• Real Assets
  • Real Estate

Rates, retail and polarisation: three themes for UK and European real estate

Jonathan Bayfield and Vivienne Bolla discuss the outlook for UK and European real estate.

3 minute read

modern business buildings in tallinn

Current conditions make these uncertain times for UK and continental European real estate. Investors are increasingly concerned that the global economy is slowing down, with particular implications for Europe. This is, in part, driven by political events such as Brexit, the French ‘yellow vest’ movement, Italian populism and Catalan independence, all of which can weigh on demand.

In that respect, the European parliamentary elections of 23-26 May presented a key risk, with populists making significant gains in some countries. But they fell short of securing enough votes to have a decisive say in the future direction of Europe, giving investors some respite.

Although economic sentiment has continued to decline, first-quarter activity was surprisingly positive in Europe, supported by good performance in Spain and France and a return to growth in Germany and Italy, which should result in continued demand for real estate.

In this context, our base case is of an economic slowdown rather than a recession, supporting three key trends for UK and continental European real estate.

1. Lower interest rates are extending the cycle

At the end of last year, we expected interest rates to start rising and therefore demand for real estate to be subdued. However, fears of a potential slowdown have put rate rises on hold. For investors,  lower rates will extend the real estate cycle: even at their current levels, real estate yields are higher than government bonds yields. In April the market’s forecast for the ten-year German bund yield in 2020 was 0.1 per cent, compared to our assumption of a 3.2 per cent equivalent yield for Europe (ex UK) All Property. Similarly, the market’s forecast for ten-year UK gilt yields in 2020 was 1.6 per cent, compared to our assumption of 5.5 per cent for the equivalent UK All Property yield.

Real estate also remains attractive compared to other income-producing asset classes such as investment-grade and high-yield corporate bonds. And while we anticipate lower returns in the UK and continental Europe, they should still compare favourably with other regions.

Thanks to lower interest rates, investors can now find positive total returns in several markets across the UK and Europe (Figure 1). In this context of medium cyclical risk, London and Manchester appear to be in a better position than many other European cities. This is mainly because price growth paused after the 2016 referendum on the UK’s membership of the European Union compared to other markets, giving the two cities a comparative advantage. But we also expect Germany and the Netherlands to see a strong occupier market, especially in the office and logistics sectors.  

At this stage in the cycle, debt may be more appropriate than equity for investors. We forecast varied negative rental and capital growth in different sectors in the UK over the next five years, from shopping centres to retail units in small and large towns. In the rest of Europe, rental and capital growth values compare more favourably.  We are adopting a defensive positioning, focusing on income-producing strategies, and generally moderating exposure to developments that have not been significantly de-risked.

2. European retail faces headwinds

 Retail continues to face challenges from the structural shift to online shopping. So far, the UK has been the hardest hit as e-commerce is most developed, but we expect other European economies to follow. Over recent years, robust labour market conditions and modest economic growth have supported demand for retail in continental Europe, generating sustained rental growth for investors. However, as store-based retail sales growth starts to slow, we expect rental growth to be more modest, and investors should be cautious.

In recent months, UK retail has faced the new twin challenge of debt financing being harder to access as well as deteriorating investor sentiment. Over the next five years, we expect rents to contract significantly depending on asset type, and capital values to decline up to 45 per cent. It is becoming increasingly difficult to find good opportunities.

But in the UK, as in continental Europe, this weakness hides many local and asset-specific nuances. Investors can still find attractive growth opportunities in some areas, even as others decline. For instance, the structural challenges are affecting low-engagement retail disproportionately, while prime locations are much more resilient. Attractive opportunities remain, including on some leading high streets in Germany, London and Dublin, though investors should be extremely selective.

3. Real estate markets are increasingly polarised

In contrast, investors can benefit by allocating to other types of real estate that should continue to grow strongly over the medium term. This emergence of two opposite ‘poles’ is startling – secondary location and low-engagement retail with bleak prospects at one end versus  prime office space, logistics and ‘alternatives’ at the other.

Given the ongoing polarisation, investors can expect strong growth on the very best deals in the largest cities. In most countries, solid growth can be found from rents in office and logistics sectors, especially prime office stock.

European real estate investors have also started allocating significant amounts of capital to more defensive investments such as supermarkets and alternatives like student housing and senior living.  In addition to a lack of opportunities elsewhere, investors are allocating capital to these investments as they are becoming more comfortable with them and because ‘alternatives’ are often supported by demographic and societal changes. We therefore anticipate they will perform better than most other real estate assets over the next five years.

