At year-end 2020, Colliers ventured some outrageous predictions for the coming year, claiming, for instance, that initial yield requirements would drop by as much as 50 bps to below 3% in several segments, and that transaction volume would increase by 50% to an all-time high. These predictions, as unlikely they may have seemed 12 months ago, came to be true: Today, net initial yield requirements on the best residential or office investment properties are just shy of 3.0%, on residentials even as low as 2.7%. In addition, transaction volume in the Danish investment property market has been historically high.
2021 has indeed been a remarkable year: It started with extensive lockdowns and restrictions due to COVID-19 – and it ended with renewed restrictions.
Paradoxically, economic growth momentum was the strongest seen in many years. Moreover, employment was historically high, and unemployment rates correspondingly low.
For the first time since the financial crisis, central banks saw their dreams of slightly higher inflation come true, and then some – with an inflation rate of around 3%, Denmark was quite a bit below the +5% rate seen in Germany, and below the US rate, which is approaching 7%.
It has been several lifetimes since savers with cash funds and bonds saw a similar erosion of their purchasing power.
If your investments in short-term bonds produce a yield of zero or negative, all the while prices are increasing by 5% or more, the value of your savings will drop at an alarming pace.
Even so, investors do not complain: They have achieved fair returns in the stock market, with investments in real estate and other alternatives producing favourable results.
Property prices and rate hikes
The time is rapidly approaching for rate hikes in the USA. Some European economies are still lagging behind in terms of economic growth, with rate hikes therefore yet to hit the European agenda, although it is perfectly understandable that inflation-scared Germany views negative interest rates with concern, all the while inflation has now exceeded the 5% mark.
Many economic pundits tend to argue that rate hikes are prone to drive down property prices. This is undoubtedly correct in terms of the ownership housing market, but investment market dynamics are not necessarily the same.
Higher yields, matched by (even) higher inflation, do not as such pose a challenge to the investment property market. Rental income is often inflation-linked, and a high inflation rate will likely drive up construction costs, enhancing the value of existing properties, all other things being equal.
The property market with the perfect storm – right behind
Is it possible to imagine better framework conditions for the property market than the ones currently prevailing:
Economic activity is brisk, businesses make good money, and wages are rising. This fuels the demand for more and larger dwellings and more office, storage and production facilities, driving vacancy rates down and rents up.
At the same time, short-term interest rates are negative and long-term interest rates low. Add to this inflation, real interest rates are driven deep into negative territory.
The cost of financing is therefore de facto at an unprecedented low, with investors averse to having funds tied up in cash deposits or bond investments.
All these factors taken together makes it hard to imagine a situation with more tailwind than now – we have the perfect storm right behind us.
Will 2022 bring an end to the party?
We find it difficult to believe that 2022 will top 2021. Initial yield requirements are historically low, and it is hard to conceive of further yield compression.
In addition, it is worth bearing in mind the high level of ongoing newbuilding of both residential, office and logistics space. As from 2023, the supply of lease premises will increase, dampening any prospects of rent hikes.
Nevertheless, we do not believe that 2022 will be a poor year in the property market. The framework conditions for property investments will remain favourable, with vast amounts of money being allocated to property investments in 2022 as well.
Against this backdrop, we venture some new outrageous predictions concerning both the economy and the property market:
- 2022 will mark the year when COVID-19 stops being an everyday topic. Either COVID-19 is eliminated, or it becomes a manageable condition of life
- Inflation pressure eases. In 2021, inflation was not demand-driven but driven mainly by short supply situations, caused by supply chain disruptions. We expect to see a gradual return to normal in 2022
- Property investments will produce one-digit positive returns, driven by stable or slightly climbing rental prices
- Retail property will be back in vogue. Investors will realise that brick-and-mortar retailing is not a thing of the past, and that it defies natural laws when well-located retail properties with solid cash flows are trading at direct yields on a par with the yield on production and storage facilities in secondary locations, in effect exceeding the yield on logistics facilities with comparable cash-flow security by more than 100 bps.
In our quarterly report PULSE, we translate data into knowledge regarding the latest trends in the commercial real estate market. Download PULSE for Q4 2021 here.