Focus Real Estate: Look past the rate shock

Key points

1. Interest rate effect on Real Estate fades: US and European central banks near the end of the rate hiking cycles, with policy rates already at 15-year highs. As inflation rates decline, long-term bond yields are also cooling, reducing the pressure on property prices.
2. US benefits from weaker inflation, coming soon to Europe: US and European inflation should decline further to year-end, allowing stable to lower long-term interest rates. We forecast end-2023 10-year bond yields of 3.5% (v 3.8% now) in the US and 2.5% (v. 2.4%) in Germany.
3. Commercial Real Estate outlook mixed: from a structural viewpoint, we see greater growth potential from Logistics and Hospitality segments given robust demand. In contrast, the environment is more challenging for secondary Office and Retail segments.
4. Modest correction in most Residential property markets: Australia and Sweden are the most impacted residential property markets due to i) high loan-to-value ratios, and ii) high exposure to variable interests rates, France and the US fare better, with moderate borrowing levels and 90% exposure to long-term fixed rates.
5. Employment market remains key: economic stability is key to underpinning Residential and Commercial Real Estate demand. Today’s starting point is encouraging: decade highs in US, UK and European employment. 

Main recommendations

(=) Maintain Neutral stance on Real Estate. We look for stability in European Commercial Real Estate over H2 2023, then a potential price rebound in 2024. Lower long-term interest rates together with stable economic activity could prompt us to review our Neutral rating.

Potential catalysts: lower inflation expectations, continued Residential and last-mile Logistics under-supply of land. Value-add strategies of upgrading older Real Estate assets looks appealing in this context.

(+) Regionally, UK, Continental Europe and Poland look more attractive given higher starting yields and encouraging rental growth trends.

Commercial Real Estate segments to favour: More conservative investors should look to the lower volatility European Healthcare and Residential segments. More dynamic investors can favour an expected rebound in Industrial/Logistics demand.

(-) Key risks: significant contraction in global economic activity driving higher unemployment rates, lower Residential and Commercial Real Estate demand. Inflation persistence, obliging central banks to continue hiking interest rates is a second key risk.

Remember: Real Estate is a long-term, illiquid investment with positive rental growth that generally provides a reasonable inflation hedge over time.

Real Estate Outlook

Real estate prices already begin to stabilise post 2022-Q1 23 correction

After a long period of robust compound returns for global Real Estate markets post the 2008 Global Financial Crisis, 2022 and Q1 2023 delivered an unwelcome correction.

Both Residential and Commercial Real Estate markets have suffered from a readjustment phase due to a sharp spike in US and European interest rates. The return of high inflation has obliged central banks to abandon their long-held zero interest rate policies. US and European policy interest rates stand today at 15-year highs, pushing both bond and Real Estate yields higher.

Is the worst now past? The Q1 2023 performance suggested that stability may be in view for global Real Estate – unlisted European Commercial Real Estate funds saw a drop of only 1% in their quarterly returns versus Q4 2022. BNP Paribas Real Estate forecast stability in European Commercial Real Estate Prices over H2 2023, then a progressive rebound from 2024 onwards. Avoiding deep recession is key: we look for a combination of robust employment trends, easing inflation rates and a modest recovery in European economic activity by end-2023 to support a combination of stable property yields and positive rental growth. The end of the programme of interest rate hikes by the European Central Bank and the US Federal Reserve in the coming months would also be welcome for both Residential and Commercial Real Estate.

Segments and Regions to Favour: More conservative investors should look to the lower volatility European Healthcare and Residential segments. Dynamic investors can favour segments with strong rental growth: city centre Logistics, Hospitality, Healthcare, Multifamily Residential. Regionally, the UK and Europe look better value today for long-term investors given higher rental yields + growth. In contrast, Offices will take longer to recover fully; secondary offices are at risk from value impairment, as companies reassess their post-COVID space requirements.