Sector conditions and outlook1
Office sector transaction volume in Q2 2023 was the lowest on record as macroeconomic headwinds and concerns over hybrid workers kept investors on the sidelines. Capital values dropped by 16% on average across Europe over the last eighteen months. This was driven by the UK where borrowing costs have risen more than in the Eurozone and the shift towards hybrid working has been more pronounced than in mainland Europe. Nevertheless, office availability in main central business districts remains generally low, while vacancy rates in secondary sub-markets have recorded an uptick as more companies relocate while downsizing.
The industrial sector recorded the sharpest repricing as values declined by 20% from their peak as of June 2023. Prime net yields have softened across all core markets, driven by Glasgow and Edinburgh. However, the quarterly pace of softening has generally slowed considerably, and it is likely to flatten in Q1 2024. Meanwhile, occupier demand remains robust, although perspectives are weakening as the lagged impact of high interest rates weighs on the economic outlook and global trade.
The steep house price appreciation seen in the last few years and the recent spike in interest rates have significantly worsened housing affordability and locked several new buyers out of the market. Mortgage approvals fell sharply, followed by a drop in house prices. Meanwhile, builder sentiment weakened across Europe, although with different intensity. Total returns in 2023 are likely to stay negative, but the long term attractiveness of the sector remains strong amid growing demand for rentals and sluggish supply.
Transaction volume declined by 12% to €6.5bn in H1 2023 over the same period last year and 37% over the pre-pandemic long-term average. Capital values remain 14% from the pre-pandemic peak, according to MSCI. Conversely, hotels’ operational results were quite strong and ahead of expectations. In Amsterdam, RevPar increased by 58% in H1 2023 compared to the same period last year, followed by Milan (51%), London (39%) and Paris (37%). This is despite the fact that occupancy rates have not yet recovered to pre-COVID levels.
The retail sector is the only sector achieving positive total returns so far this year due to a mix of different factors. First, retail yields had already softened significantly during the pandemic; thus they could better absorb the spike in base rates. Second, a growing number of retailers took advantage of the feeble deal activity to purchase their premises, putting a floor on values. Finally, the returns of commuters and the resurgence of tourism during the summer season have contributed to increased high street footfall and bolstered operator sentiment. Across the retail sector, out of town retail parks have the brightest outlook in our view.
In the six months to June 2023, take up and new supply continued to increase, although at a lower rate due to difficulties in securing and delivering new capacity. Vacancy rates across the FLAPD markets (Frankfurt, London, Amsterdam, Paris, and Dublin) have declined further and are forecast to reach 11% by the end of 2023, marking the fourth consecutive year of decline. Meanwhile, hyperscalers are looking to expand outside core markets by investing in smaller data centres across multiple locations near the edges of their regional networks to accommodate growing demand and limit latency.
The healthcare investment market has been slow so far this year. Transactions reached €3bn in H1 2023, a 25% decline compared to the same period last year. Net initial yields for prime assets have softened marginally to an average of 5.3% as of June 2023, according to MSCI. Capital flow is expected to remain subdued given the wide price gap between buyers and sellers. Additionally, the occupier market is strained by several challenges—weakened by an extended period of lower occupancy rates, high borrowing costs, funding gaps, and a shortage of qualified workers. Restructuring and insolvency cases are on the rise.
According to MSCI, UK student housing averaged 9% total return over the last ten years (2013-2022), the second best-performing property type after the industrial sector. However, in the first half of 2023, returns were modest at around 1% as student housing suffered from yield softening, although less than other sectors. As a result, capital values declined by 8% from the peak of last year as of June 2023. The occupier market performed strongly across Europe, with most operators reporting occupancy rates above 95% in Q3 2023. Thus, rents have increased by 4 to 6% in Q3 2023 over the prior year, however, cities with the highest student-to-bed ratio recorded an increase of 10%.
1 Outlook refers to the next 12 months
Source: Principal Real Estate, September 2023
For our detailed perspective on the conditions and outlook for each sector, please download the full Europe Real estate sector report.
For Public Distribution in the United States. For Institutional, Professional, Qualified, and/or Wholesale Investor Use Only in other Permitted Jurisdictions as defined by local laws and regulations.
Investing involves risk, including possible loss of Principal. Past Performance does not guarantee future return. All financial investments involve an element of risk. Therefore, the value of the investment and the income from it will vary and the initial investment amount cannot be guaranteed. Potential investors should be aware of the risks inherent to owning and investing in real estate, including value fluctuations, capital market pricing volatility, liquidity risks, leverage, credit risk, occupancy risk and legal risk. All these risks can lead to a decline in the value of the real estate, a decline in the income produced by the real estate and declines in the value or total loss in value of securities derived from investments in real estate.
