Reshaping of the real estate risk premium: the move towards segmentation of the real estate market
By Virginie Wallut, Director of Real Estate Research and Sustainable Investment at La Française Real Estate Managers
Despite the unprecedented shock caused by the health crisis, real estate is still as attractive as ever thanks to a high real estate risk premium, i.e., the difference between the rental yield on real estate assets upon their acquisition and the risk-free rate. With the sovereign bond rate close to zero in Europe, the European real estate risk premium stood at 316 bps (1) at the end of September, which is 68% higher than its long-term average which stands at 188 bps. European monetary policy should prolong the low levels of sovereign rates in 2021, and therefore maintain the attractiveness of real estate.
A new perception of the risks related to the holding of real estate assets is however emerging and it should lead to the reshaping of the risk premium in a way which is specific to each asset. Consequently, it will no longer be possible to talk of the real estate market as a whole. Significant divergences in trajectories are expected to appear between real estate asset classes and within each asset class.
Whereas up until 2019 the additional return on secondary assets diminished as the rates of return on core and secondary assets converged (Graph 1), the health crisis should bring a new hierarchy of rates in its wake, highlighting the polarization of the markets between core assets and secondary assets. At the end of the third quarter of 2020, the additional return offered by secondary assets remained at a low level of 50 bps compared to a long-term average of 145 bps.
(1) Q3 2020 data, PMA