UK retail ‘an attractive entry point’ to European real estate market

Asset manager DWS Group has highlighted the appeal of the UK for both senior and junior lending and pointed to the retail sector as an attractive entry point. The firm – with €860bn (£748bn) of assets under management – said absolute returns were typically highest in the UK market, even after taking euro hedging costs into account, while its risk profile does not look significantly higher than in other parts of Europe. “The UK retail market in particular could be one potential entry point to the sector, given how far values have corrected,” DWS said in its latest Europe Real Estate Debt Update. Southern Europe also looks appealing, it said, with a notable return premium over the likes of France or Germany, and little additional risk when in terms of occupier fundamentals, debt covenant metrics and volatility of rents or values. The European logistics sector, as well as parts of the residential market, are still deemed attractive from a lender perspective. “Both sectors still benefit from low vacancy and strong demand, with positive long-term structural trends helping to counteract near-term economic weakness,” DWS said. The overall fall in the availability of finance from traditional lenders is continuing to allow those lenders which are still active to be more selective. It said offices are inevitably suffering, with margins rising further than the other major sectors this year. “We feel this is fully justified for lower-quality and poorly located stock. However, with the sector out of favour and with lender returns having risen significantly, next-generation office space with strong ESG credentials could still offer attractive opportunities for lenders,” the asset manager said. Near-term inflation expectations have fallen since the start of the year and the slowing European economy is likely to limit further interest rate hikes. Nevertheless, all-in financing rates have reached their highest levels since the aftermath of the global financial crisis. “Most of this increase has come from higher swap rates, although rising perceptions of risk, weakening sentiment and a reduction in the supply of willing lenders have also pushed margins higher. And as long as there is still doubt over whether values have reached a trough, the banks’ appetite for refinancing is likely to remain muted,” the report said. DWS estimated that senior margins for European real estate debt were around 30 basis points higher in the third quarter compared with the start of the year, and around 50 basis points higher than their pre-pandemic nadir. Pressure on interest coverage ratios means that senior loan-to-value ratios are currently likely to be capped at around 50%. Junior loan pricing is also estimated to have increased slightly, although healthy competition among alternative lenders has helped to offset this. To send feedback, e-mail julia.cahill@eg.co.uk or tweet @EGJuliaC or @EGPropertyNews