Our base case economic scenario for Europe in 2020 is for modest GDP growth, which, while below long-term trends and somewhat directionless, remains in positive territory. We forecast economic expansion of 0.9% in the Eurozone next year, marginally below consensus, with German and French growth expected to be 0.6% and 1.0% respectively. Performance will be uneven across geographies. Some countries may experience a technical recession as most growth will be concentrated in certain successful locations or cities. We expect inflation to be subdued next year, providing room for monetary policy stimulus. Further global and European economic uncertainty and a low interest rate environment will persist, meaning that real estate remains attractive to investors on a relative basis although we remain of the view that real estate sector has matured as an asset class in scale, liquidity and, for the most part, transparency – and defined for itself a more permanent role in global investors’ portfolios, a role characterised by stability and diversification as well as advantageous risk-adjusted returns.
A shortage of quality stock was a major feature of the real estate investment landscape in 2019. Despite a pick-up in some locations, construction activity remains low overall. The ongoing lack of supply and sustained investor demand is likely to mean the competitive environment persists next year. Total investment volumes in 2020 are likely to be below the long-term average, as in 2019, more reflective of a lack of suitable product than a lack of demand. This will maintain or compress yields for the most hotly sought-after real estate, although the scope for further yield compression beyond the relatively low existing yields remains limited, especially in the traditionally dominant sectors of office, residential and retail. The income component of real estate will therefore be the most important aspect in driving overall returns and opportunities for capital value growth through the capture of rental increases.
Along with broader thematic changes resulting from new demographics, technology and infrastructure, real estate markets have become increasingly detailed, sophisticated and data-driven, resulting in increased polarisation of returns between, and indeed within, real estate segments. This trend is likely to build even more momentum in 2020. Occupiers will continue to be discerning and unwilling to comprise in terms of location and the type of real estate they wish to occupy as technology allows them to be increasingly focused on improving the productivity of space, even as their requirements change. Investors are also likely to focus on prime, defensive assets at the expense of secondary assets. This will accelerate the widening discrepancy between successful real estate and everything else. Some core assets may morph into value-add or opportunistic space, as we have seen to some extent in parts of the retail property market and older office space. Against this backdrop investors must ensure that the real estate they buy is positively aligned to accelerating polarisation and that the style in which they think they are investing is indeed sustainable against the more dynamic backdrop.
Structural change continues to create new types of occupational demand which will support selective rental growth. For example, structural changes and the new industries, work practices and lifestyles which they spawn are driving a disproportionally large share of GDP growth in select cities. The rising importance to occupiers and workers of clusters, business networks, transport connectivity, health, amenity and liveability means that suitably specified real estate in these cities has the most exposure to economic expansion and thus rental growth.
In this climate, we see the most interesting investment opportunities in diversified, liquid markets such as Germany and France. Because office availability in major western European cities is tight and occupiers want quality, prime offices in dynamic cities like London, Munich and Madrid are attractive. We expect the ongoing occupier flight-to-quality to endure even if macroeconomic conditions weaken more than we foresee.
With this in mind, offices located in selected thematic districts of major cities that can be repositioned to better align with modern occupier demand are attractive given their ability to capture rental uplifts. Conversely, offices that are poorly specified, situated in submarkets with poor connectivity or in weaker secondary cities without thematic support may see value erosion and should be avoided.
Considering other segments, we see opportunities in well-specified light industrial and logistics warehouses close to major transport nodes serving growing populations. This type of real estate is benefiting from the structural shift towards online retail and a more holistic approach by retailers to a multi-channel offering as they reshape and revalue their physical space.
The demographic drivers of change across Europe are compelling and will support opportunities to target residential rental models catering for specialist groups like students, young professionals, key workers or retirees requiring affordability and quality with good social and/or medical access. Well-designed hospitality space which meets customer requirements across multiple seasons with strongly branded operators should also benefit from steady growth in long-term travel trends. Overall, beds represent an evolving area of the market which we expect to perform well in 2020.
Active asset manage will be critical to protecting, creating and growing income and driving performance across all asset classes next year. In this environment having a pan-European platform with skilled real estate professionals embedded across European countries is necessary to deliver the tailored local management that will be needed.
The 2020 outlook is subject to a high number of variables and there are looming macro risks such as the US presidential election, the risk of a Brexit without a comprehensive UK-EU trade deal by the end of 2020 and an escalation in trade wars, particularly US-China. By executing a thematic investment approach, with nimble, active management shaped by an understanding of structural changes, investors can still expect to access solid returns and protect capital value in a lower growth environment.
Maureen Mahr von Staszewski
Senior pan-European Fund Manager at Swiss Life Asset Managers