Last year was another challenging year for both real estate markets and the wider economy. Russia’s invasion of Ukraine led to a huge rise in energy prices and a surge in inflation. With no end in sight for the conflict, the outlook for 2023 is fragile, which is reflected in low consumer and business confidence, despite government aid for both consumers and the SME sector. Unemployment has remained low, but rising staff shortages in a growing number of sectors is putting a lot of pressure on economic growth. And while wages have risen quite sharply, they have not been able to keep pace with burgeoning inflation. The increase in construction costs, fuelled by staff shortages and related wage increases plus rising material costs, is also putting pressure on new-build projects, with some being postponed or even cancelled. At the same time, rising energy prices and government regulations related to the energy efficiency of office building is increasing the demand for sustainable offices close to public transport hubs.

Investment market

The Dutch government’s proposed regulatory changes and the increase in the real estate transfer tax create impact on the real estate investment market. Investment managers are also dealing with a stream of new (EU) sustainability regulations, including the SFDR and the EU taxonomy. On top of this, the sharp rise in interest rates has had a major impact on the investment market. Despite this and the above-mentioned inflationary pressures and rising construction costs, there is still a lot of interest in the office real estate market, although rising interest rates and economic uncertainty has led to a widening of yields, something set to continue in 2023.

All of this led to a decline in the valuations of office assets from the third quarter onwards last year, driven by high interest rates and historically low yields, although investors are still very much interested in prime offices in good multifunctional locations. The Office Fund expects to see the gap between prime and secondary office location to widen as we move forward. The sharp decline in stocks and bonds also triggered the so-called denominator effect, leaving investors (temporarily) overallocated to real estate and forcing some to trim their holdings. However, long-term investors, including Bouwinvest, are already looking beyond the current difficult market circumstances and see the potential for healthy long-term returns. Our confidence in this market and the confidence of our clients is reflected in our acquisition of De Zeven Provinciën in The Hague in December.

Responding to uncertainties

Of course, this uncertainty has also had an impact on the demands of our clients. As long-term investors, they are focused on stability and predictability. They are also more engaged with the world than ever before and have set targets in terms of environmental performance, environmental risk, social impact and solid governance. The Fund’s challenge is to continue to meet these demands in even these uncertain market conditions. With this mind, the Fund also converted to a fund for mutual account (FGR in Dutch) as of 1 January 2023, a full two years ahead of the abolition of the FII regime for direct real estate investments.

Bouwinvest has responded to the demands of our clients and regulators by refining our strategy and strengthening our risk management, compliance, financial and ESG reporting capabilities, while also investing in sustainability measures that will help make our portfolio fit for the future. We are a long-term investor and as we have proven in the past, this long-term view will enable us to continue to create real value for life in even the most challenging of markets.

The Fund’s strategy

The Fund’s fundamental strategy was unchanged and we continued to focus on our main strategic pillars of sustainability, the G4 cities and multi-tenant assets. Despite the above developments, the Fund performed relatively well in 2022. The above mentioned market circumstances affected the total fund return, which came in at -3.2% and was 7.6% below plan and 6.1% below forecast. However the Fund increased its occupancy rate and secured a number of new leases and lease extensions. The Fund and its tenants continued to invest in upgrading and updating assets, including sustainability measures. The Fund retained its 5-star GRESB rating and worked hard on our Paris proof roadmaps and now have more detailed road maps for all the assets we plan to retain. All of these assets now have a minimum of a BREEAM Very Good rating, except for the intended sales. The Fund also acquired De Zeven Provinciën in The Hague and worked on the disposal of two assets in Amsterdam to optimise its portfolio.

Market outlook

Given the level of uncertainty in the market, it is difficult to predict what will happen in the office sector in the near term. However, we do expect there to be opportunities, as we saw last year. Less committed amongst other driven by the denominator effect, less long-term investors or investors that rely on substantial leverage may partially withdraw from the market and we could well see high-quality assets coming to the market at discounted prices. Provided we have the funding, we will seize those opportunities to optimise the Fund’s portfolio.

All that remains is for me to thank our clients for their continued trust in us and our strategy. And of course I would like to thank our team for their hard work, professionalism and collaborative efforts. It is thanks to them that we emerged as strongly as we did from another dynamic year.

Bas Jochims
Director Dutch Office & Hotel Investments