Where next for real estate’s public and private equity markets?

COMMENT: CBRE’s Tim Ryan and Dom Smith discuss the outlook for the UK and Europe as the year-end draws near. European public equities have continued to give market-watchers much to talk about over the past few months, but in contrast to the initial response to the onset of Covid-19 – where there was a good degree of similarity in movement across sectors – the past few months have seen significant differentiation, reverting in many ways to the pattern observed in the first couple of months of the year. The (near) four months to the end of Q3 saw a clear split in the performance of industrials (up 20%) and residential (up 5%) versus retail (down 45%), with offices performing somewhere in the middle (down 15%). Over the whole year, therefore, industrial and residential price growth has been 32% and 16% respectively, compared with -31% and -68% for office and retail. In truth, this is in many ways no different to the relative performance hierarchy observed for a few years now – although the market has to an extent temporarily fallen out of love with some previously favoured operational sectors (such as hospitality and student accommodation) – and that has been reflected also in the relative performance of real estate investment markets. Although Q3 investment statistics are yet to be finalised, a comparison of H1 2020 and H1 2019 showed growth in residential and industrial transaction volumes and a decline in office volumes. Similarly, direct market pricing has reflected the above pattern. In Q2, 12 of the primary markets in the 17 Northern and Southern European and Nordics markets saw retail yields rise (by 5-50bp). For offices only four markets saw yields rise (by 5-10bp), while for industrial three markets saw a fall in yields. Equity raises Market preferences and fortunes could further be discerned from the contrasting equity raises seen in Q3. While residential and healthcare companies Vonovia and Primary Health Properties raised additional capital for growth opportunities at only very slight discounts to prevailing pricing, Hammerson’s deeply discounted rights issue to pay down debt betrayed the weaker historic performance of retail. Nevertheless, the cumulative €1.8bn of equity raised by European REITs in Q3 represents only a little less than the total raised in the first half of 2020 – a further sign that confidence in pricing both current value and future opportunity is returning to the market. Fundraising and dry powder In the private equity market, the fact that Covid-19 will have more than a temporary impact on European investment activity can be discerned from the change in fundraising and dry powder. Dry powder available to private real estate funds has fallen almost 20% over the year so far, from $99bn at the end of 2019 to $81bn at the end of Q3 2020. While some of this may have been invested in the market, a significant share is likely to have been returned to investors by funds. Meanwhile, fundraising activity has slowed; €22.7bn had been raised as at the end of Q3 2020 (with more than 40% of that total accounted for by one fund), compared with $39.2bn for 2019 as a whole. Heading into 2021, therefore, it is likely that the strength of pressure to invest in the market will be lower than previously, which could impact deal volume and pricing. Having said that, on these metrics 2020 does not look dissimilar to 2018, itself a strong year, so there are reasons to be cautiously optimistic with regard to the outlook for investment. Private funds As for the performance of private funds, data from CBRE’s PropertyMatch secondary trading platform suggests that pricing improved over Q3 from lows seen in April to June. Typically, UK balanced funds traded or were quoted at discounts of more than 10% to NAV in the second quarter of the year, but more recently pricing and trading activity has gathered momentum and these funds are now quoted at mid to high single-digit discounts to NAV. Discounts never hit such lows on the continent; balanced funds there remain priced at a small discount to NAV. In both the UK and Europe, specialist fund pricing reflects relative preference for underlying markets. Long-income and logistics funds are often priced more competitively than respective balanced funds; retail and office funds less so. Tim Ryan is head of real estate investment banking and Dom Smith is a senior research director at CBRE Photo: Hammerson’s Bullring retail destination in Birmingham (courtesy of FTI Consulting)