Aviva: Real estate equity returns closing in on debt

In the past year, market participants have viewed risk-adjusted real estate debt returns to be more favourable than those on offer from real estate equity. However, equity returns are beginning to match debt on an absolute basis as the property market outlook improves, according to London-based manager Aviva Investors.

The manager’s research, which uses quantitative assessment of the risk-adjusted attractiveness of each sector, showed real estate equity returns are catching up with returns on offer from real estate debt – a shift largely due to a repricing having already occurred in equity markets.

“Debt markets typically react rapidly to changes in the rate environment, and therefore reprice quickly off the back of market movements. This sits in contrast to real asset equity markets, which can take a bit more time to adjust,” said David Hedalen, head of real assets research at Aviva.

“But, broadly speaking, the repricing we have seen as a result of market turmoil has largely occurred. Whilst some risks clearly remain, in the absence of further developments, we think markets are beginning to stabilise and offer significant pockets of value,” he added.

Aviva’s proprietary data, which measures risk and return over a five-year period, highlighted that real estate equity in December 2022 would have featured higher on the risk scale and lower on the percentage return scale.

However, the level of equity risk is now moving closer to debt, sitting at between 2 and 5 percent on the manager’s risk scale. The equity return profile remains varied across Europe between 4 and 8 percent. However, the best performing property equity returns are within the UK’s industrial sector which provides returns between 7 and 8 percent. Within Aviva’s calculations, real estate debt – fixed and floating across the UK and continental Europe – sits below 2 percent on its risk scale and between 7 and 8 percent on projected returns.

The research states that the UK is outperforming continental Europe on both equity and debt because repricing in the UK has been far quicker than that experienced in continental Europe.

“Repricing for real estate in the UK has been rapid, which sits in contrast to Europe. In our view, this puts the UK further ahead on its journey. Within our propriety modelling this quarter, we have seen European returns catch up with the UK, whilst offering lower volatility,” Hedalen said.

“In reality this has merely closed the gap between the two markets, with the UK still offering higher absolute returns compared to the continent,” he added.

Aviva still believes real estate debt represents a compelling investment, with all aspects of European real estate debt displaying less risk and better projected return percentages than property equity.

“The overall outlook for the sectors we modelled appears to be trending towards a more optimistic picture, particularly as some macroeconomic concerns have begun to abate,” Hedalen said.

“We view the prospects for equity markets as having improved, whilst debt continues to offer compelling returns. Taking all of this into account, we see continued improvement heading into 2024, following what has been a volatile and uncertain 2023,” he added.