The overriding message amidst the early flurry of 2018 industry forecasts is that late-cycle European commercial property markets might be highly-priced, with historically low yields, but income-hungry investors will keep demand high.
“In 2018, we expect a year of stability,” was UBS Asset Management’s take on global real estate for example. There’s “limited opportunity for further yield compression but not yet a sizeable decrease in capital values”.
From a real estate finance perspective, 2018 will likely see the appeal of debt as an asset class increase, despite the growing challenge of finding suitable deals in which to deploy debt capital. Here are five factors Real Estate Capital has considered when making this prediction.
1. Liquidity of debt will increase: In December, Amundi’s director of real and alternative assets, Pedro Antonio Arias, explained to Real Estate Capital why the asset manager will make 2018 the year of its first real estate debt fundraising: “Returns are still attractive in terms of relative value and, through debt, you are much more protected.” Expect to see more non-traditional lenders enter the market. In addition, 2017 saw a wave of fundraising from experienced managers including AXA and PGIM Real Estate that needs to be deployed. Others are busy raising, with our data showing 29 funds in market as of late November. Meanwhile, CMBS investors proved keen to snap up 2017’s only public UK deal in November, and fintech firms continue to ramp up their lending capacity. Capital will continue to flow into property debt this year.
2. Lenders will explore emerging niche markets: While many senior bank lenders in Europe are determined to remain within strict risk parameters, a growing profile of lenders will back those investors seeking outperformance in emerging parts of the market. As noted in its 2018 predictions, Aviva expects investors – in the UK market at least – to focus on ‘thematic’ strategies as they aim to find additional value in the sector. That means sub-sectors including urban logistics, flexible office space and build-to-rent residential will be popular among core-plus and value-add investors. Lending to such product is new to many lenders, so 2018 will be the year they get to grips with underwriting unfamiliar assets and property leased on flexible terms.
3. Europe’s wall of debt maturities will create opportunity: In our recent interview with Nick Weber, the boss of value-add investor Henderson Park espoused the view that the sheer volume of legacy debt maturities coming up in Europe will contribute to creating situations where firms like his can acquire quality properties which need to be sold. Indeed, CBRE research compiled at the end of 2016 indicates that in the region of €130 billion of CRE debt is due to mature this year in Europe. Legacy debt will continue to create opportunities for recapitalising assets, meaning further opportunities for fresh financings. While this will mean asset-based opportunities for investors, it will also mean the continued unwinding of continental banks’ legacy loan books.
4. Interest rates will be on lenders’ minds: An interest rate shock is an unlikely prospect and many will remain sanguine, but there is a growing acceptance that the rock-bottom rates that have defined the last decade cannot be relied upon for much longer, potentially weakening the attractiveness of real estate in the longer term. The US Federal Reserve’s ongoing rate hikes have the potential to push global bond yields higher. Politics will also remain a talking point, even though political upheaval in continental Europe which many feared this time last year did not materialise. Most notably though, the nature of Brexit will become clearer.
5. Real estate will keep its edge, for the time being: While rates might creep up, the fact real estate is attractive compared with alternative investment options will remain the fundamental driver of capital into the sector this year. European commercial property will be an expensive purchase, but the income yield it generates will be hard to find elsewhere. As the supply of quality property for sale remains tight, expect to see more portfolio and platform deals. The biggest question, and the most difficult to predict, is when the long-anticipated real estate market correction will happen.
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