Commercial Real Estate Market in Europe: Early Signs of an Imminent Rebound?
22 DEC, 2023
By Virginie Wallut
by Virginie Wallut, Director of Real Estate Analysis and Sustainable Investment at La Française Real Estate Managers
While European real estate markets have been adapting to the new financial environment for several quarters, it appears that some segments have found a new balance that could set the stage for a short-term rebound in investment volumes and medium-term valuations. All real estate sectors are affected by rising interest rates and financing costs, but some are adapting more quickly than others. While overall real estate activity continues to decline, it is stabilizing or even rebounding in some areas. Similarly, although yields continue to rise in most markets, a consensus seems to have been reached in several others, such as logistics in Germany and retail in the United Kingdom. France, traditionally lagging behind other markets, continues to show signs of transition.
Investment Volumes: Early Signs of Recovery?
At the beginning of the year, investors and lenders adopted a wait-and-see attitude, resulting in a sharp decline in investment volumes during the first three quarters. The decline was particularly pronounced in the large transactions segment, as reliance on financing increased. Over the past twelve months, European investment volumes have followed a downward trend, with an average decrease of 55%: -50% for the United Kingdom, -52% for France, and -60% for Germany. By the end of September, offices accounted for 30% of investment volumes in 2023, compared to 51% in 2019. The proportion of diversification assets has continued to increase, reaching 24% by the end of September 2023. There are some exceptions, especially in Germany and the Netherlands, where investment volumes are rebounding, with an increase of around 30% during the quarter. The French market, slower than its neighbors in the price adjustment phase, faces competition from other European countries that are beginning to present interesting opportunities.
Prime Office Yields Follow the Rise in Interest Rates
After the tenth consecutive interest rate hike by the European Central Bank, real estate yields continue to increase across Europe. Moreover, in many European countries, the high cost of debt results in negative leverage. Prime office yields increased by 10 to 50 basis points in the last quarter, bringing the year-on-year increase to between 35 and 170 basis points (Dublin 35 basis points, London 50 basis points, Paris 75 basis points, Brussels 75 basis points, Munich 150 basis points). In the logistics sector, prime yields increased by an average of 7 basis points during the quarter, suggesting an attractive entry point for an asset class with strong rental fundamentals. The increase in yields varies within the same market depending on the quality and location of assets. Investors typically expect an additional risk premium of over 150 basis points for assets located in peripheral areas. The trend is the same for "obsolete" assets, both in terms of durability and functionality.
Difficult-to-Control Increase in Supply
Similar to what has happened in Germany amid economic slowdown, cost reduction is a key concern for companies. Hiring in major European office markets fell by 21% year-on-year, primarily due to a reduction in leased space. However, in some markets, such as Paris, Lyon, and Amsterdam, demand stabilized or even increased in the third quarter. Companies are primarily seeking quality assets that offer smaller spaces with good accessibility.
In Europe, office supply increased by 4% during the quarter, bringing the year-on-year increase to 14%. Some markets stand out, such as Brussels, Amsterdam, and Milan, where supply decreased in the third quarter. Polarization of rental markets with the emergence of a middle term Market rental polarization is evolving alongside the emergence of a third segment. So far, the rental market included:
- Prime assets in central locations, where supply is increasingly scarce, putting upward pressure on rents. Throughout Europe, except in the United Kingdom, prime rents rose in the third quarter.
- Secondary assets in peripheral locations, where abundant supply continues to increase, lowering rental values. As the economic environment darkens, an intermediate segment is emerging: prime and ecological assets that are available at competitive rental levels due to their peripheral location. The increase in availability rates across Europe highlights an issue of inadequate supply, both in terms of location and quality. Supply continues to increase in peripheral locations but decreases in central areas. Central business districts in Paris and Munich have vacancy rates of 2.1% and 0.6%, respectively, while peripheral locations have vacancy rates close to 20%. Two opposing trends will determine future supply. The high volume of vacancies in the next 24 months will increase the supply of second-hand assets, while new construction is plummeting. In the Greater Paris region, for example, for every square meter of high-quality supply, there are 2.5 square meters of obsolete space.
