Mid 2022 Outlook

The European economy is facing several headwinds, with the Covid-19 pandemic as the major threat to economic stability having been replaced by the war in Ukraine, rampant inflation and central banks attempting to limit the damages by hiking rates at a record pace.

Central Bank Policy

The European Central Bank is confronted with a difficult task in the current environment. The underlying causes of inflation in the Euro area are different from the ones in the US. The driving forces of inflation in Europe are rising energy costs, as opposed to the US where it is a result of unleashed pent-up demand and the fiscal stimulus that ensued the Covid-19 pandemic. As a result, rising rates may not lead to a containment in inflation, but rather to stagflation in a similar fashion to what happened in the 1970s during the oil crisis. 

European Real Estate Market

The European real estate market is not spared by the challenges resulting from the current adverse economic environment, with real estate prices being negatively correlated to interest rates.

Highly levered asset classes with low cap rates / high multipliers will suffer the most, such as German residential, as these are most sensitive to a change in rates and cap rates. Further, offices which are highly correlated to the economic cycle and have already suffered from the shift to working from home will have a difficult period in front of them.

Alternative asset classes that are uncorrelated to the economic cycle, should proof to be more resilient, i.e. student housing, medical centers, life sciences, or supermarkets. Moreover, sectors that benefit from strong secular tailwinds and structural under-supply like logistics leading to strong rental growth that can compensate widening cap rates should be also a safe haven.

Outlook

Significant risks lie ahead for the second half of the year and 2023: with a recession coming and rising rates, investors should shift their focus towards assets classes that are uncorrelated to the economic cycle, such as supermarkets or medical centers.