ESG Club


Christophe Montcerisier is head of real estate debt at BNP Paribas Asset Management


EUROZONE COMMERCIAL REAL ESTATE RESET CREATES OPPORTUNITIES FOR DEBT INVESTORS


The sharp rise in interest rates over the last year has lowered valuations and led buyers to demand higher yields when acquiring commercial property. Banks have increased their scrutiny and caution, reducing loan-to-value funding ratios. While there is still demand from borrow- ers, especially for refinancing maturing debt, the amount of debt offered by banks per square metre is lower. We believe this environment presents an attractive oppor- tunity for investors.


Real estate pricing Currently, real estate prices are being reset. Property markets, including those for commercial real estate, are adjusting in the face of two opposing forces: – On one hand, the significant rise in interest rates in the eurozone since the summer of 2022 has increased borrow- ing costs and is weighing on property valuations – On the other hand, higher inflation is expected to boost rental revenues over time as rents are typically partly or fully indexed to the rate of inflation.


As a result, the amount of money you can now borrow from a lender has decreased (the maximum is circa 10 points less than a year ago), while returns have increased along with market interest rates (the cou- pon rate on the bonds is typically floating). Vulnerable segments Interest rate rises have pushed up costs for property owners. Leveraged lenders may be vulnerable when asset price resets occur. Pessimists point to the lingering effects of the Covid-19 pandemic: consumers have not fully returned to shops and many workers are still working from home. These trends are undermining the value of shopping centres and offices, though more so in the US than in the eurozone. This is because the eurozone has not seen the property market excesses that will likely create problems in the US market in coming months. In the European CRE market, lower-grade office properties face both weakening demand and higher construc- tion and maintenance costs. Potential buy- ers are retreating; lenders are imposing punitive lending rates; and occupiers are upgrading, leaving lower-grade properties and moving into buildings that meet the latest environmental standards.


WFH – less impact in the eurozone The shift to working from home (WFH) during the pandemic triggered discussions about the impact on demand for office space and the damage it could do to the per- formance of office markets. News t hat financial firms are encouraging, or even requiring, staff to return full time to the office suggests the trend may have peaked, but we have not yet reached a new equilib- rium. If working from home expands, it could significantly reduce demand for


PI Partnership – BNP Paribas Asset Management


office space, resulting in higher vacancy rates, obsolescence and falling rents. Anecdotal reports suggest offices in Europe have seen a much sharper post-Covid rebound in usage than in the US. The Wall Street Journal recently noted US office occupancy was at 40% to 60% of pre-Covid levels compared to 70% to 90% in Europe. Longer commutes, poorer public transport networks and larger suburban dwellings kept US commuters working from home. Tighter labour markets may also have led US firms to hire more remote workers in recent years.


While the commercial real estate market will undoubtedly face challenges in the years ahead, we believe the office sector remains a viable opportunity, particularly when considering the regional differences.


Risk of stranded assets due to ESG requirements According to the World Green Building Council, buildings account for 39% of global energy- related CO₂ emissions. Around three-quarters of these emissions come from operating buildings, the rest from construction. New environmental regulations to address these issues have added significantly to the costs of upgrad- ing a building from today’s standards to 2030 requirements.


Owners of buildings outside city centres or in smaller towns may struggle to meet these obligations and these buildings may become stranded assets. This factor is already being integrated into the market’s assessment of buildings and contributing to lower valuations.


While the requirement to upgrade or refurbish buildings to a higher standard is a challenge for property owners, it cre- ates opportunities for those financing it.


For professional investors. BNP PARIBAS ASSET MANAGEMENT UK Limited, “the investment company”, is authorised and regulated by the Financial Conduct Authority. Registered in England No: 02474627, registered office: 5 Aldermanbury Square, London, England, EC2V 7BP, United Kingdom. www.bnpparibas-am.co.uk This article is issued by the investment company. Investors considering subscribing for the financial instruments should read the most recent prospectus or Key Investor Information Document (KIID) available on the website. Opinions included in this article constitute the judgement of the investment company at the time specified and may be subject to change without notice. This article does not constitute or form part of an offer or invitation to subscribe for, underwrite or purchase an interest in any strategy. The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial investment. Past performance is not a guide to future performance. Private assets are investment opportunities that are unavailable through public markets such as stock exchanges. They enable investors to directly profit from long-term investment themes and can provide access to specialist sectors or industries, such as infrastructure, real estate, private equity and other alternatives that are difficult to access through traditional means. Private assets do, however, require careful consideration, as they tend to have high minimum investment levels and may be complex and illiquid.


Issue 127 | October 2023 | portfolio institutional | 31


Page 1  |  Page 2  |  Page 3  |  Page 4  |  Page 5  |  Page 6  |  Page 7  |  Page 8  |  Page 9  |  Page 10  |  Page 11  |  Page 12  |  Page 13  |  Page 14  |  Page 15