European non-listed real estate delivered its fourth consecutive quarter of strong positive performance in the first quarter with the INREV Pan-European Quarterly Asset Level Index posting total returns of 3.47%, slipping from the record high of 4.86% achieved in the final quarter of 2021.
Returns were driven by strong capital growth of 2.63%, the second-highest capital growth since the inception of the Index in 2014. It also pushed up the 12-month rolling return to 13.15% in first quarter of 2022, from 12.89% in the fourth quarter of 2021.
The UK posted a total return of 4.56%, bringing the 12-month rolling quarterly average to 4.60%, the highest of all European markets and substantially above the three-year quarterly average of 1.59%.
For Germany, asset level total return slowed substantially to 2.84% in the first quarter, compared with 6.29% in the fourth quarter of 2021. This is the steepest decline in the performance of all geographies. On top of the high seasonal effects in German valuations, the correction is likely to have been triggered by changing investor sentiment due to the war in Ukraine, soaring energy prices and their subsequent impacts on Germany's economic outlook.
With the exception of the Nordic region, which saw its total return increase from 2.52% in the fourth quarter of 2021 to 3.91% in the first quarter of this year, all other European markets recorded a dip in performance over the quarter.
The pan-European industrial and logistics sector continued to build on its robust performance with an asset level total return of 6.20%, marking its second-best performance since 2014, and close to its record high of 7.61% at the end of 2021. Despite positive performance in the first quarter, overall net sentiment towards the sector turned negative.
According to the most recent INREV Sentiment Survey, 20% of respondents intend to decrease allocations to industrial and logistics, and none intend to increase their allocations.
European logistics investment reached a record €62 billion in 2021, a 79% increase on the five-year average, according to data from Savills. The UK (€19.5 billion) boosted volumes, marking a record year and accounting for 31% of activity, while Germany (€8.6 billion), France (€6.5 billion) and Sweden (€5.8 billion) and the Netherlands (€5.7 billion) also recorded strong levels of activity.
Sentiment towards the residential sector was neutral for the first time since the start of the survey, despite solid asset level returns of 3.52%. This might be the result of increased regulation within the sector in some European markets.
The gradual improvement in sentiment and performance for the office sector appears to have paused, with total returns for this sector levelling off to 1.46%, compared with 3.50% in the fourth quarter. Retail, however, reported an asset level total return of 2.27% in the first quarter, only 10 basis points lower than in the fourth quarter of 2021, and no investors or investment managers plan to decrease allocations to this sector.
The INREV Sentiment Survey also points to a new phase in the investment market, most likely triggered by the geopolitical and economic consequences of the Russian invasion of Ukraine, alongside quantitative tightening by central banks in response to elevated levels of inflation.
While the application of material uncertainty clauses by investment managers dropped to only 5%, the lowest since the Survey began, 78% of survey respondents indicated they had increased their assessment of investment risk, and none is expecting a decrease in risk.
Unsurprisingly, sentiment towards Core Central and Eastern Europe and Fringe CEE has turned negative, with 22% of respondents intending to decrease allocations to these markets, in light of the war in Ukraine. Similarly, sentiment toward Germany has further deteriorated with 11% of respondents intending to decrease allocations, a rapid downturn from December 2021. However, of all investors and investment managers in the survey, 22% intend to increase allocations to the UK.
Data from MSCI Real Assets shows a substantial 52% slide in transaction volumes for the period, down from €150.8 billion in the fourth quarter of 2021 to €71.8 billion in the first quarter of 2022, with real estate transactions falling across all European markets as the first quarter of the year is usually weaker.
Iryna Pylypchuk, INREV director of research and market information, said "The European Central Bank’s decision to raise interest rates in July starts a new policy era with the aim of managing the high inflationary environment that the eurozone is facing as a result of the war in Ukraine."
"No matter how gradual, the shift away from negative interest policy and the imminent end of asset purchase programmes will impact all asset classes, and European non-listed real estate is no exception. The higher interest rates will most certainly lead to weaker performance expectations, and the phase of exceptional capital growth driving the strong performance over the last few quarters (including Q1 2022) is now likely to reach a somewhat abrupt end.
Higher assessment of risk, slower capital deployment and allocation decision-making will be the near-term features, prompting investors and investment managers to dive deeper into underlying fundamentals to unpick opportunities. This may shift the attention to the emerging sectors driven by demographics, technology and long-term structural ‘’cater to consumer” shifts even more.
"That said, the long-term value and diversification benefits that European non-listed real estate offers should support the proposition of the asset class, with the added benefit of real estate being inflation sensitive – but here too the bottom-up approach to asset selection and expert asset management is required.’’