Outlook for European listed real estate in the wake of the COVID-19 crisis

Lloyd Barton

Lloyd Barton is an Associate Director at Oxford Economics, where he manages consulting projects with a focus on financial markets and the macro-economy. He has previously worked at the Bank of Canada, the UK’s Financial Services Authority, as well as PricewaterhouseCoopers. Lloyd studied Economics at the Universities of Cambridge and Warwick.

During the initial phases of the pandemic, economic fears were widespread across Europe as stay-at-home orders were imposed to avert a collapse of healthcare systems. This not only led to significant stock market sell-offs but also to unprecedented challenges for real estate investors faced with vacant office buildings, empty shopping centres and closed restaurants. The region having now made solid progress with vaccinations is allowing economies to re-open and restrictions to be lifted, heralding a period of greater optimism amid rebounding economic activity. Against this background, Oxford Economics has published an updated analysis examining the outlook for the European economy and implications for listed real estate[1].
Policy stimulus helps equity markets to rebound
Equity prices have rallied strongly over the past 18 months, supported by central banks injecting an enormous amount of liquidity into the market to avert a potential financial collapse. The investor enthusiasm that has driven the rebound in global stock markets also benefitted European listed real estate, although the benchmark FTSE EPRA Nareit Developed Europe Index has underperformed the broader stock market. This may reflect investor concerns regarding the impact of the pandemic on real estate, including the potential for the pandemic to have accelerated longer-term structural shifts in how real estate is used. Still, the headline European listed real estate index had risen above its pre-pandemic peak by the end of August 2021.
The pandemic has affected listed real estate sectors in different ways, with those that are heavily reliant on social interactions – retail, lodging/resorts and offices – hit especially hard early in the pandemic. Although these sectors did rise strongly in Q4 2020 following the announcement of successful COVID-19 vaccine tests, they remain significantly below their pre-pandemic peaks. Conversely, residential property and commercial real estate sectors that support the digital economy have performed strongly. The latter include industrial properties, warehousing/storage (a beneficiary of accelerated growth in e-commerce) and alternative sectors such as data centres (which benefit from an increasing use of online services).
The recovery in listed real estate has to date broadly tracked the recovery pathway of the Eurozone crisis, with the benchmark FTSE EPRA Nareit Developed Europe Index very close to its pre-crisis peak after around 18 months. This recovery pathway contrasts with the persistent weakness experienced in the wake of the Global Financial Crisis (GFC), as European listed real estate companies – and property markets more broadly – were in much better shape prior to this crisis than at the time of the GFC. Large-scale policy support has also averted a potential credit crunch whilst supporting demand in the economy.
But historic crisis episodes can only offer limited information on the future trajectory of listed real estate prices. The outlook at this juncture depends very much on how the current crisis unfolds and potential structural shifts induced by the pandemic.
Outlook for property sectors
Continued robust economic growth should support demand for real estate and help stimulate a recovery in commercial property values. That said, real estate should not be viewed as a single market, with its constituent sectors following the same cycle. Indeed, the recovery in real estate, like much of the rest of the economy, is likely to remain uneven across sectors. And despite apparent attractive valuations in some sectors, there is a risk of an increase in corporate insolvencies as public support measures fade, which could put renewed downward pressure on real estate prices in the affected segments.
Beyond the near-term impact, the pandemic has accelerated pre-existing structural trends in certain sectors of the market. For example, traditional brick-and-mortar retail was already experiencing difficulties from the shift to e-commerce, and this has been compounded by the crisis. With e-commerce penetration rates still relatively low in some European countries, this shift could still have some way to go.
The pandemic may also have a longer-term negative impact on demand for offices with more flexible office working and the substitution of online meetings for in-person gatherings. That said, property investors appear to expect a rebound in prices as a recovery in demand for offices coincides with a supply shortage that pre-dates the pandemic. Indeed, it is unlikely that urbanisation will go into reverse. With only a fraction of jobs in professional services or other roles where remote-working is a practical option, urbanisation rates should continue to rise.
Meanwhile, the crisis has strengthened the momentum in certain sectors, particularly residential, logistics and alternative assets such as telecommunication towers and data centres. The secular themes underlying these trends (such as digital transformation) are likely to persist in the medium term, creating significant structural tailwinds for these sectors.
Overall, we anticipate that listed real estate prices will likely face a period of consolidation in the near term, which would be typical of a mid-cycle environment but not something that should completely derail the bull market given the enduring strength of underlying fundamentals. Indeed, there should be room for renewed upward momentum in listed real estate over the next few years, although investors would be well advised to pay attention to underlying sector exposure.