Ratings agency Moody’s said a “stronger correction” is likely in European real estate values next year.
In a new report, the firm said asset values had been supported during the first half of the year by “reasonably good” operating performances and leasing activity, but that a weakening economic outlook now “increases the likelihood that property values will decline in the coming year”.
The risks of revaluation losses are highest for retail real estate, the agency said, and then office, while market conditions and demand still support logistics and residential values.
“The operating environment is deteriorating for retail real estate landlords,” Moody’s team said. “Retail’s recovery from the pandemic was strong in the first months of 2022 as restrictions on movement ended. However, slowing economic growth and high inflation are eroding consumer sentiment and purchasing power, which could reverse the recovery and weaken valuations, even if indexation to inflation will support rental growth in the short-term.”
In the UK, however, the agency said the market had likely bottomed, with no further big revaluation losses.
On offices, the team added: “Office landlords will probably face lower demand given slowing GDP growth, increased economic uncertainty and a steady increase in remote working. However, we expect limited, if any, decline in rental income in the next 12-18 months, especially in the prime locations. Many rental contracts are inflation linked, so income will grow during the term of the existing leases.”
Tightening financial conditions and rising capital costs are both set to threaten European real estate companies’ credit quality in the next 12-18 months, analysts at the agency said, with the most significant near-term effect coming from rising refinancing costs.
“Market liquidity has weakened and capitalisation rates have started to increase, putting property values at risk as well,” the team added. “Total debt to gross asset ratios of roughly half the companies we rate would exceed the level we expect for their ratings if valuations decline 15%. Access to equity remains constrained because most public commercial real estate companies are trading at a discount to net asset values.
“Highly levered companies relying on asset sales to deleverage and which have short-term maturities to address are most at risk of credit quality erosion.”
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