Chris Zeuner (7R): Over-pricing went further in Western Europe

Published: 11. 04. 2023

Pre-MIPIM, what would you have said was likely to happen with interest rates?

I would have said they’re going to continue increasing.

So, you think the fall of banks like SVB and Credit Suisse could scare central banks into being more cautious?

There could be a reluctance from central banks to raise them as much, or maybe they’ll halt for a little bit and reassess. That doesn’t get rid of the inflation situation in Europe, though.

Even keeping them where they are now will create real problems…

Half of the economists you read say they’re going to wait and half of them say inflation is still too much of a problem, so interest rates have to go up. It’s too fresh now. Let’s be clear, however: we’re not in 2008.  So, the regulators may decide the system can withstand further hikes.

Valuations of assets don’t seem to have changed much. Not if you read the usual reports.

We don’t look at the valuations much, honestly, rather we focus on what’s been transacted or what’s going to be transacted. If you’ve got a building to sell today, all other things being equal versus 24 months ago, you’ll be selling at a lower price per sqm — a higher cap rate — than you would have done. What’s in a valuation I leave to the valuers to work out…valuation purposes vary so much and reports can be very generic.

Assuming rates don’t climb much from here, what will happen to real estate cap rates?

If rates go up, one must expect that cap rates will rise as well. But it depends on which product. If you’re talking about really good, new, long-term sustainable product, it’s not that there’s no money available. There are big investors with large balance sheets who are using this as an opportunity to buy assets at an attractive price. They’re buying on the assumption that in 2-3 years rates will come down to a lower number. And on that basis, it looks like good value what they buy today. That’s what we’re trying to deliver.

I think it’s a very different discussion if you’re looking for an existing for product that’s 7 or 8 years old, that’s not the best quality compared to what else is around today. That’s a different story. If I were an equity investor, I’d be looking more for something that’s really going up. And I would push who I’m buying it from to deliver that extra bit of quality.

Give me a ballpark range how much yields have gone out.

You might be around 75 bps in the Czech Republic, and it’s similar in Poland. But this is the key: if you have a standing asset in Germany at 3% and another in Poland or Czechia that you bought at 5.25, then you’ve already got a hedge in Central Europe. On top of that, rental growth in these countries has been far stronger than in Western Europe. Demographically, this is where your future growth is coming from, because these countries have had an influx of young people come in who may stay. The longer-term prospects for Poland and the Czech Republic are stronger. So, you’ve already got a built-in hedge, great demand and potentially more positive demographics. Those are three things that make me feel more comfortable.

Then what justifies the discount vis-a-vis Western Europe?

The stability of the political systems in these countries (though I realize you could say that Brexit is an argument against that). But business still takes longer to do. There are geopolitical issues as well. Poland has Ukraine next door and that caused some investors to be initially concerned. There’s still a difference in pricing — and there should be one. The question is how big that difference should be. I do think the difference between the two got bigger than it should have been.

Relatively speaking, then, there will be a greater adjustment in Western Europe than in Poland and Czech?

Yes. I think it got more over-priced there and therefore yields needed to come out, rather than everything proceeds on a linear basis and the gap remains the same. I don’t think that makes sense – market specifics need to be accounted for.

If interest rates go up 2%, do yields go up 2%?

No, because it depends what your rental growth is going to be. And of course, you’re not levered on the whole investment. Interest rates can go up and down, it depends on your hold period. It’s one thing if you’re planning to hold the asset for ten years and you’ve got debt in place and you’re not in breach. It’s another for investors who have to do mark-to-market on debt that’s expiring and who need to sell the asset in one or two years.

Will interest rates go back to what they were in a couple of years? Or is that gone?

No. We were in an abnormal environment when interest rates were so low and we’re in an abnormal environment now. I think somewhere in the middle is normal.


Chris Zeuner is Chief Investment Officer and a Board member at 7R


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