2024 Euro Real Estate Outlook: Fundamentals

Executive Summary

  • In part 1 of our 2024 Outlook for the European Real Estate sector we discuss the outlook for rental income, fundamental drivers, valuations, LTVs, leverage, liquidity, interest coverage ratios, investment and shareholder returns. In part 2, to be published in the coming days, we will discuss relative value.
  • We expect 2024 to be another year of strong rental income growth for the sector, though Residential issuers’ growth will continue to lag due to regulatory constraints. The indexation of leases will remain a key tailwind in particular for names like GFCFP and CASTSS, while we expect solid growth from Logistics names LOGICR and BPPEHX which have greater UK exposure. We expect growth from the Residential players to improve in 2024 but to remain low versus peers.
  • Investors will be focused on Office portfolios in 2024, as the impact of hybrid work continues to become clear. We would flag CWHARF, ARNDTN and CPIPGR as names where we are particularly cautious. Among the other major subsectors, we expect Residential demand to remain firmly intact in key markets; we expect Retail and Logistics to also post solid results, albeit with growth and KPIs deteriorating from 2023 and 2022 levels, respectively, in part as COVID comps continue to be worked through.
  • We expect property valuations on balance sheet to continue to decline in 2H23 and 2024 driving up LTVs. On average since 2Q22 valuations are down by around -9% for the names we monitor, and we expect YE23 results to see further write-downs across the board. We expect volumes in the transaction market to improve in 2024, which will help provide more insight into “fair value” levels. We provide simple stress tests in this report which make clear the lower LTV names are able to sustain the next leg down in valuations in our view, which is reassuring, as investors start to try and look through this property cycle.
  • Asset sales will continue this year as issuers look to improve liquidity and manage LTVs. Asset sales and equity raises in 2023 have helped to limit the impact of valuation declines on LTVs and shore-up liquidity. We expect further large assets sales from the likes of ANNGR, HEIBOS, CPIPGR, ULFP, and SBBBSS in 2024. To avoid selling only the highest quality assets and risk re-setting book values downward, we expect JV/minority equity stake sales to remain a key lever to raise cash.
  • We expect leverage metrics to again improve in 2024 and equity cushions are reassuring despite the uncertainty around property valuation declines. For the listed names on average EV/LPA EBITDA (last period annualized EBITDA) of around 24x compares to 14x net leverage. EVs are on average 85% of the value of property portfolios on balance sheet.
  • Bond refinancing needs for the sector in 2024 are manageable but the primary needs to re-open in a meaningful way ahead of 2025’s bond maturity pillar. We expect to see more secured debt and asset sales from names looking to avoid the primary entirely. ULFP’s issuance in December was reassuring that demand for the right name exists, and our base case is more defensive names tap the market in the near term.

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  • Interest coverage ratios (ICRs) are the metric we think should be the focus for investors looking to determine the health of issuers through this property cycle. We expect further ICR deterioration not only in 2024 but for years to come as issuers refinance legacy low-cost debt in a higher interest rate environment. This should be manageable for most issuers, though that hinges on the outlook for rates, and it’s not clear it will be manageable for names with near term refinancing needs, low EBITDA growth, and already low ICR ratios (HEIBOS, BPPEHX, SBBBSS, AKFAST).
  • Development activity will continue to decline, and we expect shareholder returns to remain in-check which will help support cash flows in 2024. We except more equity raises are likely in 2024 as issuers address over-levered balanced sheets. Investment in standing portfolios remains a priority for most names, which is the right strategic decision given the implications for value preservation from modernization.

Financial Metrics

Rental Income & Fundamentals

Growth remained solid in the European Real Estate sector YTD and we are optimistic on the outlook for growth in 2024, though performance will vary by subsector. We expect a similar trend this year, with growth to be strongest from the players that benefit from indexation of rents on the Continent though with a decline from 2023 given the deceleration in inflation in almost all major markets for our coverage universe (chart below). This will in particular benefit Logistics, well-positioned Office players, and Retailers with large exposure in Europe (as a reminder, lease dynamics in the UK differ). We again expect Residential growth to be slower, as was clearly the case in 2023 (see chart above), as rent regulation particularly in Germany and Sweden constrains rental income growth.

Residential: We estimate growth from the major resi operators in our coverage excluding AKFAST to range between 3-6% in 2024, with trends on average accelerating from 2023 but still lower than peers in other CRE subsectors. As we discussed in our Resi Market Chart Pack, rent regulation will continue to limit growth in the tenant friendly markets of Germany, Sweden and France. Given the importance of the German market in particular, we would flag ANNGR’s 2023 guidance for organic rent growth of 3.7%-3.8% and early indications of 2024 organic growth >5% which we think is a useful indicator for the German resi market more broadly. The uptick in 2024 will be driven by several factors, including a detailed Mietspiegel in Berlin this year (see our recent ANNGR note for reference charts on the German regulatory regime and the timing of expected new Mietspiegel levels). We have not seen preliminary growth guidance from any of the Nordic names we cover, though BALDER recently reached an agreement with the Tenant Association in Stockholm for an average rent increase of 4.5% to take effect from early this year.

Regulatory regimes vary across Europe and key markets such as the UK and Finland are more landlord friendly, which should be more supportive of growth depending on supply/demand drivers. KOJAMO expects growth to improve in 2024 in its Finnish based portfolio in part due to lower levels of supply, which is encouraging for SATOYH/BALDER. AKFAST, which skews to unregulated North American markets, stands out givens its strong growth in 2023 and we expect it to remain an outlier in 2024.

Retail: The Retail names in our coverage universe delivered solid growth in 9M23, in part due to easy COVID comps to start the year. Given this dynamic, we expect growth to slow in 4Q and likely in 2024 though our base case is that headline growth remains solid as footfall improves more gradually to 2019 levels. We have been reassured by LIFP’s and ULFP’s color around their European operations, though dynamics in the UK and US are mixed. We also recognize that growth in 2024 is at higher risk of being impacted by a recession via sales-backed-rents and the health of the Retailers’ tenants more broadly. On the latter point, as we detailed in our cross sector piece with the Retail team published in September, OCRs increased in 1H23 due higher lease costs. However, footfall trends and color from landlords on their ability to push through rent hikes has reassured.

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