LaSalle’s 2022 Mid-Year ISA: European real estate investment acutely impacted by geopolitical crisis, but opportunity in uncertainty remains

Heightened geopolitical risk, persistent high inflation, and a possible recession will place European real estate under acute pressure in H2 2022. However, the asset class is expected to continue to provide longer-term stability for core investors via carefully curated portfolios, as well as offering new opportunity for investors seeking value-add returns – according to the mid-year 2022 edition of the Investment Strategy Annual (“ISA”), the report published by global real estate investment manager LaSalle Investment Management (“LaSalle”).

Europe is facing a macroeconomic environment rendered fragile by supply chain issues, a hot war on the region’s periphery and a squeeze on consumers’ disposable incomes. As a result, LaSalle expects real estate investors to adopt a much more cautious approach in the second half of 2022. However, while inflationary pressures have surged, and interest rates have increased earlier and more quickly than expected, real estate assets can act as a hedge against inflation in cases where landlords have pricing power. Fundamentally, this will manifest for investors with the best assets in the right locations, where supply-demand imbalances underpin rental growth.

Furthermore, in an uncertain environment, investors seeking higher returns can expect to benefit from dislocation and opportunities to repurpose assets. Off-market or value-add opportunities could potentially offset the effect of rising operating expenses, construction costs and interest rates, either through building-specific renovation or repositioning to achieve occupancy improvement or rental uplift. 

Long-term resilience will be underpinned by careful stock selection. Although European real estate markets have been impacted by global headwinds, pockets of opportunity persist for investors across each sector.  

Retail rebound postponed

In retail, the post-Covid recovery has been shaken by the impact of inflation on consumer discretionary spending power. Bricks-and-mortar retail warehouses have, however, remained resilient due to the non-discretionary nature of underlying demand for grocery anchors and their convenience offer. But fundamental challenges for European shopping centres and high-street retail is expected to persist, despite destination shopping continuing to remain an integral part of the retail experience in the long term. We remain optimistic on the outlook for outlet centres, which are set to benefit from increasing consumer frugality.

Office sector ‘trifurcation’

As with retail, the office sector is experiencing occupier and investor needs varying greatly by the quality of asset and micro location. Experientially rich buildings in prime locations that meet sustainability standards and benefit from high-quality amenities will continue to attract demand. In addition, with the pathway to Net Zero Carbon in mind, the age and quality of existing stock in European markets presents an opportunity to create the offices of the future, particularly through refurbishment. However, there is a growing range of older stock which is likely to be stranded and should be sold at – or at times even below – current valuation before liquidity dries up.

Logistics demand story remains intact

Logistics has not been immune to recent market shocks and the ongoing cost-of-living crisis. A slowdown in take-up by major occupiers marks a change from many years of continued expansion. However, LaSalle believes that the sector remains in a robust position to grow in the coming months. European logistics properties recorded the highest demand for new space ever in H1 2022, driven by continuous e-commerce expansion, as well as just-in-case inventories and the nearshoring of some manufacturing activity. As a result, vacancy rates are at historical lows, and we remain confident of future prospects for European logistics rental growth.

Living strategies’ prospects at risk of divergence

The living sectors remain underpinneD by strong demand drivers including robust household formation, growth in key cities, an ageing population, increasing mobility and a structural undersupply across Europe. However, potential home buyers may tilt toward renting, owing to the rising cost of debt. For the more niche living sub-sectors, such as student housing and senior housing, investors will need to be ahead of the curve to take advantage of attractive pricing.

Finding value across the yield spectrum

With the European landscape evolving quickly, assessing the prospect for various sectors requires consideration of assets’ pricing yield levels and income growth potential.

LaSalle’s framework finds that for low-yield sectors with excellent fundamentals, like logistics, prime low-carbon offices in key cities and unregulated residential, valuations will hinge on the potential for and relative magnitude of future rental growth and an upward shift in yields. In low-yielding sectors where inflation cannot be offset by rental growth, caution must be exercised until markets stabilise.

Although higher-yielding sectors with challenged fundamentals are intuitively those in which value may be identifiable, recent concerns around economic growth have made their impact felt. The nascent retail recovery, for instance, is at risk from inflationary pressure on real incomes, while capex-intensive strategies to renovate buildings are affected by rising construction costs. Meanwhile, sectors with relatively higher yields and stronger net operating income growth potential – namely alternative living sectors, such as student accommodation or senior living – continue to remain attractive.

Brian Klinksiek, Head of European Research and Global Portfolio Strategies at LaSalle, said: “The past six months have seen macroeconomic headwinds and geopolitical risk affect the global economic outlook. European investors should therefore exercise caution in the coming months until market valuations and asset pricing stabilise. But despite this, real estate will remain an anchor as other asset classes struggle, and investors look for predictability. Underpinned by the long-term resilience of the asset class, careful portfolio construction across the key sectors of European real estate can continue to deliver the benefits of diversification, stability and long-term income growth for investors.”

Jacques Gordon, Global Head of Research and Strategy at LaSalle, added: “Real estate generally provided shelter during the waves of volatility that swept through the securities markets in the first half of the year. In the second half, we foresee different dynamics unfolding. The big change has been the sharp rise in inflation in Western countries and a “regime shift” from highly accommodative to tightening monetary policies by several central banks. Many world events simultaneously contributed to this inflection point including: the re-opening of economies after COVID-19, Russia’s invasion of Ukraine, trade wars, and government stimulus spending. Although these pressures were building in 2021, there is no escaping the fact that the financial and commodity markets shifted sharply in the first half of 2022. Our guidance for investors to seek inflation protection in real estate is a focus-theme of our mid-year update.”

About LaSalle Investment Management 
LaSalle Investment Management is one of the world’s leading real estate investment managers. On a global basis, we manage approximately $82 billion of assets in private equity, debt and public real estate investments as of Q2 2022. The firm sponsors a complete range of investment vehicles including open- and closed-end funds, separate accounts and indirect investments. Our diverse client base includes public and private pension funds, insurance companies, governments, corporations, endowments and private individuals from across the globe. For more information please visit www.lasalle.com and LinkedIn.

NOTE: This information discussed above is based on the market analysis and expectations of LaSalle and should not be relied upon by the reader as research or investment advice regarding LaSalle funds or any issuer or security in particular. The information presented herein is for illustrative and educational purposes and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy in any jurisdiction where prohibited by law or where contrary to local law or regulation. Any such offer to invest, if made, will only be made to certain qualified investors by means of a private placement memorandum or applicable offering document and in accordance with applicable laws and regulations. Past performance is not indicative of future results, nor should any statements herein be construed as a prediction or guarantee of future results.