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Renovating Europe
European real estate offers better value than the US or Asia.
Written by
Ioanna Exarchou, Real Estate Investment Specialist
Europe was late to the real estate party. But being late isn’t always a bad thing. It means that Europe’s real estate cycle is less advanced, with more growth still ahead compared to the US, and with valuations that are more attractive than those in mainstream Asian markets.
appetite for offices
EU unemployment rate vs office occupancy rate
Source: Eurostat, CBRE. Data covering period 31.12.2017-31.12.2018.
After under-investing in their real estate for close to a decade, several European cities are full of buildings that no longer fit their occupiers' needs.
Renovation, refurbishing and re-purposing can therefore be expected to become a bigger feature of urban planning, giving rise to a number of attractive investment opportunities.
What's more, Europe’s economy is on a sufficiently strong footing for people and businesses to be able to pay for space that better meets their requirements. As unemployment has fallen, office occupancy rates have reached an average 93 per cent (see chart).
In Europe’s most popular markets occupancy is at 95 per cent or even higher. Historically, this is a level where good spaces are scarce and start to attract more than one potential occupier, which creates competition and leads to long-awaited rental growth.
Changing demands
For prospective real estate investors, the first challenge is to identify the changing needs of buildings’ occupants, both commercial and residential.
In Europe’s larger cities, tech companies now occupy more office space than banks, which marks a radical shift from a decade ago1. The consequent growth in co-working means that the amount of space required per employee is falling, while flexibility is becoming increasingly important – not only in terms of how office space but also in the way lease agreements are structured.
fewer homes, more households
EU construction vs single household formation
Source: Eurostat, CBRE. Data covering period 01.01.2009-31.12.2017.
Residential demand, meanwhile, is largely influenced by changes in demographics. Construction has failed to keep pace with the rise in the number of households as more and more people live alone (see chart). Millennials often rent and tend to favour modern apartments in urban centres, which are in short supply. At the same time, an ageing population is fuelling demand for more senior housing. European countries are also seeing an influx of foreign students2, as the continent’s universities increasingly use English as a teaching language3, which has helped boost enrolment from increasingly affluent Asians, not least China’s burgeoning middle class.
In retail and logistics, opportunity comes from the fact that e-commerce in Europe is less developed than in the US or much of Asia.
Across all sectors, there is a growing concern for the environment – improving the efficiency of buildings and reducing their environmental footprint from construction to operation.
The other is “space as a service”. Whether it’s where we work, sleep or relax, we are now seeing demand for additional services, be that networking and socialising facilities in an office, a concierge and a gym in an apartment block, or storage facilities for business travellers in their regular haunts. Providing the right services in the right way can boost rental income.
Active management
We have identified four main routes to the active management of real estate assets.
The first is refurbishment and repositioning – buying an underperforming asset with the aim of transforming it into a strong, core one. That could, for example, involve changing a traditional office into modern creative space that meets a tech occupier’s needs or finding a completely different use for a secondary retail asset.
The second is growing the gross leasable area by adding extra floors or redesigning the layout. In a business hotel, for example, clients may value comfortable beds and modern facilities more than space, making it possible to refurbish to include more rooms while also improving the hotel's desirability or quality.
The third is to increase rent by offering more services within a building, such as concierges, laundry, or organised events. The fourth route, “buy and build”, involves purchasing several small assets and packaging them together into a single portfolio that’s large enough to appeal to major institutional investors.
Location matters
We all have a home bias when it comes to real estate. It is a local business, so the domestic market is the logical first place to start. But, as with any investment, diversification is important. Pan-European investing offers a broader range of opportunities, through varied economic and occupier dynamics.
Spain, for example, is still recovering from the 2008 property bust. Madrid is really changing gears, becoming an international city in the mould of London or Paris. So far, Spanish real estate has only recovered half the distance from peak to trough, so there is a lot of potential. Germany is one of Europe’s strongest economies and has a thriving tech scene, particularly in Berlin. The Nordic countries, meanwhile, stand out for their stable economic growth. They tend to be very deep local markets, with strong demand from local players.
Of course, even amid the uncertainty over Brexit, it is impossible to ignore the UK, which remains a major real estate markets. Brexit will bring – indeed has already brought – volatility, reducing demand from occupiers and investors alike. But we believe London will remain a global city and market turbulence could present interesting investment opportunities, particularly from forced sales by businesses exiting the country or shutting down altogether.
A truly pan-European investment manager can thus have an advantage, particularly when it comes to sourcing attractively-priced off-market deals. By having the flexibility to navigate across sectors and regions, we can tap into the best opportunities on offer at any given point in time.
Real estate investing increasingly demands a much more operationally intensive model – to generate attractive returns it is no longer enough to just buy and hold a property. This is where a value-add, active approach really comes into its own, helping to maximise investor returns throughout the cycle.
Benefits of real estate investing
Diversification
due to low correlation with other major asset classes (see table below)
Attractive income stream
which can be further boosted by active management and re-positioning/re-purposing of buildings
Inflation protection
with rents usually linked to inflation
Diversification benefits
Source: Pictet Alternative Advisors, as at 30.09.2018. Indices used: NCREIF Property Index, MSCI World, MSCI EM, JPMGGBI, Barclays Global Aggregate Corporate TR, FTSE NAREIT All Equity REITS TR.
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