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Emerging Europe: War reinforces weak values outlook

The war in Ukraine will have spillover effects for property in Central and Eastern Europe (CEE), albeit that Russia will be far worst hit. Economic growth is expected to be slower, which will weigh on property demand, while inflation and interest rates will rise faster. We still think that office and retail rents in the CEE region can return to growth this year, but the recovery is likely to be slower than previously expected. With bond yields already higher, we think that there is less scope for further falls in property yields this year and that they will rise more quickly from next year than we previously forecast. Overall, this reinforces what was already a weak outlook for property values.
Amy Wood Senior Property Economist
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The rapid turnaround in the interest rate environment has led us to revise down our expectations for property performance in Scandinavia and Switzerland. Property valuations deteriorated sharply in Q1 and are expected to come under more pressure given further rises in bond yields. We now think property yields will reach their troughs this year and will rise by a cumulative 30bps-35bps over the following few years. With structural changes weighing on the office and retail sectors, rental growth is unlikely to be strong enough to prevent a material slowdown in capital value growth, with falls likely in 2023-24. This will contribute to a sharp drop in returns after this year. Within this, industrial is still expected to perform best, but the margin of outperformance will reduce significantly compared to recent years.

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Rising interest rates to speed up property correction

The weaker economic outlook and larger increases in interest rates are expected to weigh on property performance. With valuations under increasing pressure from sharply rising bond yields, we think that property yields will reach their troughs this year and rise by a cumulative 35bps at the all-property level over the following few years. Rental growth is unlikely to be able to provide much offset to prevent falls in capital values in 2023-24, with structural changes dragging on the retail and office sectors. This will leave annual total returns languishing in low single digits on average over the forecast. Beyond 2022, we think retail will overtake industrial as the best performing sector, while offices are expected to underperform.

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More from Amy Wood

Non-Euro European Commercial Property Outlook

Scandi & Swiss: Rising pressure on property yields

Property demand in the Scandinavian and Swiss markets is expected to hold up this year, as they are more insulated from the negative impacts of the war in Ukraine on economic activity. However, structural shifts will continue to cloud the outlook for offices and retail. And given the outlook for even higher inflation, we now expect interest rates in the region to rise sooner, putting more upward pressure on bond yields. We still think there is scope for property yields to fall in the next couple of years outside of Oslo, where property valuations already look stretched. However, we have brought forward the timing of property yield rises in Stockholm to 2024. Overall, this means property returns are set to reduce, including for the industrial sector where returns are expected to converge with the other sectors after 2022.

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War in Ukraine adds to uncertainty; retail most at risk

While the direct impact of the war in Ukraine is likely to be small, we think there will be indirect consequences for euro-zone commercial property markets. Economic growth is expected to be slower, which will weigh on property demand. But as much of the slowdown is likely to come from lower consumer spending, we think there will be a more material impact on rental growth in the retail sector this year. Inflation is also likely to be even higher, and we now expect the ECB to start raising interest rates by the end of the year. However, with the spread to bond yields still wide, we think there is further scope for property yields to fall over the next couple of years before they edge up from 2024. Long Run Outlook Drop-In (23 March, 11:00 EDT/15:00 GMT): What will be the lasting impacts of the war in Ukraine? What legacies will the pandemic leave? What does a future of higher inflation mean for economies and markets? Neil Shearing hosts this special discussion with senior economists about the long-term investing outlook on Wednesday. Register here.

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Most industrial markets overvalued in Q4

Higher government bond yields and falls in property yields across all sectors contributed to a deterioration in European property valuations in Q4. While most industrial markets now look overvalued, for now we think that this is justified by the sector’s better rental prospects. However, the sharp rise in alternative asset yields so far in Q1 will weigh further on property valuations. Given the war in Ukraine, this will be of particular concern for Moscow property.

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