Given the economic scenario, the commercial real estate market goes into ‘wait and see’ mode
Commercial real estate performed very well in the first half of 2022 but this situation is changing rapidly in the wake of the sharp hike in interest rates implemented by the ECB to curb the advance of inflation. All the evidence seems to suggest that office property may see the largest adjustment in valuation terms as this has the narrowest yields. Retail, whose valuations have already suffered several years of intense adjustment, could now become more stable than the rest of the segments. On the other hand, logistics assets, the star product lately due to the boom in e-commerce, may be more sensitive to any deterioration in the macroeconomic environment. Finally, we look at the co-living segment which has been attracting a lot of investor interest recently in Spain, especially in the case of senior living, a segment with very positive prospects considering the demographic outlook that will support demand in the medium and long term and the current limited supply.
The upward trend that began early in 2021 in the commercial real estate market continued through the first half of 2022, mainly thanks to highly favourable financing conditions and considerable investor appetite for this type of asset. According to the latest price index for the commercial real estate market provided by the Bank of Spain,28 over the past year and a half valuations have recovered across the board, almost recovering their pre-pandemic levels in the first half of 2022.
The revival is even more evident in terms of investment: in the first three quarters of 2022, the volume of investment exceeded the annual figure for the last 10 years (€14.226 billion), with the exception of 2018 (around €20 billion according to the real estate consultancy firm CBRE).
- 28. A description of the methodology used for this recent price index is contained in the working paper by Matías Lamas and Sara Romaniega (March 2022): «Designing a Price Index for the Spanish Commercial Real Estate Market». Occasional Paper, no. 2203.
The most notable recovery in prices has occurred in office property. This is one of the segments hardest hit by the pandemic, especially in the early stages of severe restrictions on travel and with people working from home, when prices fell by more than 15% year-on-year. Once these more acute phases of the health crisis were over, and after teleworking had started to normalise (a hybrid approach appears to be the new predominant model), the office segment has gradually regained its previous valuations while yields have increased,29 although it’s true that investment volumes are still modest compared with the segment’s past achievements.30
- 29. The yield (or profitability) of commercial real estate investment refers to the ratio between the income gained and the value of the asset.
- 30. Investment has recovered in Madrid, improving on the dismal figures posted in 2021. Nevertheless, investment volumes are below the average for the last five years according to data used by the real estate consultancy firm CBRE. In Barcelona investment moderated in 2022 compared with its excellent performance in 2021, when it was boosted by the 22@ district project, but it’s also slightly below the average for the last five years.
Offices are the asset where valuations have recovered the most but retail is the segment in which investment has outperformed its average for the last five years.
Similar conclusions can be drawn for the segment of retail. This is the other real estate asset most affected by the consequences of the pandemic. Since then, this sector has clearly recovered, already posting valuations just 0.2% below those recorded before the health crisis, while investment volumes have rebounded more strongly than in the office property segment.31 In the specific case of shopping centres, a gradual recovery in terms of sales and footfall towards pre-pandemic levels is also being observed, much more evident in terms of revenue (only 4% below 2019 levels) than visits (–16.5% below), as the return of people to the leisure facilities provided by such centres has been much slower since the pandemic.
- 31. So far, investment in retail has clearly outperformed the annual investment since 2019 (cumulative investment of €3,556 million up to Q3 2022) and is now at levels similar to its pre-pandemic five-year average.
Shopping centre indicators continue to move towards their pre-pandemic levels but the rebound in footfall is incomplete due to a delayed recovery in leisure.
Finally, the segment of industrial and logistics suffered the least throughout the pandemic. In fact, supply shortages and the new needs associated with the rise in e-commerce and data centres (again, related to the boom in teleworking and digitalisation processes), among other post-pandemic trends, have made it the star segment in commercial real estate investment in the last two years. The predominant aspects of 2022 were a large area of warehouses under contract, a sharp decline in vacancy rates, and an increase in available supply.
Digitalisation processes, the boom in e-commerce and teleworking have turned the industrial and logistics segment into the star asset for investment in Commercial Real Estate (CRE).
The outbreak of war in Ukraine at the beginning of 2022 has been a differential factor for the global economic scenario and, therefore, also for the Spanish economy. Although it is true that Spain is less exposed to the conflict than other central European economies, the energy crisis, especially on international natural gas markets, has had a significant impact on inflation, driving it to 40-year highs. Signs that this rising energy bill is being passed on to other items in the shopping basket and fears that inflation is becoming entrenched in the economy led the ECB to abandon its ultra-expansionary policy of recent years and raise benchmark rates particularly aggressively (+200 bp since June). Given this situation of high inflation and rising market interest rates, growth forecasts for 2023 have been revised downward across the board.32
This context will also directly affect the commercial real estate market. There can be no doubt that a widespread increase in interest rates makes the financing of investment operations more expensive. As a result these operations, which are usually accompanied by leverage, become less attractive compared with other alternatives. An investor in commercial real estate will therefore look for higher returns (and this requires either an increase in rents, a moderation in prices, or both) to make such investments attractive.
- 32. For a more detailed examination of the factors behind the change in scenario for the Spanish economy according to CaixaBank Research forecasts, please refer to the Outlook Dossier published in the November 2022 Monthly Report.
