Europe Real Estate

Introduction

With interest rate cuts on the horizon, we're witnessing a rekindling of market dynamics potentially sparking a revival in transaction activities in some of the major European markets.

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2024 so far has been a year of both challenges and opportunities in most markets. The industrial sector continues to shine as a prized asset class, with low vacancy rates driving up prime rents. Meanwhile, the office market is seeing renewed interest in value-add prospects, though with some nuances in rent trajectories.

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On the residential front, affordability concerns are reshaping demand patterns, with a noticeable shift in focus towards the rental market. This evolving scenario is creating intriguing possibilities for investors attuned to market shifts.

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In this edition of our newsletter, we'll delve into these trends, exploring how macroeconomic conditions are influencing Europe's real estate ecosystem. We'll examine the factors driving investment decisions, analyze emerging opportunities, and provide insights to help you navigate this dynamic market.

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Economic Snapshot: Recovery Taking Hold

The euro area and the UK have emerged from their recent economic slump, with Q1 2024 showing positive GDP growth. This marks the end of the recession that plagued both economies in the latter half of 2023, signalling a turn towards recovery. While we consider the euro area as a singular homogeneous region, it is important to acknowledge the country-level differences.

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The European Central Bank and the Bank of England are expected to implement additional rate cuts. The ECB led with a 75 bp reduction in June, followed by the BoE with a 50 bp cut in August. These moves are anticipated to catalyze a series of positive developments in the real estate sector, including lower debt costs, lower yields, and potential price growth.

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Economic forecasts paint a picture of modest but steady growth. The euro area is expected to grow by 0.6% in 2024, while the UK economy is projected to expand by 0.3%. Inflation has largely remained within the target range. However, if pressures persist, the rate cuts may be slower than expected.

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Real Estate Outlook

Commercial

There is a clear trifurcation emerging between prime, secondary, and tertiary assets. Investor appetite for traditional office spaces is waning, with a growing focus on assets ripe for repurposing or repositioning in major European cities.

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There is a marked preference for amenity-rich buildings with strong ESG credentials in prime locations. Gradual interest rate cuts are anticipated to increase confidence in the office sector. Despite falling behind APAC, return-to-office mandates will likely increase further boosting demand.

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Upward pressure on rents in core CBD markets across the UK, France, Germany, and Benelux is likely to continue, but at a more moderate pace due to reduced inflationary pressures and redevelopment costs and growing Grade A supply.

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The retail sector is showing signs of a steady recovery. With inflation normalizing, disposable incomes are expected to stabilize, though the impact of recent high inflation will still be felt in 2024. Euro area retail sales volumes rose by  0.7% y-o-y in March, the first positive annual growth since September 2022. Looking ahead, sales volumes are forecasted to grow by 1.3% in 2025.

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Investor interest is increasing in retail parks for their stability and in high-quality shopping centers, especially those with mixed-use potential. Retail leasing activity is also gaining momentum as retailers compete for prime spots. However, declining vacancy rates in top locations are expected to push rents up, with rental growth across prime high streets in Europe projected to average 2% annually over the next three years.

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Residential

Population growth, aging, urbanization, and increased student mobility are shaping long-term demand in Europe's residential markets. However, home affordability has markedly declined over the past decade, leading to decreased homeownership rates and boosting demand for private rentals and affordable housing.

Housing demand in Europe is strong and is expected to remain robust due to population growth, student mobility, urbanization, and an aging population. However, due to declining housing affordability over the past decade, homeownership rates have fallen and given rise to new demand in the form of rentals, affordable housing, and BTR.

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Yield expansion in the European rental market slowed down in Q1'24 suggesting a trough in prime residential prices. Investors remain optimistic despite a 39% y-o-y fall in transaction volumes. Over 20% of real estate portfolios are currently allocated to residential and 80% plan to increase exposure within the next 5 years. Social/affordable housing and senior/co-living segments are gaining traction and are expected to mature in the medium term.

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Key challenges include high construction costs and the need to balance tenant protection with investor interests.

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Logistics and Industrial

The industrial sector is emerging as the most coveted asset class for investors. Take-up fell by 21% y-o-y in Q1'24, however, take-up levels are approaching pre-pandemic levels. Low vacancy rates are expected to be sustained throughout the year due to a softening under-construction pipeline which will increase upward pressure on prime rents. Gradually lowering interest rates will also put upward pressure on prices. As a result, investment activity is expected to increase following a rise in volumes in Q1'24.

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Hotels

In Q1 2024, the hotel sector was the only real estate segment in Europe to see a rise in transaction activity, up 20% y-o-y, driven by growth in the UK and Southern Europe. Transaction volumes are expected to exceed 2023 levels, aided by lower debt costs and stabilizing yields. RevPAR increased by 6% in Q1, boosted by recovery in CEE and continued growth in Southern Europe. Occupancy rates for summer months are projected to surpass both 2023 and 2019 levels, though rising labor costs are squeezing margins.

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High construction and financing costs are limiting hotel development, with few markets like Dublin, Frankfurt, and Vienna being exceptions. Office-to-hotel conversions are gaining traction but remain relatively limited. As disposable incomes rise, demand for travel is expected to grow, with projections indicating international visitor arrivals to Europe will exceed pre-pandemic levels by 2024 and grow by another 10% in 2025.

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Alternatives

The aging population in Europe is fueling demand in the life sciences sector, leading to growth in healthcare services. Increased funding, R&D spending, and favorable tax incentives are positioning the life sciences industry for substantial expansion.

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Interest in data centers continues to grow, driven by AI, rising data traffic, increased digitization, widespread 5G adoption, and greater use of cloud services. EMEA operational IT data center capacity rose by 10% from H1 2023. However, challenges such as limited power availability and developable land are constraining growth in mature markets, pushing investors to consider secondary markets like Oslo, Milan, Berlin, and Madrid.

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With an improving macroeconomic environment, capital is expected to flow into alternative sectors such as life sciences and data centers, which are demonstrating strong fundamentals.

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Conclusion

The current trajectory of Europe’s real estate market reflects a period of recalibration and strategic pivoting, driven by shifting economic signals and evolving investor priorities.

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With rate cuts on the horizon, there is a window of opportunity for investors to re-enter markets with strong fundamentals, particularly in sectors like industrial and alternative assets that offer resilience and growth potential.

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However, the complexities of affordability, ESG requirements, and structural changes in demand necessitate a more nuanced approach. Investors who can navigate these dynamics, leveraging local insights and adopting flexible strategies, will be best positioned to capitalize on this transitional phase, balancing risk with the promise of sustainable returns.

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