European investors lowering RE allocations, Germany loses ground

For the first time in years, European investors have lowered their allocation target for real estate, according to INREV's Investor Intentions survey for 2023.

This year's target is a 10.5% allocation, as against a current allocation of 10.8%, reflecting a 30 bps reduction, due to what INREV describes as a technical over-allocation to the sector. By contrast, Asian and North American investors have stated their intention to boost their allocation to the sector, resulting in a 20 bps positive gap between their current allocation of 10.2% and a target allocation of 10.4%.

The sudden European reticence to invest in real estate is "due to the rapid decline in the value of stocks and bonds in portfolios," said INREV's head of research, Iryna Pylypchuk.

The phenomenon is known as the 'denominator effect', whereby a sharp decrease in the value of other asset classes pulls down the overall portfolio value. European investors' current real estate allocations are now proportionately higher as other asset classes, such as shares and bonds, fell more than real estate in 2022.

A year ago, in the same survey, just 4% of investors planned to invest less in real estate, while 63% said they planned to increase their real estate exposure. This year, 37% of Europeans said they planned to decrease their allocations to the asset class. "The sentiment is clearly negative at the moment. The faster the market corrects, the sooner this effect will go away", said Pylypchuk.

With the rapid decline in European real estate performance, European non listed returns reported the largest quarter-on-quarter decrease in capital values since the global financial crisis (GFC). "In uncertain times like this we tend to see a flight to safety, and we are in fact reporting a shift towards core funds in terms of strategy, although it is not quite as pronounced as after the GFC," Pylypchuk said.

While European investors are taking a safety-first approach, with the proportion of those citing 'core' as their preferred strategy rising from 30% to 46% over the year, Asians and Americans are showing a higher appetite for risk. Asians are reserving 20% of their capital for opportunistic strategies in Europe, with the Americans targeting 33%.

Still, appetite worldwide for investing in Europe is falling. This affects all asset classes, but logistics is especially hard hit. Last year 91% of US and Asian investors declared an interest in European logistics, but this has fallen to 38% this year, probably due to recent reversals of many years of consistent outperformance, sharp yield compression and high rental growth expectations.

Non-Europeans are also turning their backs on health care, project development and student housing. These had enjoyed approval ratings of between 45% and 26% last year. The asset classes of Office (82% to 75%) and Residential (from 73% to 63%) remained relatively stable. France, Germany and the UK as the most liquid markets continue to remain the favoured destinations for capital into Europe, with the Netherlands putting in a strong showing among European investors (44%).

Germany losing ground as 'attractive location' in Europe

Still, there are worrying indications that Germany is losing relative ground to competitors in Europe in terms of its general attractiveness as an investment location. A recent trend barometer survey by financing bank Berlin Hyp among 120 respondents highlights the rise in interest rates as the industry's greatest challenge (83% of respondents). This was followed by rising prices and cost expectations for poorly-efficient properties (64% each), financing conditions and covenants (30%), red tape in connection with building permits (25%), and availability of properties (20%), as the biggest hurdles.

The survey also highlighted Germany's relative position in investors' favour. The results were not encouraging. While 64% of the survey participants still considered the German commercial real estate market to be "somewhat or much more attractive" in a European comparison in H1 2022, this rating had drastically halved to 35% by the end of the year. 18% even consider the market to be unattractive at present. Despite the loss of attractiveness, Germany still leads the European ranking with an average rating of 5.12 points on a scale of 1 (very poor) to 8 (very good). It is followed by Scandinavia with 5.01 points, Austria/ Switzerland (4.87), Benelux (4.72) and France (4.23). Poland/ Czech Republic (3.65 points) and Italy/ Spain/ Portugal (3.61) are in the lower ranks, with the United Kingdom bringing up the rear with 3.59 points.

When asked about their willingness to invest, only 8% of respondents consider their companies' willingness to invest to be 'high' at present, 47% regard it as 'limited' to 'very limited', and only slightly less than half (45%) see it as 'balanced'.

The reluctance is likely a function of the more restrictive lending policies of banks and other financiers. For example, 68% of survey participants currently consider the willingness of commercial real estate financiers to provide financing to be 'restricted' to 'very restricted', only 28% to be 'balanced' and 4% to be 'high'.

And there is little let-up in sight. For 50% of respondents, this willingness to finance will become 'further restricted' or 'severely restricted' in the next 24 months. 36% expect their willingness to finance to remain 'restricted'. Without cheap money, it is also likely to become more difficult to prepare for and implement the "megatrends" identified by participants: ecology (86%), Digitalization (71%), Demographics (45%), Mobility (37%) New Work (21%) and Urbanization (10%).