OUTLOOK 2020: Tighter yields, lower returns, more M&A

With the new year around the corner, our reporter Dominic Gover asked real estate professionals to dust off their crystal balls and peer into the future.

What does 2020 hold for CRE? Making predictions is complicated slightly by the fact that nobody seems to know precisely where we are in the cycle as the sun sets on 2019.

The perception is the market is somewhere near or at the top, awash with equity which the European Central Bank has decided it is going to keep topping up, in the form of quantitative easing. Industry insiders expect this to continue in 2020, with evidence of yields falling further in some cities. CBRE will forecast early next year that yields will be even keener across Europe.

Asian entry
Setting the weather for investors in 2020 is likely to be interest rates staying lower for longer, bonds in negative territory and demand outstripping supply. Can income grow quickly enough to outstrip falling yields in the new year?

These headwinds mean that 2020 is likely to be a busy year for European real estate, which is seen as an attractive destination for international capital, especially from Asia.

Expect to see Singapore-listed asset manager Keppel Capital enter the market in 2020, branching out into Europe from its Far East base. The firm owns one of Asia’s biggest REITs and is to launch a Europe-focused one next year.

Meanwhile, IPOs are expected to remain an endangered species from January, continuing the dearth of 2019. Experts we have spoken with foresee 2020 will instead see more M&A activity with listed firms buying other listed firms, along the lines of Aroundtown’s acquisition of TLG. The attraction of this is that major synergies often exist between similar companies, while IPOs can take longer and be even more complex.

One thing our survey of sentiment reveals is that investors reckon the new year could see residential’s reign continue, after the asset class finished 2019 strongly. Residential offers long income opportunities, a plentiful supply of tenants and a shortage of supply. This is appealing in the present low interest rate environment for investors seeking returns from operations in the form of rental income, as well as from asset trading.

One M&A deal to look out for in 2020 is Aedifica, the Belgian senior living provider, buying Hoivatilat – which develops care homes in Norway. Dutch merchant bank Kempen is involved and we understand the transaction will complete in Q1 next year. Meanwhile, UK-based investor, M&G Real Estate, predicts it will be focusing on residential with its two open-ended funds, from next month.

Secure income
Marc Reijnen, head of investment and asset management at M&G Real Estate, says: ‘It’s all about secure income stream, not the underlying asset. We only want to invest where there’s rental growth expectation; which is getting harder to find in the office sector.’

While keeping tight-lipped on deals in the pipeline, M&G is targeting major cities in the Netherlands, Copenhagen in Sweden and also Helsinki in Finland, he notes.

Meanwhile in the UK, residential developers are busy in major cities, despite Brexit uncertainty. The likes of Quintain, as well as Greystone, Grainger and Get Living, are building family homes to rent, not sell.

Could 2020 be the year the vexed Earls Court residential development in London finally escapes the political quagmire it’s been stuck in for years?
New owners Delancey and APG have shorn the plan of some controversial elements and resubmitted it to the local council. PropertyEU understands there is now goodwill between the parties, which could help get the development going next year.

Retail rumbles on
From one rising star in the form of residential, to retail – from which the shine well and truly wore off in 2019. The past 12 months have been an ‘annus horribilis’ on Europe’s high streets and in its shopping centres, with operators such as Intu and Hammerson recording sector-worst returns through the first half of the year.

We hear Intu is looking to divest two shopping centres in Spain soon; the Intu Asturias in the northwest of the country and Intu Puerto Venecia in Zaragoza. The firm is targeting book value for the deals, or a yield in the high 4%.

Meanwhile, Savills is tipping sale-and-leasebacks in 2020, so expect to see capital-raising taking place as the firm looks to fulfil its appetite for long leases with attractive, stable incomes. In 2020, we may also see the return of US investors shopping in Europe for net leases because they like the balance of long incomes and yield profile.

But it’s not all doom and gloom in retail. Things appear to have stopped getting worse as of Q4 2019, with EU investment volumes down around 19%, in line with the other
asset classes.

