30 November 2022
Valuation divide between ‘green’ and unsustainable real estate assets deepens as energy crisis ushers in darkening economic outlook - Bouwinvest Netherlands Outlook 2023-2025
The growing valuation gap between real estate assets with strong sustainability credentials and those where prices are weighed down by a non-sustainable discount will widen further as discerning investors, spurred by the current energy crisis, increasingly focus on the ESG characteristics of their investments, Bouwinvest Real Estate Investors predicts in its Dutch market Outlook 2023-2025 report. Despite the deteriorating economic backdrop, there are pockets of investment opportunity and more resilience in the values of these properties with the highest sustainability standards, particularly in sectors where occupancy demand is lagging such as retail and offices, as well as in areas where market fundamentals are stronger like residential, healthcare and hotels, the report concludes.
Jeroen Beimer, Head of Research and Strategic Advisory, said: “A growing body of evidence shows it pays to be green over the long term, both on the financial front as well as in terms of environmental, social and governance (ESG) returns. A consensus is emerging that sustainable buildings command higher rents and values and provide more stable long-term financial returns. Impact investing is also gaining ground by prioritizing sustainability in both a social and environmental sense, alongside financial returns.”
The current economic headwinds will have an impact on the Dutch real estate market in 2023, but 2024 could be a more attractive year, he added. “The real estate fundamentals are healthy thanks to expected household growth and relatively low vacancy rates, among other things. That will generate opportunities for investors who use little or no leverage in particular given that financing costs have risen and forced sales are on the cards.”
The macroeconomic outlook for the Netherlands has deteriorated significantly since Russia’s invasion of Ukraine in February 2022 and the resultant energy crisis has put the economy on track towards a potential recession in 2023. The war followed the Covid-19 pandemic which caused structural shifts and disruptions to supply chains worldwide and led to a surge in e-commerce and working from home (WFH), impacting demand for retail and office real estate space. Inflation has also soared across the property industry on rising energy, labour and construction material costs, including the need to comply with more onerous environmental legislation in development projects, particularly for nitrogen emissions.
Rising borrowing costs to stem inflation are also hitting leveraged real estate investors and radically reshaping the economics of investment transactions conceived in the previously more benign interest rate environment. Deal volumes are drying up as a result as the market awaits the repricing expected before a new equilibrium is established in asset values.
European real estate share prices fell an average of around 20% in the year to end-September. The listed sector typically leads price movements in less liquid physical asset values by six to nine months, and a sharp market correction is expected to feed through in earnest in the non-listed sector from 2023 ahead of a long recovery, possibly extending to 2025.
Demand for residential and healthcare real estate exceeds supply
Strong demographic fundamentals continue to underpin the residential rental sector as supply falls seriously short of demand, particularly in the mid-range affordable rental segment. The same is true of the healthcare market where demand is growing strongly for more modern and ‘needs-based’ senior living and care complexes with the accelerating structural ageing of the Dutch population. More alliances between care institutions, investors and other stakeholders including local authorities, developers, housing corporations and insurers, point to the way forward for tackling the huge task of creating sufficient high-quality care accommodation in coming decades.
Overall demand for office space is expected to fall in the Netherlands now that working from home has become common practice, but rents have been rising on the back of record-low vacancies and higher inflation. While initial yields, which move in the opposite direction to prices, may rise ease in the period ahead, supply of the most modern and sustainable offices is expected to tighten further due to stricter minimum requirements for energy performance and environmental regulations for new developments.
From 1 January 2023, all offices in the Netherlands - excluding listed buildings - will be required to have a minimum C-rating for energy efficiency. Owners of offices that do not possess a C certificate or higher (A or B) will not, in principle, be allowed to lease their space from that date. A recent study by CBRE indicated that some 10% of all Dutch office stock had a D-rating or worse, while the energy performance of around 26% of total supply was not even known.
High street retail was starting to recover from the pandemic, but pressure on the sector is building again as consumers retreat in the face of the cost-of-living crisis, with the short-term outlook now significantly less positive. Convenience retail for daily groceries is faring better and the performance gap between ‘experience’ and ‘convenience’ retail will widen as market conditions sour. Repurposing of obsolete stores is underway, but more transformations in function are needed to keep vacancy levels in check.
The post-pandemic tourism revival has led the recovery in the hotel market, but clouds are building on the horizon as fears of an economic downturn intensify, while the potential emergence of another Covid-19 virus variant remains a threat. As a result, rising prime yields are on the cards in this sector.
For the full report, click here.