borrowing costs.
- Opportunities arise from volatility. Historically, returns have been highest in the
years following a market correction. We therefore assume that investment opportunities will continue
to arise for
those market participants who continue to operate in the current environment and implement their strategies under the current market conditions.
Changes in debt will create opportunities in two areas
Banks have also reacted to the current market correction and are taking a more cautious approach to granting new loans, with an increased focus on fully let core properties. While this position is slowly softening, this creates potential for alternative lenders such as IRE in the medium term: firstly, they can fill the financing gaps from which banks are withdrawing, and secondly, it creates pressure on owners in terms of refinancing periods, which will lead to property sales.
IRE builds underwriting in real estate financing on real estate-specific foundations and supports strong partners who are active in niche sectors, or where properties have a redevelopment or repositioning component, by granting both total loans or mezzanine financing. Therefore, we believe that the current withdrawal of banks from more alternative real estate sectors
will continue to offer attractive opportunities. Recent examples include a mezzanine loan secured by pre-let logistics assets in Poland and a total loan to finance the development of a cold storage facility in Italy. Both examples demonstrate the benefits of combining our pan-European debt expertise with our knowledge of local real estate markets.
In the meantime, the increased refinancing costs of existing investment properties will continue to prompt owners to review their current investments. We believe that in many cases this will be accompanied by increasing capex demand, which is required to meet efficiency requirements. We believe that such opportunities will present themselves in the market over the next four to five years
as low-interest property financing begins to phase out.
Strategy to harness this potential for outperformance
Over the past decade, there have been persistent trends in relative performance between real estate sectors. We believe that sector allocation will disappear as the key driver of returns, and investors will instead need to focus on identifying the winners within each sector. Over the longer term, relative risk premiums fluctuate between real estate sectors, both globally and within individual markets. A major reason for these fluctuations is changes in the outlook for income growth in individual sectors, with those with more positive growth prospects trading at lower yields than other sectors, all other things being equal
. However, the recent market correction and the associated illiquidity have led to greater differences in both current price levels and rental growth projections at the property level.
Our outlook for income growth in individual real estate sectors is based on their individual dependence on long-term demand drivers, sensitivity to the economic cycle and dependence on new space supply in the local market. As forward-thinking real estate investors, we no longer think in terms of the four major sectors. Instead, we analyze sub-sectors and think about how real estate is positioned within micro-niches. In the industrial sector, for example, there are large
differences in the return prospects between R&D space, cold storage and
urban logistics. In other words, it’s all about the details.
Property-specific returns are determined by clearly formulated business plans and their consistent implementation. However, the growth in net rental income is also strongly determined by long-term trends. These shape demand patterns over time, including developments in the tenant landscape, which are exacerbated by recent changes in financial markets. We focus on four key trends that will shape real estate investment in the short and medium term.
Taking advantage of the current market distortions
The first of these possibilities arises from the current market volatility. We already see opportunities to achieve high inherent value (“deep value”). Our primary focus is on accelerated property sales that align with our long-term investment goals. Typically, such situations arise for owners who are about to refinance or who are under pressure to sell due to an ending fund term, with upcoming investments in ESG measures often further increasing the
motivation to sell.
In this context, we also see opportunities to partner with project developers or operators who want to provide new space in underserved markets and where tight capital market conditions limit their sources of financing. Our local networks in our core markets are of great advantage here, as IRE can use off-market access in this way, both for the acquisition of existing properties from those owners who need to strive for a quick or discreet sale, or through special situations that include the already visible emergency sales in the market.
Demographic change
Demographic change, including urbanization, is one of the main drivers of changes in real estate demand. The most obvious sectors to which this topic relates are found in the housing sector. However, these structural changes also have a significant impact on real estate, which does not only affect beds.
Europe continues to suffer from a long-term and persistent undersupply of housing in relation to household formation. In addition, the recent rise in mortgage interest rates means that many potential buyers who have been prevented will continue to be tenants. At the same time, many project developers in the residential sector are also under financial pressure, which reduces supply. As a result, residential is a sector where there is constant demand, resulting in high occupancy rates and stable cash flows. However, there are also concerns about the affordability of rents in some cities. This is reflected in the fact that more and more states and municipalities are introducing measures to regulate rents, while at the same time policymakers must ensure that the creation of new supply does not come to a standstill in the current environment. We therefore continue to look for opportunities in this area, but we are primarily focused on rental properties in the free, unregulated market segment that are affordable in the local context and are not limited by regulatory intervention.
However, the effects of demographic change and urbanisation on the real estate asset class are not limited to the residential sector. For example, an increasing overload of urban delivery networks can also be observed. Advancing urbanization is increasing the density of demand and at the same time the requirements are increasing due to the growth of online retail. Processing online orders requires about twice as much storage space as traditional brick-and-mortar
retail. In addition, transport connectivity is crucial: for a tenant, a 1% saving on delivery or transport costs justifies a 10% increase in rent. Our main focus is on the European megacities of Paris and London, but other cities with high purchasing power such as Munich and Amsterdam are also eligible.
