The real estate market is coming to terms with a new phase of pricing discovery as the pace of investment activity slows. Colliers predicts this will lead to a resetting of market pricing in the face of continued interest rate hikes over the next 12-24 months.
‘The full outcome for the market could take up to 24 months to fully materialize, but the next six months will be driven by a re-calibration of pricing,’ said Damian Harrington, head of Global Capital Markets Research, Global and EMEA. ‘The scale of the reset will differ markedly across locations due to the speed and extent to which interest rates are changing, in combination with variant local real estate fundamentals and pricing dynamics.’
On average, yields are predicted to move out by 75 basis points, which converts to a 15% reduction in capital values. Capital values are expected to decline by up to 30%, and the timing of the changes unfolding will vary across the globe.
Colliers Capital Markets experts believe that the shock the market is now feeling can largely be absorbed, as current market dynamics are not echoing the past financial crisis when loan-to-value levels were much higher than today. Equally, these changing conditions create new opportunities.
‘Now is a time of opportunity. If investors pick their markets, assets and strategies carefully, this is a good time to capitalize,’ added Chris Pilgrim, Global Capital Markets Director. ‘Cash is king and equity-driven investors, notably private buyers can bid for assets in an environment with limited buy-side competition. They are typically immune to market forces and will continue to be active despite market flux. Markets with a renowned safe haven status, such as London’s West End will be active. Similarly, locations with deep, embedded levels of private capital will also prosper.’
The need to re-imagine investment strategies will support a shift in the deployment of capital from equity to debt. Re-financing requirements will continue to build in the face of higher interest rates and all-in-cost of debt. This equates to higher returns for those providing debt into the market, typically at lower risk.
Contracyclical investment, primarily sale and leaseback opportunities will also arise for investors as companies seek ways to improve their capital position and support their business strategy. For some, working with an investment partner that provides the capital expenditure to upgrade the assets they occupy to a higher ESG standard is a positive development.
Colliers notes there are other sources of deal activity, notably the termination of closed-end funds leading to the sale of assets, which will support investment activity across markets while investors prepare for their reset.
Luke Dawson, managing director, EMEA Cross Border Capital Markets said, ‘The European real estate market has been stable and prosperous for some time now. Over a 10-year period, an investor could expect an 8.8% multi-sector return on European real estate, on average. If yields move out by 100 basis points, this return level would drop to 7.6%, so most markets and portfolios should be able to absorb this pricing reset. That position gets trickier the shorter the hold period, but long-term strategies allow investors to weather these market changes. Strong fundamentals are in place across European markets, with industrial and logistics, residential (multifamily, student housing) and core office positioned best to provide rental stability and growth once the economic outlook improves in 2023. Additionally, the value-add route will increase in popularity as investors seek assets to reposition them for the mid to long-term once the market resets.’
Concluding, he added: ‘In the short-term lower levels of investment market activity should be expected. The inertia we will witness needs to occur while we go through a pricing recalibration. At the same time investors will need to look at their planned investment approach and revise their strategies to reflect current and predicted market dynamics. As with previous market cycles many opportunities will arise for savvy investors who are willing to diversify their approach and take action.’