A Resurgence of Investor Confidence
Key insights from this year’s EXPO Real trade fair
Earlier this week, real estate professionals from over 70 countries gathered in Munich for the annual EXPO Real trade fair. After a muted year of investment volume, participants were eager to meet with peers to discuss prospective deals and the outlook for the market.
The mood can be best described in two words: cautiously optimistic. After rising interest rates caused months of uncertainty and volatility, attendees finally feel stability is on the horizon. Below are three key topics discussed as delegates look ahead to 2025.
Interest rates on the decline
Monetary policy decisions on both sides of the Atlantic were a major topic at this year’s EXPO. The European Central Bank began cutting rates this summer, followed by the Federal Reserve in September. These rate cuts are an indicator that inflation is on track to reach its target level for price stability.
As a result, we’ve seen the bid-ask spread between buyers and sellers narrowing as real estate values adjust to more realistic levels. For investors waiting on the sidelines for economic clarity, this has also served as the impetus to start deploying capital into new and existing assets.
At W. P. Carey, however, we would caution that investors should not focus too much on the next interest rate decision. Instead, they should consider the more important factor – long-term borrowing costs. Real estate investors typically borrow on a long-term basis given the length of their leases, so short-term rate cuts won’t have as much of an impact as some are anticipating.
New sectors growing in popularity
Post-pandemic challenges in sectors including office and some segments of retail have made investors far more selective in terms of capital allocation. Industrial remains among the most popular asset classes as it continues to benefit from strong market fundamentals. The e-commerce boom and logistics sector’s key role in European supply chains remain long-term growth drivers, while the emerging trend towards nearshoring will provide manufacturing and logistics with a further boost.
We’re also starting to see some newer sectors growing in popularity. Self-storage, cold storage, senior living, hospitality and data centers have emerged as attractive investments, with strong operating fundamentals and positive long-term growth potential. As investors continue the flight to safety to protect returns, we expect to see a shift in the sectors – and geographic markets – receiving the most capital.
An uptick in sale-leasebacks in 2025
Despite some volatility, the overall environment for sale-leasebacks remains favorable, with high-yield debt and leveraged loans continuing to be expensive. The influx of cash from a sale-leaseback remains incredibly valuable for companies, supporting debt restructuring, strengthening balance sheets and providing capital for operating expenses and growth investments.
In addition, we continue to see interest from private equity firms in sale-leasebacks as a means of financing new acquisitions or bolstering the growth of portfolio companies. Last year alone, approximately 75% of W. P. Carey’s investment volume was attributable to transactions with PE-backed companies and we anticipate a significant portion of this year’s deal volume will be as well.
While it will take some time for the sale-leaseback market to recalibrate and reach its new normal, we are starting to see the green shoots of a more stable industry as we gear up for a busy fourth quarter. We remain “cautiously optimistic” heading into 2025 and look forward to continuing to find opportunities to help companies unlock capital from their real estate assets.
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Optimism Amidst Uncertainty: Key Takeaways from EXPO Real
Earlier this month, Europe’s largest real estate trade show EXPO Real returned in Munich. Nearly 40,000 attendees gathered to network and discuss trends, innovation and opportunities in the real estate market. Traditionally, EXPO is a place “where deals get done” but given the current challenges in the macroeconomic environment attendees were more focused on understanding where the market is heading into 2023. Here were three of the most prominent topics discussed. Rising interest rates With the European Central Bank announcing its third consecutive rate hike this month, interest rates were the main topic of discussion at EXPO Real. Largely, attendees were focused on how assets should be priced to reflect rising rates, with the consensus that we’ll continue to see cap rates rise and property prices fall into next year. However, a big challenge that attendees are facing is how to bridge the gap between seller expectations and the pricing buyers will need to generate adequate returns. To compound the issue, inflation remains at record highs in Europe which means more interest rate increases are certainly on the horizon. This will create an even more challenging environment for real estate investors that require third-party debt financing to close transactions, making all-equity buyers better positioned to execute on deals. Logistics still dominant Despite the macroeconomic doom and gloom, the current market still has room for certain sectors to thrive. Logistics remains the darling of the real estate world, with Europe seeing record logistics investment volumes in the first half of 2022. 20% of all real estate investment in Europe is in the logistics sector, suggesting there is still a very strong investor appetite for the asset class. The sector continues to benefit from tailwinds amplified by COVID such as the rise of e-commerce, which continues to drive occupier demand for logistics and warehouse space. Record-low inventory and high demand have meant the logistics sector has been slower to see cap rate increases than others; however, many are seeing a re-pricing period take place which is critical for investors looking to close transactions. Sale-leasebacks gaining prominence as bank lending becomes more restrictive Amidst all the uncertainty at EXPO Real, there was still an undercurrent of optimism among attendees. Historically, we’ve seen more sale-leaseback opportunities come to market in challenging economic environments as a result of companies seeking ways to shore up capital to support ongoing business operations and growth. With banks becoming more restrictive with lending, alternative forms of capital such as sale-leasebacks provide an immediate opportunity to plug the financing gap for companies. And with interest rates likely to continue rising into 2023, now is a great time to pursue a sale-leaseback and lock in an attractive rental rate for the long-term.
