By Virginie Wallut, Director of Real Estate Analytics and Sustainable Investments at La Française Real Estate Managers
European real estate markets have adapted to the new financial environment in recent quarters, but some segments appear to have found a new balance that sets them up for a short-term recovery in investment volumes and medium-term valuations. . All real estate sectors have been affected by rising interest rates and funding costs, but some have adapted faster than others. Although overall real estate activity continues to decline, it has stabilized or even recovered in some regions. Similarly, while yields continue to rise in most markets, there appears to be agreement in several other markets, such as German logistics and UK retail. France has traditionally lagged behind other markets and continues to show signs of transformation.
Investment amount: Early signs of recovery?
Earlier this year, investors and lenders took a wait-and-see attitude, resulting in a sharp decline in investment volumes in the first three quarters. The decline was particularly pronounced in the large trading sector, due to increased reliance on financing. Over the past 12 months, European investments have been on the decline, with an average decrease of 55%. The UK was at -50%, France at -52% and Germany at -60%. As of the end of September, offices accounted for 30% of investment in 2023, up from 51% in 2019. The proportion of diversified assets continued to increase and reached 24% by the end of September 2023. With some exceptions, investment volumes have rebounded, particularly in Germany and the Netherlands, increasing by around 30% during the quarter. The French market lags behind its neighbors in the price adjustment phase and faces competition from other European countries, which are beginning to present interesting opportunities.
Prime office yields follow rising interest rates
Real estate yields continue to rise across Europe after the European Central Bank’s 10th consecutive interest rate hike. Additionally, many European countries have high debt costs, resulting in negative leverage. Prime office yields rose 10-50 basis points last quarter, with year-on-year increases of 35-170 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 rose by an average of 7 basis points during the quarter, suggesting an attractive entry point for the asset class with strong rental fundamentals. Yield increases vary within the same market depending on asset quality and location. Investors typically expect an additional risk his premium of more than 150 basis points for assets located in the surrounding area. This trend is the same for “obsolete” assets, both in terms of durability and functionality.
Increased supply that is difficult to control
Similar to what happened in Germany during the economic downturn, cost reduction is a major concern for companies. Employment in Europe’s major office markets fell 21% year-on-year, primarily due to less leased space. However, in some markets, such as Paris, Lyon and Amsterdam, demand stabilized or even increased in the third quarter. Businesses primarily seek high-quality assets that offer small spaces with good accessibility.
In Europe, office supply increased by 4% during the quarter, for a year-on-year increase of 14%. Some markets stand out, including Brussels, Amsterdam and Milan, where supply fell in the third quarter. Polarization of the rental market with the emergence of the medium term The rental polarization of the market is evolving with the emergence of a third segment. So far, the rental market includes:
- Prime central assets are increasingly in short supply, putting upward pressure on rents. Prime rents rose in the third quarter across Europe, excluding the UK.
- Abundant and ever-increasing supply of secondary assets in surrounding areas reduces rental values. As the economic environment darkens, a middle segment is emerging. It is a prime, environmentally friendly asset available at competitive rental levels due to its peripheral location. Rising occupancy rates across Europe highlight the issue of insufficient supply, both in terms of location and quality. While supply continues to increase in the periphery, supply in the center is decreasing. Vacancy rates in the central business districts of Paris and Munich are 2.1% and 0.6%, respectively, while vacancy rates in the surrounding areas are closer to 20%. Two opposing trends determine future supply. A large amount of vacancies will occur over the next 24 months, leading to an increase in the supply of used properties while new construction will plummet. For example, in the Paris metropolitan area, for every square meter of quality supply land, there are 2.5 square meters of dilapidated space.