European real estate market commentary: January 2025
Despite economic sentiment deteriorating in the closing months of 2024, real estate occupier markets remain robust and pricing is stabilising with first signs of selective yield compression, supporting our view of a cyclical buying opportunity in key markets and segments.
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Economic backdrop
Economic growth in the eurozone remains sluggish and, whilst GDP growth modestly improved from 0.2% in Q2 2024 to 0.4% in Q3 2024, the composite PMI fell below 50 in November and December, indicating contraction. The manufacturing sector, particularly in France, Germany and Italy, remains depressed. In contrast, the service sector displayed more robust activity, but this was insufficient to offset the manufacturing downturn.
Consequently, household spending became the primary growth driver, increasing by 0.7% compared in Q3 2024 compared to the prior quarter, its fastest quarterly rate in over two years. This was bolstered by a resilient labour market, where wage growth has likely peaked but continues to exceed inflation. Additionally, consumers benefited from improved credit conditions.
With elevated uncertainty over global trade, as well as political uncertainty in Germany and France, investment and export growth are likely to remain muted in the coming months. In addition, fiscal policy is becoming moderately restrictive due to the reinstatement of EU fiscal rules this year. Reflecting this and in-line with the downgrades to the growth outlook for Germany and France, the December Consensus forecast for 2025 Eurozone growth was downgraded to 1.0% in 2025 from 1.2% in October.
Monetary policy is likely to provide some growth support through continued easing. Eurozone headline inflation (HICP) rose from a temporary low of 1.8% in September to 2.4% in December. Despite this, the ECB instituted a 25-basis-point reduction, lowering the deposit rate to 3%. The further weakening demand outlook has prompted market expectations for additional rate cuts in due course.
Markets are now anticipating another 25bps cut in both January and March, with a probable stabilisation of rates in the second half of 2025, projecting the deposit rate to settle between 2% and 2.25%. However, uncertainty remains regarding the path of inflation, scope for future rate cuts and government borrowing, as evidenced by the increase in 10-year German government bond yields from just above 2% in early December to over 2.5% in mid-January.
European real estate market
Despite muted economic conditions, occupier markets remain on a solid footing. However, office demand was affected by further declines in business sentiment and cautiousness regarding the near-term growth outlook, resulting in year-end take-up remaining below long-term averages on aggregate. Yet, tight supply conditions, particularly for modern space, continue to support rental levels, with further prime rental growth recorded in Paris, Stockholm, select German centres, the UK and Southern Europe over Q4 2024.
Indeed, over the past 12 months almost all major European office markets have seen further prime rental growth. Competitive tension for scarce high-quality stock in accessible locations remains, reflecting the ongoing polarisation of office demand, which will be a permanent feature of the market for the foreseeable future.
Whilst aggregate market vacancy rates have generally increased over the past 12-18 months across the region, vacancy rates for Grade A space remain significantly lower and overall vacancy is increasingly consisting of lower quality or even obsolete stock. Supply pipelines are forecast to drop significantly from this year onwards, with net-additions declining from 1% of stock over the past three years to approximately 0.6-0.7% this year and beyond.
This supply constraint is due to the lack of projects that commenced during the pandemic, as well as the impact of elevated finance and construction costs. Although finance costs are decreasing, current forecasts do not indicate a strong resurgence in office construction. Moreover, any increase in development activity would only impact supply levels over the medium term due to the length of the planning, approval and construction processes.
Prime industrial and logistics rents were largely unchanged over the quarter, with only select markets showing growth, often attributable to a new generation of assets entering the market and setting new benchmark rents. We project rental growth in the sector to be c.3% p.a. through 2025 and 2026, given that demand remains well supported by the structural growth in ecommerce, supply chain reorganisation and firms seeking inventory to improve supply chain resilience.
At the same time, occupiers are increasingly focusing on modern supply, with a small yet growing issue around aging stock in certain markets and a growing focus on features such as renewable power provision and amenities for employees. On the supply side, speculative development has increased, but higher development costs and restrictive planning environments continue to constrain pipelines and maintain prevailing low vacancy levels.
Despite the normalising inflation, further wage growth and robust household spending, conditions in the retail sector are expected to remain challenging. Eurozone consumer sentiment deteriorated over Q4 2024 and consumers are more cautious. This, together with the competition from online retail, will mean ongoing pressure on store sales that will, in turn, maintain elevated vacancy rates. Furthermore, retailers face pressure on margins through higher staff costs.
