The extent to which European real estate markets will re-price has not yet played out in full.
There is certainly no shortage of equity across the risk spectrum waiting to deploy, deals are still taking place, albeit at far less scale and with far less frequency, all-in borrowing costs have increased, as has the cost of foreign exchange hedging for non-euro currencies, sterling and Swedish Krona particularly.
A significant number of senior lenders are closed for business for the remainder of 2022 at least. Rents may continue rising for the right assets, in the rights sectors, in the right locations, but we cannot escape a basic truism that, all other things being equal, if interest rates and borrowing costs go up, cap rates move out and real estate values go down. This is a simple fact, whether or not investors and valuers are prepared to admit it.
What baffles me is the question: why does the European private real estate market go through the drawn out, often emotional, rollercoaster of not admitting this more expediently? It would make it more efficient, more liquid, more transparent and more attractive to global capital, which would likely result in values rebounding more quickly when there is a correction.
The warning signs are well established, even if they do not always display in the same sequence or extent. First, an unanticipated, often non-real estate-specific event takes place and the listed sector experiences re-prices, then the US private market does the same. Both move at a greater and less emotionally draining pace than private markets in Europe. This is followed by the dreaded sentiment shift spreading though the herd, before finally the UK market re-prices. That is then followed by a westerly wind blowing cap rate expansion across the continent, albeit at near glacial speed. This chain of events can be categorized into five emotional states:
Denial: “It’s fine, I know SEGRO is down 40 percent since March and, yes, the 10-year US treasury is yielding more than my German logistics assets. But my portfolio is different and I’m not a seller anyway. Yes, I’ve read the Financial Times, but private real estate markets are much more nuanced. I’ve taken a look at my competitors’ portfolios, though, and they look horrible.”
Anger: “This is all because of Putin, Lizz Truss, Brexit, covid, China, Italian elections, QE and all these credit committees being too risk averse. How can the market be so fickle and short-sighted?”
Bargaining: “Having said I’m not a seller, I think I’ll ask a broker to quietly speak to one or two preferred, unlevered parties on a one-to-one basis. I’ll be able to generate a small, private auction and push pricing back above my conservative underwrite. That could work, couldn’t it?”
Depression: “My promote has disappeared, this downturn will last for 10 years, this time it’s much worse than ever before, this isn’t a repricing, it’s the worst in living memory. Forget PIGS, potential Euro break-up, Lehman, this time it’s terminal. I need to fire half my team.”
Acceptance: “OK, values have adjusted, the recession is here, it’s time for pragmatism, I’m going to keep buildings occupied, ensure liquidity, a cycle has ended, the world hasn’t. Provided I haven’t made any terrible decisions I should be OK. What was I thinking? Of course, a shed in the Midlands of the UK was fully priced at 3 percent.”
It may well be too early to know how the latest correction will play out and who the winners and losers will be. But would it not be refreshing if market participants opted for pragmatism over emotion sooner rather than later?
Charles Baigler is head of acquisitions, private equity real estate at manager Pictet Alternative Advisors