Real estate in Europe continues to be impacted by economic factors such as inflationary pressures and interest rates that are expected to remain higher for longer, leading to rising costs of debt are influencing lender sentiment and contributing to a peak-to-trough fall in European values of roughly 20%. These factors have also impacted optimism for an improved second half of the year.
However, with interest rates expected to peak at the end of 2023, leading to a slowdown in the revaluation phase, it is expected that this may lead to optimism returning to the market in the near future with some investors already taking advantage of improved valuations. This may further improve as fixed-term loan re-financings occur, potentially leading to further declines of another 5-10% before the end of the year.
As we move into the weaker economic environment, the pressures in the real estate market will switch to focus on the quality of income and those asset types that are more closely linked to economic trends.
Offices
Office vacancy rates are rising quickly due to oversupply from hybrid working leading to weak sentiment from investors and lenders with more distressed situations occurring now. There is high demand for top-quality assets, particularly energy-efficient buildings, but the rest of the office sector is being left behind.
Logistics
The logistics sector is slowing down, in line with the economic environment; however, positive sentiment remains about the long-term demand drivers of online shopping and supply chain improvements.
Given the short-term impact of the weak economic background, rental growth is expected to slow from recent highs. But in the longer term, rental growth is expected to improve and attract investors back into logistics as the market improves.
Retail
The retail sector has struggled in recent years, but investment activity in retail has improved in 2023 with retail parks providing a preference for investors and meeting the needs of flexible workers. However, the shorter-term outlook remains subdued due to low levels of consumer confidence, but it is expected to be somewhat offset by the slowdown that already occurred in this sector prior to the pandemic, which should help to limit valuation compression compared to logistics and office properties.
Living
Rental growth in the residential market has remained strong during the pandemic and the current downturn, with rents increasing by around 8% in 2022 with likely growth at 4% over the next three years.
Some European countries have introduced regulations to limit rent increases which, when combined with higher borrowing costs, may impact valuations, but to a lesser extent than other sectors. It remains to be seen how the limited supply of residential properties will offset this effect.
Outlook for the next year
Further falls in property values of around 5% are expected through the middle of 2024; however, risks remain due to the continuing economic weakness and debt refinancing challenges. A recovery at some point in the latter half of 2024 seems more likely, followed by single-digit returns for the subsequent three to five years.
Additionally, as mentioned above, top-quality assets—particularly energy-efficient (green) buildings using sustainable materials and drawing upon renewable energy sources leading to reduced waste and emissions—are rapidly becoming the norm across all sectors, and their use is increasing worldwide. However, willingness to pay more for green buildings is dependent on awareness of the benefits, which currently is not broad-based across all stakeholders.
Given these trends, investment opportunities in European real estate should start to become apparent in the next year.
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References:
- JLL Global real estate perspective, August 2023
- Aberdeen European real estate market outlook Q3 2003
- Market Research Future May 2023
