While market equilibrium often refers to the balance of supply and demand when referencing fundamentals, here we refer to the equilibrium between the buyers’ and the sellers’ expectations.
Since our Q3 2022 forecasts, we have witnessed a period of resilience, the resurgence of concerns about a potential financial crisis, and reassurance from central banks.
Our baseline remains largely the same: growth has surprised on the upside with some markets avoiding ‘technical’ recessions, but underlying growth remains low.
Against the backdrop of anaemic growth, high interest rates and tighter credit conditions, investment is expected to remain subdued and pick up in the latter half of 2023.
Downside risks include sticky core inflation (and thus a risk of higher rates) as well as further tightening in credit conditions because of the recent turmoil in the banking sector. If more clarity on the interest rate outlook emerges sooner than we expect, investment momentum could gather steam and yield compression could commence sooner. This is an upside risk.
With the sharp adjustments in yields since H2 2022, commercial real estate valuations are heading towards fair value (we will be publishing our Fair Value Index following the forecast update). The property to 10-year government bond yield spread is lower than it was during the post-GFC period where policy rates were at the zero bound. It is now at 153 bps as of Q1 2023: this compares to the 30-year average of 208 bps and an average of 122 bps from 1992-2010 (the era prior to policy rates at zero).
Further re-pricing will be front-loaded in the first half of this year. Prime yields across all sectors will continue to move outwards as higher costs of debt continue to filter through in 2023, albeit to a lesser extent as seen in 2022. Retail yields are the exception and are expected to move out +44 bps this year, versus +24 bps in 2022. For office and logistics, we expect yields to expand by +54 bps and +40 bps, respectively, in 2023 (compared to outward movements of +61 bps and + 88 bps in 2022, respectively).
Although these figures were not far from our prior forecast, prime rental growth was upgraded for European prime office (5.5%) and logistics (14.5%) in 2022 despite low economic growth. This has been largely due to undersupply of high-quality space within these two sectors. In some markets we expect the undersupply to continue as higher capital costs are delaying development starts. Both sectors face the challenges of obsolescence as decarbonisation gathers momentum. This will widen the prime and average markets further.
European prime rental growth is expected to ease in 2023 across all sectors, averaging 3.3% for office, 7.3% for logistics and 0.4% for retail.
European CRE Forecast
We are entering a period where real estate market conditions are expected to “settle” in H2 2023—that is, real estate markets find a new equilibrium.
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