Following the political and economic upheavals of 2016, the European real estate debt markets face challenges across several fronts in the coming year. Below, Real Estate Capital takes a look at some of the main themes to watch in 2017.
The global political picture
Globally, the US presidency of Donald Trump could define 2017. Ahead of his inauguration in January, it remains unclear how the president-elect’s economic agenda will play out. On 21 December, Trump announced the creation of a National Trade Council, to be led by Peter Navarro, an academic and noted sceptic of trade with China. In some respects, Trump’s economic policy appears distinctly Republican – lower taxes, less regulation – although his approach to foreign trade remains uncertain, with much protectionist rhetoric espoused on the campaign trail.
In Europe, the unfolding of the UK’s ‘Brexit’ from the European Union will continue to be a major theme. As we enter 2017, we know that the UK government plans to begin formal talks with the EU by March, although little is known about what Brexit will actually look like. It has been suggested that the UK will leave the EU but opt into certain agreements. For the financial services sector, there will be much anticipation as to whether London-based firms will retain ‘passporting’ rights to operate throughout Europe.
Other political factors could shape Europe. France, Germany and the Netherlands all have elections in 2017, prompting some to fear that the growth in populist sentiment could further destablise the continent and create greater uncertainty over the future of the EU. Meanwhile, Italy is still dealing with the fall-out of the ‘no’ vote in its constitutional referendum and the prospect of the government bailing out the country’s oldest bank, Monte dei Paschi di Siena.
Jacques Gordon, global head of research and strategy at LaSalle Investment Management, commented on the impact of global macro-economic and political factors on real estate in 2017: “As we look to the year ahead, across the G7 a shift to more expansionary fiscal policy and away from reliance on monetary policy, along with the potential for protectionist trade policies, could accelerate the end of the “triple low” regime – economic growth, inflation, and interest rates.
“These factors are all likely to be at work in the US economy during the next three years. These same policies could possibly push the UK to higher rates. Investing solely in domestic markets greatly reduces the number of potentially rewarding opportunities to take advantage of in the next two years.”
Where we are in the real estate cycle
Since mid-2015, some real estate investors in Europe’s core markets have applied the brakes in the belief that property values, especially in the prime London market, are “toppy”. However, some put forward the argument that although the cycle is in its mature phase, it is not yet at the peak.
Scott Brown, global head of real estate at Barings, said: “While the political environment remains fluid and adds uncertainty entering 2017, the slow growth, low interest rate outlook and favourable property market fundamentals throughout industrialised economies – bolstered by demographic, societal and technology-induced structural forces – set the stage for continued but varied improvement in local market performance and a relatively attractive outlook for property yields.”
However, Brown added: “At this stage of the cycle, amid lower expectations for price appreciation of core assets, we believe successful investment is less about broad macro trends and instead centres on sub-market dynamics and asset specific characteristics. As a result, 2017 will be a year of heightened selectivity, during which successful investment will require local skill and expertise to execute the business plan at the asset level.”
European investment trends
Cross-border capital accounted for around $151 billion of the $816 billion total dollar volume of global property transactions during the first three quarters of 2016, according to Barings. The UK’s Brexit vote temporarily dampened European volumes in the third quarter, although top-tier markets such as London, Paris, Frankfurt and Amsterdam continue to attract foreign capital, especially from Asia. Real estate finance specialists will hope that an increasingly expanding investor base generates opportunities to support investors with debt.
Schroders’ Duncan Owen, global head of real estate, said that individual cities, rather than countries, should be the focus for commercial real estate investing in 2017, to counter the political uncertainty across the continent.
“How should real estate investors proceed? One response might to be to adopt a national model and avoid countries where populist parties are likely to take power. However, the difficulty with this is that it is a blunt approach. Opinion polls can be unreliable and investors might be left with a very small set of markets (e.g. Germany, Ireland),” said Owen.