Finally, we expect to find opportunities for long-term growth in emerging locations set to benefit from new transport infrastructure. In Paris, the Grand Paris infrastructure development will improve transport links and promote development in areas on the outskirts of the French capital, while in London areas surrounding the new Crossrail stations will be more connected, helping them thrive. In the long run, this type of infrastructure will support valuations and occupation, giving investors an opportunity to capture outperformance in selected areas.

Figure 1: Under/Over Pricing Analysis: 5 Year View – Europe Offices 2019-2023
Figure 1: Under/Over Pricing Analysis: 5 Year View – Europe Offices 2019-2023
Source: Aviva Investors, April 2019. A positive value indicates that the forecast total return exceeds the hurdle rate.


Related views

Important information


Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (AIGSL). Unless stated otherwise any views and opinions are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Information contained herein has been obtained from sources believed to be reliable, but has not been independently verified by Aviva Investors and is not guaranteed to be accurate. Past performance is not a guide to the future. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Nothing in this material, including any references to specific securities, assets classes and financial markets is intended to or should be construed as advice or recommendations of any nature. Some data shown are hypothetical or projected and may not come to pass as stated due to changes in market conditions and are not guarantees of future outcomes. This material is not a recommendation to sell or purchase any investment.

The information contained herein is for general guidance only. It is the responsibility of any person or persons in possession of this information to inform themselves of, and to observe, all applicable laws and regulations of any relevant jurisdiction. The information contained herein does not constitute an offer or solicitation to any person in any jurisdiction in which such offer or solicitation is not authorised or to any person to whom it would be unlawful to make such offer or solicitation.

In Europe, this document is issued by Aviva Investors Luxembourg S.A. Registered Office: 2 rue du Fort Bourbon, 1st Floor, 1249 Luxembourg. Supervised by Commission de Surveillance du Secteur Financier. An Aviva company. In the UK, this document is by Aviva Investors Global Services Limited. Registered in England No. 1151805. Registered Office: 80 Fenchurch Street, London, EC3M 4AE. Authorised and regulated by the Financial Conduct Authority. Firm Reference No. 119178. In Switzerland, this document is issued by Aviva Investors Schweiz GmbH.

In Singapore, this material is being circulated by way of an arrangement with Aviva Investors Asia Pte. Limited (AIAPL) for distribution to institutional investors only. Please note that AIAPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIAPL in respect of any matters arising from, or in connection with, this material. AIAPL, a company incorporated under the laws of Singapore with registration number 200813519W, holds a valid Capital Markets Services Licence to carry out fund management activities issued under the Securities and Futures Act (Singapore Statute Cap. 289) and Asian Exempt Financial Adviser for the purposes of the Financial Advisers Act (Singapore Statute Cap.110). Registered Office: 138 Market Street, #05-01 CapitaGreen, Singapore 048946.

In Australia, this material is being circulated by way of an arrangement with Aviva Investors Pacific Pty Ltd (AIPPL) for distribution to wholesale investors only. Please note that AIPPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIPPL in respect of any matters arising from, or in connection with, this material. AIPPL, a company incorporated under the laws of Australia with Australian Business No. 87 153 200 278 and Australian Company No. 153 200 278, holds an Australian Financial Services License (AFSL 411458) issued by the Australian Securities and Investments Commission. Business address: Level 27, 101 Collins Street, Melbourne, VIC 3000, Australia.

The name “Aviva Investors” as used in this material refers to the global organization of affiliated asset management businesses operating under the Aviva Investors name. Each Aviva investors’ affiliate is a subsidiary of Aviva plc, a publicly- traded multi-national financial services company headquartered in the United Kingdom.

Aviva Investors Canada, Inc. (“AIC”) is located in Toronto and is based within the North American region of the global organization of affiliated asset management businesses operating under the Aviva Investors name. AIC is registered with the Ontario Securities Commission as a commodity trading manager, exempt market dealer, portfolio manager and investment fund manager. AIC is also registered as an exempt market dealer and portfolio manager in each province of Canada and may also be registered as an investment fund manager in certain other applicable provinces.

Aviva Investors Americas LLC is a federally registered investment advisor with the U.S. Securities and Exchange Commission. Aviva Investors Americas is also a commodity trading advisor (“CTA”) registered with the Commodity Futures Trading Commission (“CFTC”) and is a member of the National Futures Association (“NFA”). AIA’s Form ADV Part 2A, which provides background information about the firm and its business practices, is available upon written request to: Compliance Department, 225 West Wacker Drive, Suite 2250, Chicago, IL 60606.