ACROSS: At the beginning of the year, you typically spend a lot of time with investors in Frankfurt and London to discuss their outlook for the year as well as industrial developments with leading investment managers. What impressions have you been able to gather for 2024 thus far?
Steffen Hofmann: The first few weeks of the year have, indeed, been characterized by numerous discussions with investors and banks. Our regular personal presence in financial hubs such as London, Zurich, and Frankfurt enables us to form our own market view and anticipate developments in discussions with a wide range of market participants. We expect to see a gradual resurgence in transaction markets in 2024 and 2025. We do not predict a rapid transition back to a euphoric seller’s market.
ACROSS: Let’s take a closer look at the transaction market: Contrary to widespread expectation, some very exciting and major transactions were signed in 2023.
Hofmann: Yes, there were some notable transactions in the retail asset class in 2023, which may have come as a surprise to some. Overall, however, there were fewer transactions than at any other time in the last 15 years. The most prominent and highest-volume transaction in the European shopping center sector, which has also been recognized as an international benchmark, was the PEP in Munich, which ECE Real Estate Partners and Generali Real Estate acquired in a joint venture in spring 2023.
ACROSS: Can you give a few more examples of transactions?
Of course. The Rhein-Ruhr Zentrum, for example, has found a new owner in the form of its joint venture partners Eurofund Group and Signal Capital Partners. Outside of Germany, the Austrian SES Group was able to acquire a small shopping center near the northern Italian city of Vincenza from Marathon. At present, there are several other major transactions that are pending between the signing and closing stages. French financial investor Sofidy, together with Klepierre, has signed a purchase agreement to acquire O’Parinor, one of the largest shopping malls in Paris. In Castellón, Spain, DWS has concluded an agreement to sell the Salera shopping center to a South African joint venture comprising Lighthouse Properties and Resilient Reit. In addition, the European real estate transaction volumes were and continue to be impacted by the restructuring of the ownership structure of numerous SIGNA properties.
ACROSS: Has retail real estate become more attractive from an investor’s point of view?
Hofmann: In the asset class of retail properties, the necessary yield correction is well underway and should be completed in the near future. Based on the entry yield levels that we expect for the first half of 2024, new acquisitions in the retail and mixed-use real estate sector should be appealing to financial investors with a view to the next cycle. We definitely perceive an extremely interesting window when it comes to launching new allocation programs. Incidentally, we take a similar view of the situation in the hospitality sector for the hotel asset class.
ACROSS: What will shape the 2024 transaction year?
Hofmann: Deal pragmatism. The interest rate outlook has improved, but lending through the heavily regulated banking sector will likely be carried out with caution. Extending maturing loans will still be easier than taking out a new one. Financiers also frequently demand additional equity for loan prolongations. This means that there will be so-called “motivated sellers” in the market who are simply unable or unwilling to provide such equity. Thus, they will become sellers. However, given the current state of the market, they should be willing to accept lower prices in order to execute disposals and free-up their resources for the future. Higher acquisition yields consequently provide purchasers with a little more leeway in their deal underwriting, which is something they need. During shaky seasons, equity investors demand high risk premiums in view of alternative investment opportunities.
ACROSS: Who intends to sell?
Hofmann: Several fund vehicles and project partnerships that got launched in the last decade have since reached the end of their originally intended lifespan. Investors are not necessarily prepared to extend such terms by a few more years in the hope of perhaps securing better exit values in the medium term. Even fund vehicles without fixed fund terms were faced with redemptions from their capital sources last year. Servicing such redemptions requires fund managers to preserve sufficient liquidity. If their funds are tied up in real estate portfolios, mortgages must be taken out on the existing portfolios – or properties must be taken to the market. Last but not least, there are a number of assets that, due to their stage in the individual property lifecycle, require owners to decide whether to provide fresh capital for strategic asset management initiatives – or whether to sell.
ACROSS: What effect will the expected turnaround in interest rates have on the transaction market?
Hofmann: The availability of debt-finance and the level of the associated borrowing costs was and continues to be a strong driver of commercial real estate transactions. The fact that, in 2022, it suddenly became incredibly difficult to obtain affordable financing from an economically sensible point of view was the key reason behind the real estate market’s complete slowdown across all asset classes. The low transaction volumes in 2023 are proof of that effect. The consideration is always the same: Can my investment property deliver a risk-adjusted target return that is sufficiently higher than the return for risk-reduced alternative investments, such as government bonds, fixed-term deposit accounts, or money market funds?
ACROSS: In summary: This year, there are many interesting properties on the market that look more favorable than ever before while investors’ expertise regarding the future viability of retail assets has matured, and we are on the verge of an accretive interest rate movement – all of which are positive factors for 2024.
Hofmann: That is, indeed, a nice summary of the market setting on the horizon for this year. I would simply add that recently drastic scenarios should also give way to a healthier pragmatism when it comes to ESG in the real estate sector. That’s what I would like to see, at the very minimum.
