Mispriced risk in EU, UK real estate brings appealing opportunities: Abrdn

European real estate prices are adjusting, creating mispriced risk amid current market turbulence. This brings attractive opportunities for investors targeting undervalued real estate equity or debt, said Neil Slater, global head of real assets at UK investment firm abrdn plc, pronounced like the Scottish city Aberdeen.

Particularly, UK real estate is in the midst of a broad repricing, and performance for the remainder of the year and into 2023 will turn negative, he said. The pricing impact will be greater and more prolonged on secondary assets, which do not meet current occupational and investor demand, he added.

Leading real estate management firm abdrn has £43.2 billion ($50 billion) in dedicated assets under management (AUM), including £18.3 billion in logistics and industrial assets and £7.4 billion in residential assets.

It allocates 61.7% of its real estate AUM to the UK, 31.5% to Europe, 1.3% to Asia and 5.6% to other regions. Logistics make up 45.3% of its entire real estate assets, while residential, office and retail account for 14.9%, 12.7% and 12.5%, respectively.  

The following is our interview with Slater via e-mail.

▲ The global economy is expected to stagnate in the post-pandemic era. What is your view of the real estate economy in Europe next year?

"Despite surprising levels of resilience across the European economy, the outlook is uncertain and markets are digesting the effects of a stagflation scenario. We expect the European Central Bank (ECB) to frontload its tightening cycle, pausing its hikes once the recession hits.

The continued rise in both short- and long-term interest rates has had an immediate impact on real estate values, largely as a result of the spike in the cost of debt. We believe this revaluation of real estate yields is just the first phase of a broader correction. Public listed markets are currently pricing in a fall for direct market valuations of around 15% to 20%, depending on sector and geography.

Occupier markets have held up extremely well so far. Vacancy rates remain generally low and demand levels are still very healthy overall. Some of this reflects the resilience of the underlying economy to date, but we also believe there is still some momentum from the pandemic recovery coming through in the numbers. We expect a recessionary environment to hit retail tenants hardest, although most commercial sectors are vulnerable to weaker demand drivers.

The performance outlook for European real estate can be split into three broad phases: the initial period of revaluation and relative pricing we are seeing today; the recessionary and recovery phase; and the longer-term, low-supply-driven rental growth phase, where the limited supply of good-quality property will underpin a healthy performance period.

We continue to prefer sectors where there are strong thematic demand drivers, mainly demographic, technological and social. This exists primarily in logistics, all parts of the residential market, many alternatives (such as data centers and healthcare-related real estate) and core offices. We remain cautious toward most retail types, especially as we enter a recession and as tenant risk rises.

We expect attractive opportunities to increase as prices adjust and risks become mispriced by the market. We also expect opportunities for investors to 'step in' to specific situations, where equity or debt shortfalls offer attractive pricing situations."

▲ How about the outlook on the UK economy in 2023?

"The Bank of England is expected to continue its hiking cycle in a bid to quell inflation and help reestablish its credibility. However, the UK government’s ‘U-turns’ on fiscal policy may result in the terminal rate ending up slightly slower than previously forecast. Although the timing and speed remain uncertain at this time, we expect the Bank of England to begin a cutting cycle in late 2023 in a bid to pull the UK economy out of recession.

Rising debt costs, predominantly driven by swap rates moving out considerably since the start of the year, have proven to be a catalyst for repricing in UK real estate and, along with rising government bond yields, have caused many investors to step back from the market. Looking forward, we expect transaction volumes to see further falls into Q4 and early 2023 as investor concerns persist.

UK real estate is now in the midst of broad repricing, and performance for the remainder of the year and into 2023 will turn negative. While the sector impact of a real estate repricing will be asymmetric, capital value declines are expected across all sectors and the pricing impact is expected to be greater and more prolonged on secondary assets that do not meet current occupational and investor demand.

A repricing of UK real estate should provide opportunities in the medium term and so it is important to position portfolios appropriately in order to access the full benefit of a future recovery in real estate performance."

▲ What is abrdn's major investment strategy amid the high-inflation, high-interest-rate environment?

"Amid economic turbulence, we often lean toward residential real estate on the grounds that this is a segment with the potential to generate stable income. The reason is that residential demand tends to be less volatile than other real estate segments, making the income stream more stable over the long term. As such, we see residential investments as quite defensive during periods of economic uncertainty.

By way of example, the residential segment showcased its resilience during the global pandemic, with one of our residential strategies recording a rent collection rate of almost 100% over that time. 

The key regions for our strategies would be the UK and Europe. These are markets where we see opportunities. In terms of the residential space, abrdn focuses on three A's -- affordability, accessibility and amenities -- to drive asset selection.

Our extensive experience in residential real estate tells us that its performance is ultimately determined by investing in sustainable properties at affordable prices in places where people want to live. We would target 'winning cities' across the region where there are strong inflows of population and household sizes are shrinking.

At the same time, real estate debt strategies can benefit from high and rising interest rates as the income that the debt investments generate has the potential to rise in line with interest rates. In addition, we see risk management benefits as real estate debt investments tend to be less affected by changes in valuation during volatility, especially assets backed by collateral or strong covenants. 

Separately, we also like real estate logistics, which centers around the rent and sale of warehouses, distribution centers, flexible spaces and other industrial buildings. The lack of quality logistics assets in the UK and Europe is supportive of demand and valuations during turbulent economic periods, underlining the defensive nature of these investments. We have already seen some rerating in valuations in the logistics market, which is creating some appealing opportunities from an entry-price perspective."

▲ What are the major risks in the European real estate lending market? Also, what are abrdn's principles to the market to manage such risks?

"The major risks from a European lending perspective, outside of the core, common risks of asset value decline and income stress are the challenges of different jurisdictions from an enforcement perspective. Each jurisdiction is unique and will have a different path to recovery, which can have material cost and timing implications.

The abrdn team experience, having restructured and worked out facilities in every major European jurisdiction, together with our expertise and coverage in equity markets is a key element of our underwriting and deal assessment process to help us navigate through these areas."

▲ Abrdn's direct investment in Asia is focused on value-added strategies. What are the major asset types and regions in Asia? Also, where do you see investment opportunities in South Korea?

"Abrdn sees opportunities in the office and logistics market in South Korea. In the short to medium term and dependent on interest rates, we see opportunities arising due to refinancing concerns.

We would consider that the office market in Seoul is a key market for value-add opportunities as supply is low currently as are vacancy rates. In the logistics market, due to negative leverage, there will be asset refinancing issues and expected discounts."

Slater joined abrdn in 2011. Initially, he led a multi-disciplinary team responsible for product structuring, tax, legal and debt for Standard Life Investments’ real estate business, while supporting product financing across asset classes. he developed and managed the firm’s real estate investor debt platform with responsibility for some £600 million across mandates. He has also served as CEO of Aberdeen Standard Investments Japan.

Previously, Slater spent more than six years in Switzerland with Man Group where, as head of product finance and risk transfer, he was responsible for a multi-billion debt book in addition to leading the team structuring Man Group’s equity derivative products and over-the-counter (OTC) derivatives, fund financing and custodial structures. 

Slater is an English-qualified solicitor. He received an MBA in finance with distinction from Manchester Business School in January 2007 and earned a master’s from St. Andrews University in 1999.

Write to Jihyun Kim at snowy@hankyung.com
Jennifer Nicholson-Breen edited this article.