In a recent update we focused on challenges facing Europe’s real estate sector, but highlighted that by focusing on fundamentals within specific sub-sectors and related businesses we can identify select credit opportunities
In our analysis we typically break the real estate sector down into several segments – European residential, US residential, logistics, datacentres, offices, hotel/leisure, and retail. Of these groupings, for example, we’re currently wary of a retail sector impacted by cost-of-living and consumer confidence issues. We are also keen to avoid offices – a sector exposed to macro headwinds and which is still getting to grips with the hybrid working model as well as high and rising vacancy rates.
Conversely, see real potential in Europe’s residential and datacentre subsectors. In these market segments we can identify solid fundamentals and credit spreads pricing in an overtly negative outlook. So, what makes each of them attractive?
Strong incumbent firms in Europe’s residential sector look well placed. An imbalance between supply and demand provides support with comprehensive social security systems in countries like Germany and Sweden meaning there are very few issues with rent collection or deferral. Even in extreme times such as we saw during the pandemic the sector was helped by supportive fiscal initiatives. Earnings visibility is provided by long and well-regulated index-referenced leases and threats from new supply or entrants are limited.
We’re seeing governments becoming more accommodative of the sector given the challenges it faces in meeting energy efficiency targets and provision of new supply. In terms of risks, we’ve previously discussed how some challenged issuers have turned to asset disposals to raise capital and the potential issues around having to sell prime assets and future earnings potential. Of course this is a potential issue, but larger names can protect themselves through ‘self-help’ measures such as reducing dividend payments like Vonovia did in 2022.
Media streaming, gaming, mobile traffic, internet of things, cloud computing and artificial intelligence are just some of the drivers of booming data storage demand. At the same time supply is struggling to keep pace with headwinds from land availability in key geographies, power supply constraints and skilled labour shortages. All in all, it’s a supportive backdrop for larger companies – like DLR and Equinix – with established capabilities and infrastructure. Companies increasingly look towards bigger datacentre providers as they’re keen to benefit from infrastructure already connected to customers.
And it’s an environment that’s allowed datacentre operators to regain pricing power. There are risks to be cognisant of, however, not least environmental considerations around levels of energy and water use. We see real advantage for businesses prioritising reduction of water use and utilisation of renewable energy sources and both DLR and Equinix have made firm commitments around their energy transition from here.
Of course, opportunities aren’t limited to these two subsectors alone. We also like a logistics sector boasting rental growth underpinned by structural drivers such as supply chain onshoring, inventory build-up (as companies move to improve supply chain resilience) and scarcity of urban last mile land.