UK leads decline as latest figures reveal Europe-wide market correction

The UK showed the sharpest decline in asset-level performance amid a stark picture across the European non-listed real estate market in Q3, according to figures released today. The Quarterly Fund Index from the European Association for Investors in Non-Listed Real Estate Vehicles shows that the total return for the European market fell to -1.6%, down from the 2.61% recorded in the previous quarter. This is the lowest quarterly performance since Q2 2009, when the impact of the global financial crisis was in full effect. The correction is taking place across almost all markets, but is most acute in the UK where the Q3 asset-level performance hit a low of -4.79%. This compares with more moderate falls in performance for other core European markets, such as France (-1.39%), Germany (-1.38%) and the Nordics (-1.30%). For most markets, quarter-on-quarter declines in performance were between 280 and 410 basis points, however it was significantly higher for the UK, at 844 bps. This reflects the rapid and sharper monetary policy adjustments seen in the UK – recording the highest interest rate rises in more than three decades – alongside the more pronounced real estate cycle created by frequent valuations in the UK. The market as a whole saw a quarter-on-quarter capital growth decline of 429 bps to -2.34% as investment sentiment took  another hit. The sharp correction is driven by the ongoing energy crisis – triggered by Russia’s invasion of Ukraine – leading to record inflation and substantial, rapid interest rate rises across European markets. Industrial correction Drilling down into markets and sectors, the correction of the previously best-performing industrial/logistics sector stands out. Total returns fell from 4.21% in Q2 to -4.06% in Q3. However, Inrev said this was “no surprise, given many years of consistent outperformance, sharp yield compression and relatively high rental growth expectations in most geographies”. The decline was most notable in the UK, where Q3 industrial/logistics returns hit a low of -6.8% – an underperformance of 288 bps compared to offices, the next weakest sector at -3.92%. In Germany, the difference in performance between the industrial/logistics and office sectors was more pronounced at 381 bps. Once pricing levels adjust, Inrev expects the fundamentals to continue to support the sector. Underpinned by e-commerce as a mega-trend, occupancy rates for industrial/logistics will likely remain relatively stable and high. Residential was the best-performing sector, with Q3 returns staying largely in positive territory across the three largest core markets – UK (0.73%), France (0.59%) and Germany (0.37%). Looking ahead, Inrev said absolute levels of rents, business models and occupier affordability would be the key differentiating factors for keeping certain real estate segments more resilient in the difficult operating environment. Iryna Pylypchuk, director of research and market information at Inrev, said: “This quarter’s findings paint a stark picture, but one that many in the industry have been expecting for several months. The current downturn is much more synchronised geographically, in contrast to the GFC, when the UK was some 6-9 months ahead of the continent in terms of repricing. The faster the correction takes place the sooner non-listed real estate will be on an equal footing with the main asset classes, which should help to mitigate the denominator effect. However, until we see stability return to the geopolitical environment, inflation and interest rate paths will remain difficult to assess, leaving downward pressure on performance across most asset classes, including real estate.” Investor sentiment takes another dive Unsurprisingly, according to the Inrev Sentiment Survey, 83% of respondents indicated that their assessment of investment risk had increased – this being the case for the fifth consecutive quarter. The short-term performance expectations for European real estate were increasingly subdued, with 82% of investors and investment managers expecting a further slowdown in performance. Similarly, as a result of deteriorating investment performance and growing risk, 46% of respondents were less confident about increasing their weightings to real estate. In the short-term, real estate may look unattractively priced compared to other asset classes. However, while deal flow stalled in Q3, the correction in asset pricing is already beginning to crystalise – especially in the UK – setting up the potential for revival in investor demand later in 2023.   To send feedback, e-mail julia.cahill@eg.co.uk or tweet @EGJuliaC or @EGPropertyNews Photo by Lydie Gigerichova/imageBROKER/Shutterstock