The commercial real estate market has gone into ‘wait and see’ mode as valuations and yields are still adjusting to higher market interest rates.
In fact, in the last few months of 2022 there was already an evident mismatch in the market between a supply that is reluctant to reduce the value of assets that had been in strong demand in previous months and a demand that needs valuations more in line with the current situation and more attractive returns. This mismatch is reflected in the paralysis or postponement of many investment operations. As a result, the market has gone into ‘wait and see’ mode, at least until it becomes clear to what extent the ECB will raise benchmark interest rates.33 In any case, we don’t expect the market to come to a complete or abrupt halt, seeing as interest rates are still relatively low in historical terms and, above all, bearing in mind the fact that there is still liquidity in the market.
In this respect, those assets whose yields have already accumulated significant adjustment, as is the case of the retail segment of commercial premises, should be the least affected by higher market interest rates. On the other hand, in the case of the star segment in recent months, namely industrial and logistics warehouses, yields still have room for upward adjustment.
But beyond any impact the interest rate hikes may have, there are also more structural factors that will affect the commercial real estate market. In the case of office properties, the current outlook is relatively positive as the penetration of teleworking has not been as extensive as initially thought and, in addition, hybrid formats are creating a need for new spaces. Significant investment in traditional offices will therefore be required in order to transform them to the hybrid model. Moreover, the labour market outlook has not deteriorated to any material extent.
As far as retail premises are concerned, the sector was already exposed to digitalisation processes and e-commerce long before the outbreak of the pandemic, which explains this segment’s strong consolidation in recent years. Although it is true that the current scenario assumes consumption will slow down in the short term as a result of the loss of household purchasing power, a severe correction is not expected in a segment that gone through huge adjustments in recent years. In addition, as with offices, the emerging need for hybrid locations that combine shopping in person (still the predominant form) with e-commerce suggests that this segment will remain quite attractive for investors.
Finally, industrial warehouses and logistics assets will continue to be of great interest to investors, especially because the supply and the processes that have been driving them (digitalisation and e-commerce) still have a lot of room for expansion in Spain over the medium to long term.
- 33. For more on monetary policy expectations, see the article «Is there light at the end of the tunnel? The outlook for monetary policy in 2023» in the November 2022 Monthly Report.
Residential property is one of the commercial real estate segments arousing the most interest in investors since the outbreak of the pandemic.34 Behind this interest lie aspects such as the new housing needs arising as a result of the pandemic, the emergence of the co-living segment which is closely associated with increased teleworking and the attraction of talent, as well as the need for greater integration between the social and work-related aspects of housing. This is also a segment in limited supply in Spain compared with neighbouring countries. In fact, since the outbreak of the pandemic the rise in property prices has once again highlighted the need to expand supply in the rental market and public-private partnerships are being promoted to expand the supply of rented housing through the build-to-rent segment.
Within this broad segment is a totally new asset that is working well in neighbouring countries and becoming increasingly important in Spain: senior living. This refers to alternative living spaces to the traditional retirement homes, designed for the senior population (65 and older) who have reached retirement age in good health and with the ability and need for social, leisure and community-based activities. This type of product combines the benefits of rented accommodation (in terms of low maintenance) whilst providing the opportunity for leisure activities inherent in a shared living space. In addition, care-type services can be added as the years go by without incurring excessive costs, thanks to economies of scale and synergies.
The fundamentals on the demand side of this asset are very solid. The Spanish population is ageing gradually and progressively, so that the traditional population pyramid is flattening at the base (lower birth rate) and widening at the top (more population in older cohorts), losing its triangular shape. Moreover, population projections by the National Statistics Institute suggest this trend will continue in the coming years. Specifically, the Spanish senior population will grow by 64% over the next 30 years and account for 31% of the total population (20% today).
- 34. The co-living segment has been the most dynamic in CRE investment in 2022, with an investment of around 3.7 billion euros up to Q3 2022, the highest figure in the available series.
Spain’s senior population will grow by 64% over the next 30 years and account for 31% of the total population (20% today).
Andalusia, Catalonia, the Community of Madrid and the Community of Valencia would be the regions with the largest senior population in Spain, which is not so surprising since they are also the most populated. But how do these figures compare with the senior living properties currently available? In fact, most of Spain tends to have a smaller supply available than recommended: according to the WHO, the optimal coverage ratio would be around 5 places for every 100 citizens aged 65 and over.35
The following map clearly summarises the current mismatch between supply and demand in Spain, where the average coverage rate is 4 places per 100 senior citizens. The only notable exception is Castile & Leon, while the smallest supply is in the island regions and Murcia. On balance, the conclusion is obvious: there is room to expand the supply of places in this segment.
- 35. This reference includes the case of residential homes for the elderly.
In addition, population projections suggest that the largest increases in the senior population up to 2035 will occur in the island regions, Murcia, the Community of Valencia and Madrid. In other words, demand will be even greater in those regions that are not only particularly dynamic in economic terms (Madrid and Valencia) but also particularly attractive for senior foreign nationals (this would be the case of the rest of the highlighted regions).