This material covers general information only and does not take This material covers general information only and does not take account of any investor’s investment objectives or financial situation and should not be construed as specific investment advice, a recommendation, or be relied on in any way as a guarantee, promise, forecast or prediction of future events regarding an investment or the markets in general. The opinions and predictions expressed are subject to change without prior notice. The information presented has been derived from sources believed to be accurate; however, we do not independently verify or guarantee its accuracy or validity. Any reference to a specific investment or security does not constitute a recommendation to buy, sell, or hold such investment or security, nor an indication that the investment manager or its affiliates has recommended a specific security for any client account.
Subject to any contrary provisions of applicable law, the investment manager and its affiliates, and their officers, directors, employees, agents, disclaim any express or implied warranty of reliability or accuracy and any responsibility arising in any way (including by reason of negligence) for errors or omissions in the information or data provided. All figures shown in this document are in U.S. dollars unless otherwise noted.
This material may contain ‘forward looking’ information that is not purely historical in nature. Such information may include, among other things, projections, and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.
This material is not intended for distribution to or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.
This document is issued in:
- The United States by Principal Global Investors, LLC, which is regulated by the U.S. Securities and Exchange Commission.
- Europe by Principal Global Investors (Ireland) Limited, 70 Sir John Rogerson’s Quay, Dublin 2, D02 R296, Ireland. Principal Global Investors (Ireland) Limited is regulated by the Central Bank of Ireland. Clients that do not directly contract with Principal Global Investors (Europe) Limited (“PGIE”) or Principal Global Investors (Ireland) Limited (“PGII”) will not benefit from the protections offered by the rules and regulations of the Financial Conduct Authority or the Central Bank of Ireland, including those enacted under MiFID II. Further, where clients do contract with PGIE or PGII, PGIE or PGII may delegate management authority to affiliates that are not authorised and regulated within Europe and in any such case, the client may not benefit from all protections offered by the rules and regulations of the Financial Conduct Authority, or the Central Bank of Ireland. In Europe, this document is directed exclusively at Professional Clients and Eligible Counterparties and should not be relied upon by Retail Clients (all as defined by the MiFID).
- United Kingdom by Principal Global Investors (Europe) Limited, Level 1, 1 Wood Street, London, EC2V 7 JB, registered in England, No. 03819986, which is authorized and regulated by the Financial Conduct Authority (“FCA”).
- United Arab Emirates by Principal Global Investors LLC, a branch registered in the Dubai International Financial Centre and authorized by the Dubai Financial Services Authority as a representative office and is delivered on an individual basis to the recipient and should not be passed on or otherwise distributed by the recipient to any other person or organisation.
- Singapore by Principal Global Investors (Singapore) Limited (ACRA Reg. No. 199603735H), which is regulated by the Monetary Authority of Singapore and is directed exclusively at institutional investors as defined by the Securities and Futures Act 2001. This advertisement or publication has not been reviewed by the Monetary Authority of Singapore.
- Australia by Principal Global Investors (Australia) Limited (ABN 45 102 488 068, AFS Licence No. 225385), which is regulated by the Australian Securities and Investments Commission and is only directed at wholesale clients as defined under Corporations Act 2001.
- This document is marketing material and is issued in Switzerland by Principal Global Investors (Switzerland) GmbH.
- Hong Kong SAR (China) by Principal Asset Management Company (Asia) Limited, which is regulated by the Securities and Futures Commission. This document has not been reviewed by the Securities and Futures Commission.
- Other APAC Countries/Jurisdictions, this material is issued for institutional investors only (or professional/sophisticated/ qualified investors, as such term may apply in local jurisdictions) and is delivered on an individual basis to the recipient and should not be passed on, used by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.
Principal Funds are distributed by Principal Funds Distributor, Inc.
© 2023 Principal Financial Services, Inc. Principal®, Principal Financial Group®, Principal Asset Management, and Principal and the logomark design are registered trademarks and service marks of Principal Financial Services, Inc., a Principal Financial Group company, in various countries around the world and may be used only with the permission of Principal Financial Services, Inc. Principal Asset Management℠ is a trade name of Principal Global Investors, LLC. Principal Real Estate is a trade name of Principal Real Estate Investors, LLC, an affiliate of Principal Global Investors.
MM12006-03 | 10/2023 | 3163286-122024