ACROSS: In general, retail space has increased for a variety of reasons over the years. Now, there is too much space on the market. What is being done with the less attractive space?
Hofmann: Asset managers and their operators have increasingly developed expertise in the complementary use of space. Location- and property-specific solutions, through which potential synergies of surrounding uses can be leveraged, are required in that respect. Unfortunately, a one-size-fits-all approach simply will not work. Some locations can potentially be used for leisure and entertainment purposes, while others have no such potential at all. The conversion of former retail space into offices or medical centers is, likewise, not an approach that can be applied across the board. Sometimes, conversion to a budget hotel or micro-living use might be a more suitable approach.
ACROSS: Will there be any properties for which no solution can be found – which will be taken off the grid, so to speak?
Hofmann: Almost certainly, yes – but it often takes a while for existing contractual arrangements to be wound down before a physical repurposing can be considered. In a theoretical competitive arena of 12 properties, finding four owners willing to close down their struggling properties so that the other eight can outperform seems unrealistic. In many cases, all 12 players will fight for their respective asset values. The good news is that the retail real estate asset class has been on this path for several years now, so a certain market adjustment has already taken place. However, the phase of gradual transformation will continue to demand creativity from the sector for many years to come.
ACROSS: In Germany and the UK, in particular, department stores are a hot topic. What exactly is being done with those buildings?
Hofmann: With very few exceptions, traditional department stores will undergo a mixed-use conversion or a complete repurposing of the properties in the decades to come. Their urban integration is advantageous due to the fact that inner-city sites are scarce, rendering the land a valuable asset in itself. Many cities, project developers, and potential users show great interest in securing such prime sites at reasonable entry prices, with the aim of future redevelopment – into something that will shape the cityscape and can become a new landmark. Retail may still play a key role in the future concepts of many projects, but it will often become a complementary purpose. Wherever planning authorities insist that the use of such properties cannot be changed, a partial closure may be the unpleasant route to go down.
ACROSS: What do you think the future has in store for department stores in general?
Hofmann: In general, I don’t share the view that is widely held in the media that the only reason department stores are struggling is because rent levels are too high; they are probably also struggling because sales are so low. In their current form, they no longer reflect the preferences of the consumer. A nostalgic call for the format to be retained across the board doesn’t solve the task. Selective premium positioning of a very few properties, on the other hand, carries great potential.
ACROSS: Generally speaking, what is important to potential retail real estate investors in 2024?
Hofmann: The predominant factor is their expected return on investment. At present, the entry-level pricing looks very attractive. Yield compression in the next phase of the cycle is likely. Beyond that, it depends on what type of investor is investing. In terms of total return expectations, a risk-averse core investor requires lower returns than an added-value investor. Core investors are prepared to accept a moderate return level that is somewhat higher than their equity return on risk-free alternative investments. Added-value investors are prepared to buy into risks with open eyes and to mitigate these through active asset management. What is important to both types is clarifying whether the investment property will be a relevant retail destination for the future.
ACROSS: To what extent are the recent insolvencies in the shoe and fashion sector holding back investors?
Hofmann: That evolution has caused some uncertainty, which is why operational managers and specialist firms need to educate financial institutions on which segments and occupiers are deemed to remain viable in the long term. Ultimately, it’s all about the old adage: Get to know the tenant’s business model and, if in doubt, create new contract structures that can work over a long period of time.
ACROSS: Is the outlet mall sector further along in terms of landlord-tenant cooperation?
Hofmann: If, at the time of signing a new lease contract, a retailer is unsure how well its business will be accepted in the new catchment area to be developed, the outlet mall sector often grants its rental partners a period to grow to a sustainable rent level via a dynamic step rent or a higher turnover rent share. Such arrangements make sense and are increasingly being incorporated into the drafting of contracts for shopping centers. However, the different sub-sectors are only comparable to a limited extent and fulfill different functions. In terms of occupancy costs, outlets generate lower service charge burdens, as their open-air configuration means that there are almost no heating and cooling costs for common areas, for example, and the maintenance of elevators and escalators is eliminated due to the mostly single-storey village style. While that eases the burden on retailers’ P&L, it’s difficult to transfer.
ACROSS: What is one specific point that the shopping center industry can learn from outlets?
Hofmann: Among other things, considerably lower overall construction costs and, as a result, cheaper space remodeling costs: There is a whole range of designer outlet malls that look beautiful, offer great shopping experiences, but are nowhere near as complex and expensive to build. The entire customer journey at outlet malls is also often very well thought out.
ACROSS: What are the most important ways in which a shopping center owner can leverage the value of the real estate?
Hofmann: The overall conceptual quality and very disciplined implementation of the targeted positioning are paramount. Immediately after that, the focus must be on achieving the highest possible occupancy rate at economically viable rent levels and the continuous optimization of the tenant-mix created. The burden of operating and ancillary costs, including an associated ESG strategy, has also become increasingly relevant to property value. Last but not least, operational management quality must be considered.
Steffen Hofmann
Steffen Hofmann is Managing Partner at ambas.
