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11/14/2024
Tom Francis
Property Market Research, Europe
Cartsen Lieser
Property Market Research, Europe
We have seen significant falls in long-term rates and financing costs over the past months, while yield curves have steepened. The main drivers have been falling inflation rates and upcoming recession fears in the US due to a weakening labour market and the larger-than-expected rate hike in Japan (the first since 2007) that triggered a stock market sell off in early August and a partial unwinding of the yen carry trade. Lower growth and inflation expectations also raised market expectations of future rate cuts. Euro five-year swap rates dropped from 3% in June to 2.2% in September, while five-year GBP swaps eased from 4.5% to almost 3.6%. Government bonds also saw a strong uptick as 10-year gilt yields came down by 80 basis points to 3.6%. The first-rate cuts in the Eurozone and UK also provided some easing for short-term or floating debtors like project developers. The BoE cut the base rate by 25 bps to 5.00% in August for the first time since 2020 while the ECB cut rates by 25 bps in June and September. Both swaps & bonds have moved out by 40-50 bps since mid-September as stronger than expected data releases and geopolitical uncertainty increased financial market volatility.
Easing inflation pressures across Europe and the UK should also set the path for further rate cuts. In September, headline inflation reached 1.7% in both the euro area and the UK, although inflation in the services sector and wage growth remained somewhat sticky. Inflation expectations also eased significantly with market based break-even rates at 1.4% in Germany and 1.6% in France. In the UK, survey-based consumer inflation expectations fell from 3.9% in January to 2.6% in June 2024. Lower inflation rates and worsening business indicators fueled rate cut expectations.[1]
Underlying real estate pricing has stabilized and a handful of markets are even showing early signs of recovery as transaction activity is on the rise from a low level. It may probably take some time for the valuations to adjust, but transaction-based market prices, especially in the logistics and residential segments, are on the cusp of an upturn. Asset-level total returns in the European real estate market recorded the highest quarterly return in two years at +1.2% in the second quarter of 2024.[2] From a geographic perspective, the strongest quarterly returns were witnessed in Sweden, Portugal and the Netherlands, with the UK not far behind. On an annual level, year-on-year returns from the Real Estate Debt Fund Index significantly outperformed the wider Pan-European Quarterly Property Fund Index at 5.6% compared to -7.4%, respectively.[3]
The interest rate environment is still elevated compared to previous years and investment volume remain low as property owners wait for better exit prices. But real estate fundamentals are improving and with a narrowing price gap between buyers and sellers, an increasing willingness of lenders to deploy money can be observed. Lower benchmark rates should support the investment market and loan volumes are already showing some signs of strength. With volume of new debt being just half of 2022 levels across Europe, it rebounded to €15bn in the first half year of 2024, about double compared to the same period last year.[4] Restricted capital markets and high levels of loan extensions and restructurings by existing lenders have prevented higher volumes.
Also, increasing ESG requirements and the scarcity of quality projects eligible for financing have resulted in relatively low financing volumes. While core deals continue to be rare, there is growing demand for capex financings in order to meet rising sustainability standards. Moreover, we see increasing demand for niche segments like self-storage and data centres. The attractiveness of real estate debt has also improved significantly for borrowers over recent months thanks to the return of a positive leverage effect, as lower long-term rates and higher property yields have pushed the spread between prime yields and debt costs positive again. This should support the underlying transaction market as well as loan volumes looking forward.
Macrobond, September 2024
DWS, Property Performance Monitor Q2 2024
MSCI Europe Quarterly Private Real Estate Debt Fund Index (Unfrozen) - EUR
Dealogic, September 2024.
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