“An alternative strategy, which we favour, is to focus on those cities which have diverse economies, strong universities and good infrastructure. These cities are likely to continue to attract businesses, almost regardless of politics. They are centres where people wish to live and work,” Owen added, citing Amsterdam, Berlin, Brussels, Hamburg, Lyon, Madrid, Munich, Paris, Stockholm and Stuttgart.
The UK as Brexit unfolds
Although large real estate investment and financing deals continued to be closed in the UK throughout the second half of 2016, the market undoubtedly took a major hit from the Brexit vote. One significant risk for the financial services sector is that banks and financial institutions based in London might lose guaranteed access to the EU, meaning some activities, such as trading in euro-denominated securities, will be switched to the continent.
However, most in the real estate market remain confident in the UK. Mahdi Mokrane, head of research and strategy for Europe at LaSalle Investment Management, said: “We believe that the UK will remain one of the world’s most transparent, liquid and supportive destinations for investors in spite of the current uncertainty around the country’s future relationship with the EU. Looking ahead, given the prospect of a hard Brexit, fewer of the larger, longer-term occupier decisions are likely to be made until much of the volatility has dissipated.”
In its 2017 predictions, Savills pointed out that sterling is expected to remain weak, offering savings to non-domestic investors into the UK. However, the consultancy also pointed out that yields on some sectors may not be high enough yet to look attractive, compared to other domains for investors who have to hedge currencies.
One real estate sector to watch in the UK during 2017 is the residential private rented sector (PRS). While countries such as Germany have thriving institutional PRS markets, it remains fledgling in the UK, with its culture of home ownership. The country is in a housing crisis, however, and some argue that the provision of high-standard built-to-rent homes would provide an alternative.
The lender landscape
Throughout 2016, Europe’s real estate market continued to be served by a diverse mix of lenders, ranging from traditional banks, to institutional investors, to independent debt funds. Many faced a challenging year but continued to write loans, while some were far quieter than in the previous year.
When Real Estate Capital published its Top 40 European Lenders in October, it was apparent that the make-up of the European lending pack had remained fairly constant in recent years. There were, however, a growing number of emerging lenders including Asian banks which had gained exposure to European real estate debt through taking participations in syndicated debt deals.
Market watchers will be keen to see whether this growing crop of non-European banks continue to increase their exposure to European real estate debt, perhaps through originating loans themselves, and whether any of the established crop of lenders will fall by the wayside during the year.
The strength of investor demand for real estate debt
Several European real estate debt funds are in the market aiming to raise fresh capital for their strategies. For instance, in October, Real Estate Capital reported that Europe’s largest institutional real estate debt fund manager – AXA Investment Managers – Real Assets – is in the process of raising €1.5 billion of follow-on capital for its senior property debt strategy.
As we head into 2017, investors remain keen on real estate debt as an asset class. Barings’ Brown, commented that allocations traditionally focussed on the four standard property sectors – offices, industrials, retail and apartments – will increasingly focus on alternative sectors such as student housing, as well as both mortgage debt and global real estate securities.
“The progression toward a broader definition of the investable universe is largely a result of increasing transparency and familiarisation with these sectors, and can also be attributed to increased competition for assets in the traditional property sectors and a growing recognition that these evolving opportunities could present enhanced return prospects and additional portfolio diversification benefits,” Brown said.
More non-core deleveraging
In an article published this week for Real Estate Capital, Gifford West, managing director at The Debt Exchange, predicted that real estate loan sales markets look likely to emerge in Greece, Central and Eastern Europe and the Commonwealth of Independent States during 2017. As NPL portfolio sales activity gradually winds up in markets such as the UK and Ireland, there will be fewer large-scale loan books put up for sale. Rather, West said, investors would be wise to consider smaller-scale portfolios in emerging markets.
“For Greece and the CEE/CIS countries, 2017 may be the year during which sales begin in earnest. A number of government initiatives appear to be coming to fruition and the pressure/incentives being applied by the various “troikas” and “quartets” may have broken log jams. These sales will be more likely to be below €100 million in proceeds and may address more challenging assets such as SME and commercial and industrial loans. For the bold, these may offer interesting returns,” West said.