Despite these considerations, rental levels for many retail formats have likely troughed and, consequently, we are becoming less cautious over prospects, albeit remaining highly selective with regards to segments. We expect retail parks with a low exposure to fashion, as well as convenience formats including supermarkets, to be able to provide resilient inflation-linked cashflows.
Turning to capital markets, investor surveys have recorded further increases in sentiment in the last three months, with e.g. the December INREV Consensus indicators showing investors’ assessment for investment liquidity and financing conditions improving further, while maintaining a positive assessment of leasing market conditions.
This sentiment seems to be filtering through into renewed investment activity, with preliminary numbers from MSCI RCA showing c.€45bn was traded in Europe in Q4 2024, an increase of c.20% on Q3 2024, though it should be noted that the absolute volume remains low. Renewed liquidity does, however, create more certainty over pricing, and we expect bid-ask spreads to narrow further and market liquidity to continue to improve over the year, with an increased number of repriced opportunities coming to the market and activity supported by decreasing finance costs.
Delving further into pricing, the unweighted average from CBRE’s Monthly Yield Monitor, covering the 13 largest European countries (including the UK, but excluding CEE), remained largely stable across all major sectors in Q2 2024 and Q3 2024. However, instances of yield compression began to emerge in Q4 2024, ranging from 5 to 25 bps.
These movements were observed in select logistics, prime offices, retail warehouses, and "living" sectors such as multifamily and student housing. Improvements were also evidenced by Green Street’s European transaction price data, which increased by 1.8% in 2024, albeit this path stalled in Q4 2024 with only 0.2% growth recorded for the quarter. Valuations are now catching up with market pricing, albeit this dynamic is uneven with markets such as the UK, Netherlands and Nordic region showing the most expedient rebasing and DACH markets lagging.
Investment outlook
Owing to the extent of the repricing observed since the spring of 2022, our proprietary market valuation framework is signalling that immediate opportunities can be found across multiple markets and sectors. Several property types, notably the industrial and logistics segments, have rebased to attractive price points, and are supported by strong structural fundamentals. Investors should also be cognisant that history points to the periods following economic downturns as delivering above average performance.
Regarding our current asset views, our preferred sectors and portfolio positioning have remained largely unchanged over the past three months. This reflects both that our expectations for income growth already reflect a challenging environment, and that market repricing is progressing as anticipated, especially in terms of sector ordering.
We continue to favour industrial estates (including outdoor storage facilities), cross-dock warehouses, and urban logistics assets that are benefitting from ecommerce and urbanisation trends. Opportunities are appearing to capitalise on significant repricing through acquisitions, refurbishments and/or development on rebased land values. There remains an opportunity to capture mispriced reversionary potential in the region, as existing leases expire and roll to higher revised rental levels.
The prevailing – and in many cases exacerbating – lack of supply of residential space across major Western European markets, coupled with continuing urbanisation trends, are creating opportunities across “living” segments that provide long-term resilient cashflows. We have a particular focus on undersupplied affordable and mid-market rental housing segments. Careful consideration needs to be given to local regulations that are shifting to further protect residential tenants from rent increases. We also see opportunities in selective senior and student housing markets in major university locations across the region.
Elsewhere, we see continued opportunities in selective parts of the hotel market, with a preference for leased hotels in main destination locations that provide inflation-linked base rents and variable components capturing operating profit, or operating hotels where the repositioning, restructuring of operations and/or completion of stabilisation activities can drive value creation.
The polarisation in demand and performance in the office sector between “best in class” and “the rest” is expected to persist. Modern assets with good amenity provision in major metropolitan central business districts (CBDs) should continue to perform, and prime assets are potentially offering value. Given the emerging lack of modern space, we also see an opportunity to upgrade and refurbish well-located workspaces in supply constrained major capital and regional CBDs, capitalising on a growing supply shortfall.
Given the cyclical opportunity we see, our view is that investors should now actively seek to capitalise upon opportunities as they emerge throughout the course of 2025. Performance will be asynchronous across geographies and markets – and across asset types within markets. But we anticipate this year to be a particularly strong investment vintage for deployment with the potential to deliver outsized prospective returns over the medium-term.
Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. The forecasts should be regarded as illustrative of trends. Actual figures will differ from forecasts.
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