Key Highlights
- European real estate investment trusts (REITs) activity indicates a positive outlook for direct real estate.
- Lower interest rates are expected to enhance core pricing first, with reduced debt costs boosting return potential.
- We forecast all-property total returns of 7.3% over the year, with three- and five-year annualised total returns of 9.3% and 8.7%, respectively.
European economic outlook
Activity
Eurozone Q2 GDP was revised down from 0.3% to 0.2%, and there’s been a further loss of momentum since. The September composite PMI was just 49.6, back into contractionary territory. European growth prospects look increasingly divergent – France and Germany appear to be stagnating, while most Southern Europe is growing solidly. With strong real wage growth and the European Central Bank (ECB) easing, we think the economy will avoid recession.
Inflation
Helpful base effects and lower commodity prices drove Eurozone headline inflation down to 1.8% in September, below the ECB’s target. Admittedly, progress in reducing underlying inflation pressures still looks bumpy and slow. Headline inflation is likely to fluctuate around the 2% target over 2025. Over the near term, base effects will drive the headline rate back above target by the end of the year.
Policy
The ECB lowered its deposit rate by 25 basis points (bps) to 3.5% in September, and we expect it to cut again in October. We think the ECB deliver a series of cuts through Q1 2025, seeking to normalise policy in response to weak growth and price data. The pace of easing should then slow as the ECB seeks to gauge the neutral interest rate.
Key takeaway
European growth has softened. However, a resilient US economy and stimulus in China, combined with policy easing, support the ongoing real estate recovery in Europe.
Additional risks have emerged from the conflict in the Middle East and we’re monitoring inflation and interest-rate expectations. The five-year Euribor swap rate increased by 30bps from 2.1% to 2.4% after geopolitical tensions escalated in early October. Nonetheless, the market is not currently pricing in a reversal in inflation trends and the swap rate has dipped back below 2.4%.
Eurozone economic forecasts
| (%) | 2022 | 2023 | 2024 | 2025 | 2026 |
|---|---|---|---|---|---|
| GDP | 3.5 | 0.5 | 0.7 | 1.1 | 1.4 |
| CPI | 8.4 | 5.4 | 2.3 | 2.0 | 1.9 |
| Deposit rate | 2.00 | 4.00 | 3.00 | 2.00 | 2.00 |
Source: abrdn October 2024
Forecasts are a guide only and actual outcomes could be significantly different.
European real estate market overview
In June 2024, our abrdn multi-asset Investments Houseview upgraded global listed real estate to overweight. In September, global direct real estate received the same upgrade. This marks the first overweight rating for this asset class since June 2022, indicating a recovery phase in its typical five-to-seven-year cycle. Despite the market cooling in October, our June call was well-timed, with Eurozone REITs rising 10.2% in Q3, while the Euro Stoxx 600 Index remained flat.
We anticipate direct real estate performance will improve in the next quarters, with evidence already emerging. INREV reported a 1.2% return for European assets in Q2 2024, driven by capital growth – the highest in seven quarters. The Netherlands, Spain, and Italy excelled, while Ireland, Germany, and the Nordics underperformed.
For European real estate, we have a high conviction on the turning point for three reasons.
- Interest rates are now fundamentally lower, and debt costs have dropped sharply in recent months. This means leveraged investors are back and refinancing challenges have eased.
- Fixed income yields are also materially lower, supporting the relative appeal of real estate cash flows. The spread of European real estate yields and German bond yields has increased to 2.9%.
- Rents are rising in good-quality European real estate. According to MSCI, European all-property rents increased by 4.4% over the year to June 2024. Rental growth is generally exceeding inflation, while vacancy rates are also stable or falling. This means net operating income is rising.
Despite pockets of distress, the broader debt funding gap feels distant. In July 2023, European REITs faced a €35 billion (bn) gap due to limited credit for maturing debt. Bond markets were essentially closed for unsecured loans, and affordable bank debt was scarce.
A year later, things have shifted dramatically. By September 2024, Green Street estimated the gap had shrunk to €12bn. This significant drop resulted from disposals, debt repayments, refinancing, and fresh equity raises. Finance costs fell, LTVs stabilised, and interest cover ratios improved. While this data focuses on REITs, we believe it reflects most capital pools. Distress now mainly affects poor-quality offices, overleveraged developers, and parts of the German real estate market.
Focusing on REITs, their recent shift in strategy indicates the market's recovery. In the Eurozone, REIT share prices have risen by 30% over the past year and by 12% over the past six months. Most have transitioned from balance-sheet rebuilding to external expansion, having secured €7bn in unsecured loans during the third quarter, along with additional fresh equity from rights issues. Many are now trading nearer to NAV and seizing growth opportunities, leveraging increased market liquidity. This significant strategic shift points to higher overall market sentiment to come.
European real estate sector trends
Offices
London, Amsterdam, Lisbon, Warsaw, and Brussels are reducing excess supply faster than others, mainly by converting or demolishing surplus offices. With slower supply growth, these cities are set to reach equilibrium faster, potentially quicker than the historical seven-to-ten years to shed excess stock due to higher sustainability requirements and housing needs currently.
Prime office rents are rising due to space shortages. Since December 2019, rents increased by 27% in Munich and Amsterdam, 24% in Brussels, and 16% in Paris. Paris Central Business District’s (CBD) top rents are about €1,200 per square metre, with limited supply compared to the broader Paris market. This rental growth is drawing investors back, lowering Paris CBD prime yields to 4.3%. As core office markets tighten, value-add investments might become more appealing despite high construction and financing costs.
Logistics
Logistics rents grew by 5.7% year-on-year as of September 2024, though this was slower than the 11% growth in 2022. Rental growth is expected to outpace inflation in 2024 and 2025 due to limited supply in prime locations, although secondary stock does not experience the same amount of tenant competition.
Investor sentiment in logistics has improved markedly, ahead of other sectors. Competition for prime logistics assets is rising, with logistics investment representing 23% of the total in the first three quarters of 2024. Brokers expect logistics yields to remain flat in September 2024.
Retail
Shopping centres face structural issues, with vacancy rates climbing to 13%. By contrast, retail warehousing is our preferred segment within the retail sector, increasingly supported by MSCI data showing stabilised net operating income per square metre. The vacancy rate for retail warehouses in Europe averages 3.8%, dropping to as low as 2% in the UK.
Living
Rent affordability remains crucial for performance and risk. Low new supply supports sector resilience, with EU construction orders down 18% by September 2024. However, the tight supply outlook means local and national authorities will remain under pressure.
Outlook for performance and risk
The outlook for European direct real estate returns improved further in the third quarter. This supported an overall upgrade of the asset class in our multi-asset Investments Houseview to an overweight allocation for the first time since June 2022.We forecast European all-property total returns of 7.3% over the year to September 2025, with three- and five-year annualised total returns of 9.3% and 8.7%, respectively.
We no longer anticipate any further falls in prime European all-property values. Secondary assets, particularly weak offices, have not repriced enough and will suffer further valuation declines. Stabilising yields and continued healthy income growth should support an improvement in momentum.
We believe that risks are evenly balanced to the upside and downside. Macroeconomic weakness and geopolitics present the largest risks to our outlook. However, with a significant correction in values behind us, interest rates falling and real estate trends gathering momentum, there’s some upside risk.
Value-add strategies should benefit from stronger underwriting on exit yields in a lower-rate environment. We favour overweight allocations to logistics, rented residential, hotels, student accommodation, modern retail warehousing, core offices and alternative segments like data centres.
European total returns from September 2024