European real estate market commentary: November 2024
An increasing number of repriced opportunities are now coming to market, supported by an imbalance of supply versus demand and strong operating fundamentals.
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Economic backdrop
Economic growth in the eurozone remains muted with second quarter growth slowing to 0.2%, reflecting ongoing weakness in both the French and German economies. Conditions in the manufacturing and industrial sectors remain challenging, which is dragging down growth, while decreasing household consumption in Q2 was also a detractor despite easing inflation, ongoing strength in the labour market and positive wage growth.
Headline eurozone inflation (HICP) fell below the European Central Bank’s (“ECB”) 2% target rate for the first time in three years, to 1.8% in September. Consumers and businesses remain cautious, with uncertainties surrounding national governments and geopolitical risks persisting. Fiscal policy is also likely to turn moderately restrictive given the re-imposition of EU fiscal rules in 2025 and 2026. The October Consensus Eurozone GDP forecast for the current year was unchanged at 0.7%, but 2025 was downgraded to 1.2% from 1.3% in September.
Easing inflation has enabled the ECB to further reduce policy rates, with 25 bps cuts in both September and October resulting in a 3.25% deposit rate. Further improvements to both core and headline inflation, along with the softening in the demand outlook, has fuelled market expectations for faster than previously envisaged rate cuts. The prospects of further easing and growing confidence that inflation has returned to target levels have filtered through to bond yields, with the German 10-year government bond yield decreasing from levels of c.2.5% in June to 2.2-2.3% during October.
European real estate market
Despite muted economic conditions occupier markets remain on a solid footing, with tight supply conditions, particularly for modern space, continuing to support rental levels. Office demand has stabilised at low levels, with recorded absorption for Q1-Q3 2024 broadly in line with take up over the same period last year. Competition tension for scarce high-quality stock in accessible locations remains, reflecting the ongoing polarisation of office demand.
By way of illustration, rents in the Paris central business district (CBD) submarket have increased by more than 8% over the past 12 months, while equivalent top rents in the more affordable La Défense market have fallen by over 5%. Meanwhile, 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 with, for example, the overall market vacancy rate in the Brussels office market at above 8%, compared to below 2% for Grade A space.
Supply pipelines are forecast to drop significantly in 2025, with net additions as a percentage of stock declining from levels of around 1% in the last three years to around 0.6-0.7% for 2025 and beyond. This reflects both the lack of projects that commenced during the pandemic, and the impact of both elevated finance and construction costs.
Prime industrial and logistics rents were largely unchanged over the quarter, with only select markets seeing growth that is often attributable to a new generation of assets entering the market and setting new benchmark prime 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 low vacancy levels. Market vacancy rates have, however, seen slight increases through 2024 to date, with for example the industrial and logistics vacancy rate rising from 3.5% to around 4.3% in France, and from 2.1% to 3.3% in the Netherlands.
Conditions in the retail sector are expected to remain challenging in the coming months. Despite the normalisation in inflation and further wage growth, consumers remain cautious and sentiment amongst both consumers and retailers remains in negative territory. This, together with the ongoing growth of online retail, will mean further pressure on store sales, and elevated vacancy rates are likely to be maintained. With rents for many retail formats having likely bottomed out we are becoming less cautious over prospects for the sector, but we expect retail parks with a low exposure to fashion and convenience formats including supermarkets, in locations with high footfall and with large and growing catchment areas, to trade notably better.
Investor sentiment surveys have recorded notable increases over the summer and, with uncertainty over pricing declining, we expect investment activity to improve from Q4 2024 onwards. The latest INREV Consensus indicators, for example, show investor’s assessment for liquidity and financing conditions turning from fairly negative at the start of the year back into positive territory in September.
The notable bid-ask spread that has prevailed in recent quarters is expected to close, with an increased number of repriced opportunities coming to the market. The unweighted average of CBRE’s Monthly Yield Monitor for the 13 largest European countries (incl. UK ex. CEE) has now been virtually unchanged for all major sectors over the last six months, suggesting a floor in transaction pricing is emerging. Valuations have increasingly caught 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 activity in Q3 2024 remained subdued, with preliminary numbers from MSCI RCA showing c.€37bn traded in Europe. While we expect this figure to be adjusted upwards in the coming weeks, volumes will still be significantly below the historic levels recorded in the run up to 2022.
Investment outlook
Owing to the extent of the repricing observed to date, our proprietary market valuation framework is signalling that immediate opportunities can already be found across multiple markets and sectors. Several property types, notably the industrial and logistics segments, have now rebased to attractive price points, and are supported by strong structural fundamentals.
Upcoming refinancings will likely drive asset disposals, as will other liquidity dynamics such as anticipated sales from corporate defined-benefit pension schemes in the UK as they continue to de-risk. Investors should be cognisant that history points to the periods following economic downturns and associated price corrections delivering above average performance.
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 also 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 cash flows. 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.
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 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.
We are still cautious about the retail sector but have conviction that convenience and grocery-anchored formats providing inflation-linked cash flows will continue to be most resilient. We also see opportunities in selective parts of the hotel market, with a preference for leased hotels in the main destination locations providing inflation-linked base rents, as well as variable components capturing operating profit or operating hotels where the repositioning, restructuring of operations and/or completion of stabilisation activities can drive value creation.
Given the extent of the revaluations experienced, our view is that investors should position themselves on the front foot. Priority should be given to opportunities as markets rebase across geographies, sectors, and investment structures, seeking to capitalise on opportunities as they emerge through the remainder of this year and into 2025, which we anticipate being a particularly strong investment vintage for deployment.
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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