The new year is likely to bring more retail repurposing and redevelopment, particularly in Germany, Norway and the UK, as the sector evolves into new forms under pressure from the rise of e-commerce and changing consumer habits. As a result, the asset class may be a bit smaller by the end of 2020.

Based upon conversations PropertyEU has had, we wouldn’t be surprised to see an uptick in office transactions in 2020, as investors take advantage of sharp pricing. It is rumoured a BNP Paribas office in London is going to come on the market for a yield of around 3% early next year.

Active office markets next year look like being Germany, Belgium and the Netherlands. A Munich office is currently under offer at a yield of between 2.5-2.75%.

These are places where a lot of capital was invested back in 2014 by Korean investors, whose five-year business plans come to end in 2020. It is said there are many assets that have failed to be securitised by asset management groups and their investment banking advisors. New players to look out for in the segment next year include Mastern Investment Management, which is to launch the first EU-focused REIT targeting offices in France, the Netherlands and Germany, PropertyEU understands.

Co-working crisis
How will the flexible office segment fare in 2020? The sector was shaken by the near-death experience of WeWork, triggered by industry dismay at the state of its financials ahead of its proposed IPO in August.

Co-founder Adam Neumann said he wanted to put WeWork on the planet Mars. Instead, the firm’s valuation came crashing back down to earth from $47 bn, all the way to $10 bn or less.

Despite the fiasco, everyone we spoke with expects flexible office to perform strongly in 2020, with firms such as IWG (Regus and Spaces) showing how to do it successfully.
Rob Virdee, analyst at Green Street Advisors, says: ‘It’s worth remembering flexible office is around 5% of total supply in London, and WeWork comprises around 1% of that. You need to put things in perspective.’

Nonetheless, there are consequences. We spoke with a firm which is being cautious by only investing in office assets in which WeWork controls 20% or less of the GLA, next year.

Brexit dividend?
Elsewhere, ‘Get Brexit done’ was UK prime minister Boris Johnson’s non-stop refrain during the recent general election campaign in the UK. Property investors we consulted share this sentiment.

We understand from our conversations that lots of deals have been delayed since before the 12 December poll because nobody is sure what the outcome will be. So expect a flurry of transactions getting done in Q1 2020 should certainty break out in the form of an orderly exit from the EU.

Nonetheless, appetite for the UK will remain strong next year, with Asian investors particularly attracted to the UK because it offers more yield scope than the 3% or so that is commonly found in continental Europe.

Colliers expects around £50 bn (€58 bn) in UK transaction volumes in 2020 – up around £5 bn on 2019’s total. Driving this rise is demand-side appetite – particularly from Asia, as well as the high number of deals currently tied up in ‘legals’ or being delayed by Brexit uncertainty. Don’t rule out retail CVAs drawing opportunistic buyers, either. The only thing they worry might derail things is a no-deal Brexit around Q3.

Impact investing
Away from the markets, could the new year witness a sea change in attitude among professionals? The rise of so-called impact investing could be a trend to watch out for in the new year (see box opposite page). Of course, saving the world will not come at the expense of returns, according to one investment manager we spoke with. Investors will seek ‘positive outcomes’ alongside returns, not instead of them, in 2020.

So, what sort of real estate professional is going to be in demand in 2020?

Sector insiders tell us recruitment is being dictated by the ‘lower for longer’ interest rate environment, which is forcing investors to find new ways of generating returns.
Asset managers who can repurpose an asset are set to be popular. We understand this is because the lack of new supply is necessitating change of use, as retail outlets become residential assets, for example.

Specialists in data and demographics should be in demand too, as investors dig deeper into locations in the search for yield, amid growing competition and lessening supply. Also, with pricing as sharp as it was at the end of 2019, making the right call is more crucial than ever.

Meanwhile, nobody we spoke with expects returns to grow in 2020. Quite the opposite; they will be down by around 25 bps year-on-year, is the broad expectation. Of course, it is hard to be too precise about this right now.

However, what does look likely is that as 2019 becomes history and the first year of the third decade of the 21st century dawns, real estate will be a busy place. ?


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