A Focus on the Future
The mood at this year’s EXPO Real was understandably somber. Investment volumes across Europe are down significantly and uncertainty around the future of interest rates prevails. While typically a platform to get deals done, attendees this year were more focused on getting a better understanding of the market and discussing challenges, solutions and opportunities for the year ahead – neatly summed in the slogan “survive to ’25.” Here were three of the most prominent topics discussed. Interest rates hinder transaction volume Just a few weeks prior to EXPO, the European Central Bank raised interest rates to a record high. ECB officials believe that rates “have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution” to reducing inflation, although did not rule out further increases. The uncertainty surrounding where rates will peak – and when they will potentially decrease – has created turmoil in the investment market, with Search -global commercial real estate transaction volume down 54% year-over-year as of the end of the second quarter. Most attendees at EXPO largely echoed that rates will likely not start to decrease in the near future, meaning the financing environment through the end of the year and into 2024 will remain challenging. This high interest rate environment is most challenging for asset-level borrowers, as lending for individual properties is increasingly difficult to secure. With no rate cuts in sight, the consensus was that deal volume will be muted into 2024 as both buyers and sellers adjust to the new real estate cycle and pricing expectations. New development stalling due to insolvencies Another topic of conversation was the increasing number of developers, particularly in the German market, that have filed for insolvency due to rising interest rates and construction costs. Big names such as Gerch and Development Partner have gone under, with more project development casualties expected to follow in the coming weeks as lenders look to get out. A recent Development Monitor survey shows that 40% of all development projects in the country are running at least a quarter or more behind schedule, with the number of new developments being started also down 50% from last year. Though these development challenges have largely impacted the residential market so far, we expect it will trickle into commercial real estate, adding to the long list of struggles the German market is facing. Sale-leasebacks in the spotlight A beacon of hope in the real estate market is that the sale-leaseback model remains an attractive financing option for corporates looking to unlock immediate capital. Cap rates on sale-leasebacks have increased less than interest rates on bank loans, making them a more attractive financing option for companies on a cost-of-capital basis. In this environment, the influx of cash from a sale-leasebacks can be incredibly valuable for companies, supporting debt restructuring, strengthening their balance sheet and providing capital for operating expenses and growth investments. W. P. Carey has been operating for 50 years through all real estate cycles, and in our experience, sale-leasebacks are a great tool for corporates in any market environment. While 2024 will certainly have its challenges, we are optimistic about the future and are confident in our ability to continuing working with companies to realize the full value of their real estate assets.
Navigating Economic Tides: Interest Rates & Commercial Real Estate
Last month, the European Central Bank (ECB) announced it would cut interest rates for the first time since 2019, bringing the deposit rate down to 3.75%. This decision came following Eurozone inflation declining from its 10.6% peak in 2022 to 2.5% in June. But what does this mean for the European commercial real estate market? Inflation is cooling The rate cut is an indicator that inflation is on track to reach the ECB’s target of 2%, which is its desired level for price stability. Investors are hopeful that more stability in the market will further narrow the bid-ask spread between buyers and sellers, helping boost transaction volume. The rate cut will also lower borrowing costs for some investors and encourage more bank lending, increasing liquidity in the market and encouraging those on the sidelines to start deploying capital into new and existing assets. Still a muted impact Despite the positive implications, most real estate professionals expect the impact of the cut will be muted. While it’s a first step in reducing borrowing costs, there is not a universal consensus as to how the ECB will view future rate decisions. In its July meeting, the ECB decided to keep rates stable. A key issue remaining for the commercial real estate industry is the refinancing risk for maturing loans. While the cut will likely help some borrowers at the margin, it is not expected to have a significant impact on the pressures facing those needing to refinance. Additionally, cutting rates too quickly may not be ideal for some European economies. If inflation climbs back up, the ECB may have to reverse course and increase rates again, causing further volatility in the market. It is also important to consider the divergence between the ECB and the U.S. Federal Reserve’s own decision to hold rates steady for now. This could impact the Euro-U.S. Dollar exchange rate, which feeds into inflation via the prices for imported goods and services. Final thoughts While the ECB’s decision has garnered a lot of attention, we believe the more important factor is long-term borrowing costs. Real estate investors typically do not borrow on a short-term basis, but rather on a 5- or 7-year fixed rate basis. In this context, SWAP rates often matter more than the ECB’s (short term) deposit rate. As a result, we do not see this decision having a significant impact on the real estate investment market at this point in time. Investors should remain focused on their long-term strategy and direct their attention to factors within their control like quality underwriting, timely execution and capitalizing on opportunities when they arise.