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European Real Estate: To Build or Not to Build?

August 2021 - 5 min read

Higher build costs and longer construction periods pose a potential headwind for profits. But in select markets, developers have the ability to charge a premium rent and potentially exceed required returns.

European Economy Primed for Recovery… But Inflation is a Headwind

With vaccinations reducing hospitalization rates, lockdown restrictions are easing and Europe’s economies are re-opening. High-frequency survey data is robust for both services and manufacturing sectors, indicating a broad-based recovery. In the immediate term, the pace of vaccinations—in particular, second doses—and new cases versus hospitalizations will be key to assessing the immediate risks around the recovery.

However, the specter of inflation has returned, as global shortages of key inputs and resource constraints boost pricing pressures. In our view, this inflationary bout is not reflective of an overheating economy reaching maximum velocity, but one that is awakening early by surprise. Accordingly, Eurozone inflation could potentially rise to 2.5%–3% per annum in the second half of 2021, before falling back in 2022.1 In early July, the European Central Bank (ECB) announced a new symmetric 2% inflation target, to maintain price stability and provide policymakers with the flexibility to keep interest rates lower for longer.

What Does Inflation Mean for Property Development Projects?

Property, while not a true inflation hedge, does provide cash flows with index-linked attributes, therefore offering a degree of inflation protection. In fact, inflation in small doses can even be beneficial for property markets, as it can stoke investor demand for the asset class. If in excess, however, inflation can be harmful to property market prospects, especially if it leads to interest rate hikes and negatively affects development appraisals through higher development costs.
 

1. Source: Oxford Economics. As of July 12, 2021.

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