ESG
Across the European real estate market, environmental, social and governance (ESG) criteria are an increasingly important consideration for both real estate investors and tenants. Investing according to ESG+R (ESG plus resilience) criteria is a fundamental commitment at Invesco Real Estate. The increasingly stringent regulations for the energy certificate required for rentals are likely to prompt institutional investors
to reposition less efficient properties according to the highest sustainability standards.
Our strategic response to ESG challenges is to strive to ensure the sustainability of our properties and thereby maximise their returns. More sustainable buildings have been proven to lead to higher rents and higher vacancies as well as lower yields. Therefore, our focus on sustainability is aligned with maximizing return on investment.
We regularly assess all existing IRE investments with regard to their sustainability. In addition, our business plans ensure that all properties meet all relevant standards before the regulator requires it. The resulting investment requirements depend on the expected future value effects of the individual property. Some investments will be defensive (i.e., to preserve value) and others will be value-enhancing. We also try to speed up the disposal of those properties where compliance with relevant regulations is problematic.
Furthermore, we are constantly looking for properties that we can raise to first-class levels. Buying opportunities arise especially among owners who are not in a position to invest themselves to meet increasing efficiency requirements. This is especially true in combination with financing/refinancing pressure. We will continue to focus on core properties in gateway cities, where demand from investors and tenants remains most stable over the long term. In doing so, we use IRE’s local expertise in our core markets. In this way, we also secure access to attractive yields for prime properties that are not normally liquidated.
Technological progress
Technological advancements have led to significant changes in the modern world. In real estate, we see the impact in both direct demand and indirect effects, such as demand for life science properties, to meet growing healthcare investments. Another example is the development of data centers to meet the growing demand for data storage. Both categories remain in high demand among both users and investors, even though transaction volumes remain limited.
We also see indirect effects of technological change on real estate, in particular a shift towards greater operational use in almost all sectors. The focus is increasingly on the variety of offers at individual locations, which requires a stronger integration of “live work-play” offers in real estate. This, in turn, requires the owner to participate in the provision of such facilities and the design of the environment. The increasing demand for more flexible leases is putting pressure on landlords to adapt and manage properties accordingly
. This is mainly done through technological solutions. We are also seeing many tenants seeking partnerships with landlords to jointly advance expansion plans. This, in turn, requires a high degree of operational commitment on the part of the real estate investor.
Result
As we move towards the final quarter of 2024, we expect property values to bounce back after a 24-month correction. However, the slight downward movement in interest rates in Europe probably came a little too late, so that the pace of transactions is likely to remain at a subdued level until the end of the year. We are increasingly confident that transaction activity will accelerate again in early 2025 and that the start of a new real estate cycle is imminent.
In addition, we believe that real estate offers significant diversification benefits compared to other asset classes, but also that diversification benefits exist across all real estate markets and sectors. There is no doubt that there are currently investment opportunities across the entire capital and risk spectrum. In our experience, many real estate allocations have a classic “home bias” and focus on a specific risk segment. Therefore, all investors should check if they are adequately diversified.
Geopolitical considerations remain the main risks to the outlook, but overall, we believe that the recent value correction offers attractive entry opportunities into the sector. In addition, the recent reduction in development pipelines is expected to shift the relationship between supply and demand more in favor of the landlord side. While global and macroeconomic factors continue to drive total real estate returns, we believe that local market knowledge will be particularly important in the coming years to achieve potential relative outperformance.
Significant risks
The value of investments and the income from them are subject to fluctuations. This may be partly due to changes in exchange rates. It is possible that investors may not receive back the full amount invested when they return their shares. Real estate and land can be difficult to sell, so investors may not be able to sell such investments if they want to. The value of real estate is usually estimated by an independent appraiser and may not be realizable. These documents may contain statements that are not purely historical in nature, but constitute “forward-looking statements”. This includes, but is not limited to, projections, forecasts, estimates of earnings, returns or returns, or future performance targets. These forward-looking statements are based
on certain assumptions, some of which are described here. Actual events are difficult to predict and can deviate significantly from assumptions. All forward-looking statements contained herein are based on information available as of the date of this document, and Invesco undertakes no obligation to update any forward-looking statements. Accordingly, there can be no assurance that estimated earnings or projections will be realized, that forward-looking statements will occur or that actual earnings or results will not be materially lower than those presented. The opinions expressed are those of the author, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
Important information
This marketing document is intended exclusively for professional investors in Germany, Austria and Switzerland. Disclosure to end investors is not
permitted. Past performance is no guarantee of future performance. This is marketing material and not investment advice. It is not intended as a recommendation to buy or sell any particular asset class, security, or strategy. Regulatory requirements requiring the impartiality of investment or investment strategy recommendations are therefore not applicable, nor
is the ban on trading prior to their publication.
Data as of September 31, 2024 unless otherwise noted.
Views and opinions are based on current market conditions and are subject to change at any time. The document is not part of a sales prospectus. It contains only general information and does not take into account individual expectations, tax or financial interests. This document does not constitute an offer to acquire or subscribe for any securities or shareholdings. Nor does it constitute an offer in countries where such an offer is not permitted.
Publisher in Germany and Austria: Invesco Real Estate Management S.a.r.l., President Building, Avenue JF Kennedy 37A, L – 1855 Luxembourg.
The publisher in Switzerland is Invesco Asset Management (Schweiz) AG, Talacker 34, CH-8001 Zurich.
