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European Real Estate 4Q22: Wait for It
Mary Pollock, CFA – Senior Analyst - European IG and HY Real Estate
EXECUTIVE SUMMARY
- “Fair value” portfolio valuations on balance sheet did not see the steep declines in 4Q/2H that investors are pricing into real estate spreads and equity. This was a point of discussion on earnings calls. The reason valuations have not stepped down to a greater degree yet is due in part to the quiet transaction market (i.e. no useful comps). The encouraging outlook for rent growth has also helped to offset the impact of higher discount rates.
- The transaction market is quiet especially for deals of size. There are pockets of liquidity, and we repeatedly heard the size bogey of < €100 mn for deals in certain sub-segments. A number of names (Logicor, Segro, Vonovia) also noted some improvement in market dynamics since February.
- The outlook for rent growth implies an acceleration in 2023, though with a large of mix of trends by subsector and geography. For Logistics, Offices and Retail indexation will be a key driver of growth, which should accelerate going forward. Second tier Offices will struggle with releasing, as the secular pressures related to WFH and tenants shifting strategies will be an increasing headwind. Retail/Hotels will continue to benefit from easy COVID comps to start 2023 which this will benefit landlords via turnover rent. Residential growth trends will be more gradual as the cost of living crises and regulatory frameworks limit landlords’ ability to hike rents in line with inflation.
- Companies access to the bank market was a focus on 4Q22 results calls. The bulk of these results calls were notably before the events of recent weeks, though when companies have reported across the board management were positive on access to the banks markets. Secured debt on balance sheet only increased materially for Heimstaden Bostad, Balder and Castellum in 4Q22. Any concern regarding access to bank funding going forward would a major worry for Heimstaden Bostad and Balder, while Castellum’s equity raise and SBB’s EduCo deal reduce liquidity risk.
- Shareholder returns are down, equity raises are in, and investment is out. Dividend suspensions, dividend cuts, and the introduction of scrip dividend options were themes throughout results season. Reduced shareholder returns are a positive, though from a cash flow perspective not a game changer. Slower investment will support cash flow short-term, though in the medium term may drag on growth in particular in the Residential segment.
- The return of business in the Retail, Hotel, and Event/Convention industry was a tailwind to end 2022 and this will continue in 2023. Retail players are also benefiting from a move into defense mode in 2020 due to the COVID crises, which means they are already better-placed to navigate the near term uncertainty. Higher capitalization rates on Retail properties have also helped to absorb the impact from the step-up in interest rates.
- The Office sub-segment will continue to see trends diverge depending on the property portfolio in question. Color across the sector implied that while tier-1 offices are seeing solid demand and continued rent growth, tier-2 offices are struggling with the shift to WFH and the knock-on impacts for the industry.
RELATIVE VALUE
We are in the process of launching fulsome coverage across the European real estate sector. See links below for more detail on our recommendations for names that we have launched coverage on thus far. In this report, we also discuss earnings results from Segro, Logicor, VGP, Hammerson, Klepierre, Icade, Castellum, Kojamo, Citycon, Carmila, Covivio, Merlin, Colonial, TAG, LEG, Grand City, and NEPI Rockcastle.
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