Robust underlying demand for homes particularly in major cities and the lack of new supply are underpinning the more robust performance and outlook for companies in the residential buy-to-hold segment, as such as Germany’s Vonovia SE and LEG Immobilien SE.

Logistics-related demand is similarly creating relatively favourable conditions for owners of industrial real estate such as the UK’s Segro PLC, Tritax Eurobox PLC and Netherlands-based CTP NV though one risk is possible oversupply given heavy recent investment in the segment.

“In stark contrast with the uniformly benign prospects for the sector before the Covid pandemic, the credit outlook has now turned negative for real estate developers. Refinancing risk is on the rise for companies in the office-property market. Credit quality is diverging rapidly within the rest of the commercial real estate sector,” says Philipp Wass, Executive Director at Scope Ratings.

European real estate sector outlook summary:

Residential:

• Stable interest cover: rents are growing as healthy demand for housing and limited supply balance risk from rising non-recoverable service charges and the rising cost of debt that kicks in gradually over the medium term.
• Stable leverage: assets are mostly valued below reinstatement costs while likely growth in cash generation supports current prices despite less market liquidity that will lead to slowly widening yields.

Office:

• Potential increase in leverage: a likely correction in property values with widening yields not fully offset by inflation-linked increases in rents amid weaker economic prospects and deteriorating demand for office space, leading to increased refinancing risk.
• Debt protection not at risk: relatively long weighted average unexpired terms, long-dated maturities and a high proportion of fixed-rate debt delays impact of rising interest rates and bleaker economics on cash flow.

Retail:

• Higher dispersion of credit quality: stable cashflow and asset values linked to portfolio quality – marked higher footfall and sales – will help better-placed retailers cope with CPI-linked leases and higher service charges. Higher refinancing risk especially for properties with low debt yields.

Industrial:

• Stable interest cover: strong occupier demand supports rental growth and landlords’ ability to offset higher operating expenses. Risk from rising cost of debt is limited due to large proportion of low-cost fixed-rate debt and extended maturities.
• Stable leverage: risk of severe property devaluations looks limited, largely supported by good prospects of strong rental growth.

Developers:

• Liquidity at risk: inflation has squeezed margins, as have the higher cost of capital, cost overruns and delays in sales driven by less investor appetite and/or shortage of raw material and labour.
• Higher refinancing risk: issuers with over-leveraged balance sheets look vulnerable given delays in sales as economic market conditions worsen.

“The industrial segment remains the pick of the European sector in terms of the credit outlook for real estate companies though we are keeping an eye on indications of excess capacity as economic growth slows,” says Fayçal Abdellouche, analyst at Scope.

“Good prospects for growth in index-linked and market driven industrial rents, largely supported by the favourable supply and demand balance, should largely offset rising building costs and the higher cost of capital. This will further safeguard debt protection,” Abdellouche says.

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