The economy and geopolitics
The macro-economic outlook has deteriorated significantly since Russia’s invasion of Ukraine in February 2022 and the resultant energy crisis pushed the European economy downwards by the end of the year.
The war follows hard on the heels of the Covid-19 pandemic which has caused structural shifts and disruptions to supply chains worldwide and led to a surge in e-commerce and working from home. Inflation soared on the back of rising gas, fuel, food and construction costs. Central banks worldwide have increased their interest rates and as a result, declines in the values of stocks and bonds have triggered the ‘denominator effect’ of higher relative institutional allocations to real estate. Real estate capital growth remained relatively stable, thanks to lagged revaluations which strengthened the denominator effect.
Despite the worsening economic conditions, there are still several pockets of opportunity for Bouwinvest in the Dutch real estate market. 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 Dutch healthcare real estate market where demand is growing strongly for more modern and needs-based senior living and care complexes, due to the country’s rapidly ageing population. More alliances between care institutions, investors and other stakeholders including local authorities, developers, housing corporations and insurers point to the way forward for the huge task of creating sufficient high-quality care accommodation in coming decades.
In Europe, too, the 2023-2025 period will be characterised by slower economic growth, higher interest rates and economic uncertainty. The European Central Bank, for example, raised benchmark interest rates in the Eurozone by 50 basis points (bps) in July 2022, in what was the first rate increase since 2011. This was followed by a further rate increase of 75 bps in August 2022 - the highest single hike since the launch of the euro in January 1999 - an additional 75 bps rise in October and a 50 bps rise in December 2022. The ECB rate went from -0.5% at the beginning of 2022 to 2.0% at the end of the year and further increases in 2023 are very likely to occur, whereby a 50 basis points increase in February 2023 and a 50 basis points increase in March 2023 took already place.
The tightening spread between real estate yields and 10-year government bonds – a proxy for the ‘risk-free rate’ - is also leading to asset repricing. Real estate is becoming more expensive for leveraged investors due to rising interest rates. The rising funding gap in the context of refinancing is also driving repricing as is the speed of interest rate hikes. All this, together with the denominator effect, is creating global challenges for the real estate market.
Economic growth forecasts
Source: Oxford Economics, March 2023
The UK market was also impacted during 2022 by political instability and the continuing knock-on effect of Brexit, with government finances and high interest rates proving to be particularly challenging. In North America, both the Fed and Bank of Canada are implementing monetary tightening to rein in high inflation. In 2022, the Fed raised interest rates eight times in a year by a cumulative 425bps increase, and the Bank of Canada lifted interest rates from 0.25% to 4.25% in seven steps as well. Over the last months, the Fed continued to increase interest rates to a current level of 4.75%, while the Bank of Canada increased its rate to 4.50%
The picture is similar in Asia-Pacific markets, with the exception of China and Japan. Japan is keeping a lid on interest rate growth and its benchmark 10-year government bond rate remains close to zero. Within the heterogenous Asia-Pacific region, Australia is cementing its status as a safe haven. Singapore, meanwhile, is expected to see its relative attractiveness increase versus Hong Kong while a Covid-19 policy, a troubled property sector and geopolitical tensions have added a risk premium in China.
It is still impossible to estimate the financial impact of the rising geopolitical tensions, the Ukraine war, higher interest rates and energy crisis, either globally or for Bouwinvest.
Ongoing urbanisation in major cities across Europe continues apace and it is estimated that 84% of the European population will be living in metropolitan areas by 2050. Wealth tends to be concentrated in larger urban centres with better employment opportunities where the average age of the working population is lower than in regional and more remote communities. Demand for living assets remains strong in most urbanised areas due to demographic growth and the rising number of households, boosted by immigration and the expanding number of younger and older people living alone.
The world population will grow to almost 10 billion people in the coming 30 years. However, growth is declining, from some 1% to 2% a year to 0.5% a year as birth rates fall and populations age. Just nine countries will account for more than half of future population growth while India will overtake China as the most populous country in the world within just a few years.
By 2030, the Asia-Pacific region will account for 66% of the global middle-class population compared with 30% in 2009. This increase will accelerate the existing trend of urbanisation, which means that population and economic growth will be higher in large cities, including the surrounding metropolitan areas, compared with national averages. This too could lead to interesting residential and healthcare real estate opportunities for Bouwinvest.
The North American markets are also poised for further urbanisation and demographic growth, driven by strong immigration flows. The Canadian population, for example, is set to growth by 30% to 50 million over the next 30 years.
Sustainability is another key subject for the real estate sector and Bouwinvest, and there is an increasing body of evidence which shows it pays to be green over the long term, both in terms of finance and environmental, social and governance (ESG) returns. Sustainable buildings command higher rents and values and generate more stable financial returns, a trend which dovetails with our mission to adapt to the changing market conditions and our investors’ own demands.
Impact investing is also gaining ground by prioritising sustainability in both a social and environmental sense, ahead of financial returns. The more transparent world regions are heading in the same direction: towards more energy-efficient, circular, and sustainable buildings alongside increased reporting and disclosure requirements. ‘Green’ laws are, moreover, becoming more stringent over time. For example, the EU’s Sustainable Finance Disclosure Regulation (SFDR) aims to create a more transparent playing field and to prevent greenwashing.
Circularity as a potential solution to materials shortages is gaining in popularity, due to increased awareness of geopolitical dependencies on countries like Russia (a major raw materials producer) and China (a key components manufacturer). However, developments in this area are still in their infancy.
Climate adaptation of the built environment is a big issue and the scanning of climate risks for buildings and the environment of the buildings is part of day-to-day business. Biodiversity, too, is increasing in importance in construction projects. For instance, in the Netherlands, several development projects (mostly those close to Natura 2000 sites) have come to a standstill due to uncertainties over their feasibility under more stringent environmental regulations.
Governments and the private sector are also coming under increased pressure from the public and environmental lobby groups to make their operations more sustainable. New technologies aimed at monitoring and implementing ESGs continue to evolve, but so far have been primarily focused on the ‘E’. By focusing more on the ‘S’ in ESG, real estate investors aim to find solutions to social problems such as a shortage of affordable housing, a growing gap between rich and poor and increasing isolation. Social investing can be achieved via different types of real estate including affordable homes and public or community facilities for education, healthcare, infrastructure, and general welfare, and Bouwinvest is responding to this need.
Regulator and client demands
Regulators and investors are also becoming more demanding through legislation, directives and regulation. Bouwinvest has responded to these demands by further strengthening its capabilities around risk management, ESG, research, data, (financial) reporting and compliance. Bouwinvest continues to implement Regulatory Technical Standards related to the SFDR and related legislation such as the Corporate Sustainability Reporting Directive (CSRD).