European real estate investment volumes have hit historic lows, with fears around the future of the office a key culprit, according to new data. Figures from MSCI shows that European commercial real estate investment slumped to an 11-year low in the first quarter of 2023, with plummeting office investment having a significant impact.
Offices may still be Europe’s largest real estate sector, but the first three months of this year saw the fewest properties sold on record for the quarter, while the €10.8 billion of transactions in the asset class was the lowest in 13 years.
Economic headwinds, doubts about the future of work, and a waiting game on price discovery are all influencing allocations and the speed of deployment. But that doesn’t mean that investors lack a clear ‘alternative’ strategy, if recent trends are anything to go by.
US market movements often herald what is to come in Europe, and research from Patrizia has been tracking data showing that residential, industrial and logistics real estate – and not office assets – have been consistently driving growth the other side of the Atlantic.
“The US experienced spectacular growth of alternative property types over the last decade,” notes Mahdi Mokrane, Patrizia’s head of investment strategy & research. “Alternative property assets have grown to now represent a cumulative asset value of over US$1 trillion or 43 per cent of the invested real estate stock.”
He adds: “In Europe, the alternatives market is a tenth the size, but megatrends favour its development.” These property types fall loosely into four categories: healthcare and well-being, living alternatives, supply chain, and tech and digital. “All are powered by different trends and drivers, some of which are correlated and others not, making them attractive from a portfolio construction and diversification perspective,” he notes.
Expanding living sector
Of those megatrends, the expansion of the living sector is one of the most compelling, after the outperformance of residential during the pandemic and continuing residential shortages across European markets.
In a recent review by international real estate advisor Savills of property investors with total assets under management (AUM) exceeding €1 trillion, almost half (42.6 per cent) predicted the proportion of their AUMs allocated to the European living sector would increase significantly by 2025.
Says Marcus Roberts, head of Europe - Savills operational capital markets: “The living sector has proven to be extremely resilient in a time of exceptional global upheaval. Given the amount of capital chasing the sector and the limited amount of high-quality stock available, we expect competition for the best assets in the best locations to remain high.”
Investors’ highest priorities include housing in the UK and Ireland, student accommodation in the UK and Europe, and pan-European senior living. But the interest in ‘real estate assets with a bed’ is also driving a renewed focus on areas contingent to residential such as hospitality, co-living and extended stay properties, suggests Bas Wilberts, head of residential & hotel investment at Savills in the Netherlands.
"There is a lot of focus on the living sectors, multifamily, student residences, senior living. But what is also interesting, and a potential trend, is a blending between branded living and an extended stay model, which has more in common with hospitality. The current private rental sector (PRS) model in the Netherlands is under a lot of pressure and buy-to-let propositions are less attractive to private investors, so part of that market is shrinking. With development stalling too, we expect to see the availability of traditional residential falling, which increases demand for other models, including extended stays," Wilberts said.
Dutch hotel dynamics
Wilberts also identifies a further blurring of the lines between residential and hotels as it gets harder to create the latter, with municipalities reluctant to issue new hotel permits. “Amsterdam remains the country’s largest hotels market, but new developments are declining and hard to kickstart unless something really distinctive is happening. Due to stabilising operational results after the pandemic, hotels are trading well when they come to market, but there is a shortage of supply.
“We are currently working on a sale for a plot in Amsterdam and have seen significant interest from a range of capital sources – family offices, contractors and private equity – showing that major interest is there when opportunities arise.” Wilberts also notes that long-lease models – once the backbone of hotel investment – are evolving. “We saw during the pandemic that long-leases don’t guarantee that operators or occupiers will pay, so a general revision of lease terms is happening too.”
One solution for the country’s severe residential shortages has been the conversion of office space to other asset classes, with several high-profile office-to-residential redevelopments taking place, in particular in the five biggest cities in the Netherlands, in the wake of the global financial crisis, and continuing over the past decade.
As investors fret about the future of offices, isn’t this the ultimate solution for investors who prefer beds? Wilberts thinks that investors pursuing that track may already have missed the boat. “The good locations and the most obvious office conversions have already taken place. The remainder of offices that are struggling are typically in secondary locations, or worse,” he notes, “and they aren’t a natural fit for residences.”
Conversion challenges
Robert Ciggaar, associate director in Savills Dutch residential & hotel investment team, agrees. “Due to high construction costs, office to residential transformations are not particularly viable at the moment. The way that values are going, it makes more sense to renovate and add an extra floor if possible and keep it as an office.
Between 2010 and 2017, you could pick up offices for €250 to €1,000 per square gross metre but prices have got much higher recently due to a shortage of liquid and available assets. The first office to residential conversions are up for sale for the first or second time after transformation but are not attracting interest from institutional parties due to current challenging market conditions.”
Wilberts notes, in any case, that office conversions to hotel properties are often a better fit. “Offices are often planned around a corridor with rooms along it, which makes a hotel conversion easier, and they are often in key central locations and near railway stations, which fit well with hotel use.”
Adding to the complexity of the allocations argument is the fact that not all investors want to shift into the living sector or hospitality. The owner of a US boutique, which is exploring investment opportunities in Europe right now, told Hospitality Investor he would be staying out of the living and hotels sector in the region.
“We invested in residential and in hotels in the US,” he said, “but they are not without their challenges. I still believe that it’s only easy to get into hospitality in the wake of a significant market shock, such as the global financial crisis or 9/11. Otherwise, it’s challenging to get the right prices. In residential, we came up against activist tenants in New York – it's such a politically sensitive asset class – and even small obstacles can create big problems. We’ll be sticking to commercial themes such as logistics and industrial for the foreseeable future.”