PropertyEU: ANALYSIS Europe's listed sector: tailwinds mask structural defects
According to PropertyEU Magazine:
Europe’s leading listed real estate companies are clearly in recovery mode, judging from the latest spate of half-year earnings reports released over the summer.
Internationally the listed real estate sector is still benefitting from tailwinds as the cost of debt continues to fall, says Peter Papadakos, analyst at London-based Green Street Advisors. ‘From an earnings perspective, things are looking brighter and, significantly, cashflows are not falling while many continental REITs are seeing positive or even very strong portfolio revaluations.’
Changing growth dynamics
The same may not be true for UK REITS which are seeing values stabilising or falling slightly. But even though it has been anticipated, the potential for headwinds from interest rates is not strong, he adds. ‘Generally, prospects for rental growth are good on the Continent although they are somewhat challenging in the UK. But even in the UK we do not believe values will plummet, but plateau.’
Papadakos distinguishes between two operational cycles that are helping to buoy the sector at present. ‘The investment cycle has been roaring for the past three years, but now the rental cycle is taking off as well.’ There is still significant room for rental growth for offices on the Continent, he adds: ‘Rents there have not grown anywhere near what they have for London offices since 2012. The rental recovery hasn’t really kicked in yet there. On the Continent, rental growth could offset any potential impact from rising long-term interest rates.’ Higher rents are on the cards for offices and industrial assets in particular. In that context, retail assets form an exception, he says. ‘Nobody is expecting big increases for retail.’
One of the reasons that real estate is currently in a sweet spot is the fact that there is not enough class A office stock across the Continent, from Paris to Berlin and Stockholm and Milan. New developments will need a few years to complete and demand is already increasing. Any correction that does occur will not be supply driven, Papadakos claims. ‘Either there will be a demand-driven shock or there may be something on the credit side that could disrupt. I don’t think it will be the real estate fundamentals that will cause a correction, if there is one in the next 12 months.’
One cloud that Papadakos does see on the horizon is financing conditions for development on the Continent. While financing conditions are favourable on the whole, that does not hold for development at a time when development and completions are below the long-term average.
The development of Europe’s listed real estate sector is ‘very disappointing’, says Green Street’s Papadakos. ‘This tells us something about how badly Europe has performed versus the US.’ The market cap of the listed real estate sector in the UK in the early 1990s was massively bigger, he points out. ‘The UK majors were badly funded before the crisis. If you look at LandSec, its 10-year shareholder return is 0%. What drags down the listed market in Europe are the UK majors.’
Cause for optimism
Nevertheless, there is some cause for optimism, Green Street’s Papadakos says. Germany’s share in the index has risen from 8.7% in 2012 to around 20% now and the rise of Germany’s residential sector with heavyweights such as Vonovia coming out of nowhere to burst in at the top 5 is also encouraging, he adds. At the same time, the number of failures has been fairly limited, with the exception of isolated examples such as IVG, Risanamento and Metrovacesa, he adds.
‘There may have been a few failures at the edges of the market, but there have been no major failures in Europe. There are far more failures in the direct rather than the indirect market, but you don’t hear about that!’
And in terms of returns, the sector as a whole has performed well since the peak of the market in 2007, with an average 7-8%. ‘That’s [quite] OK. The listed real estate sector offers income-like returns and a good inflation hedge.’
Read the full article from PropertyEU here.