For example in the first quarter of this year, INREV, an independent provider of non-listed real estate performance data, reported the first positive quarterly total return from European and UK real estate in seven quarters.

We think the best opportunities are to be found in ‘core’ real estate – those high-quality properties located in metropolitan areas, with strong tenants and a broader appeal to investor groups.

From this stronger foundation, expected returns have risen sharply in recent quarters and we now forecast core European real estate to deliver total returns in excess of 9% per annum over the next three years.

Here are five reasons why the omens are good for these assets, which form the foundation of many a diversified real estate portfolio:

1. Core capital value reset. The European and UK markets have seen values decline by 19% and 22% respectively from their June 2022 peak, according to data from MSCI [1]. This puts a significant amount of repricing risk behind us and provides space for a recovery. Some segments, such as UK logistics and European residential, have already seen values begin to rise once more.

2. Relative value flashing green. Real estate yields have risen in some sectors to levels not seen for more than a decade [2]. The average prime yield in the UK and Europe is now at 5.7%, up from 4.2% [3] at the peak of the cycle. This represents an appealing cashflow for investors compared to interest rates on cash and yields on Eurozone and UK government bonds, which are currently at 3.1% and 4% respectively. With the Riksbank, European Central Bank and others across Europe now easing policy and cutting rates (albeit gradually), the momentum is certainly in favour of real estate pricing.

Investors have options across the risk spectrum, but the new higher yields in core assets offer stronger potential returns at this point in the cycle. Core assets also face fewer headwinds from increasing decarbonisation costs and expensive financing for capital expenditure projects associated with higher-risk strategies. INREV’s latest investor confidence survey shows a sharp increase in appetite for core real strategies in June 2024, at the expense of more opportunistic strategies.

3. Cycle-defining income growth. After the 2008/2009 global financial crisis, rental growth across sectors turned negative and took the best part of three years to recover. In the latest downturn, (which was almost entirely fuelled by sharp interest-rate hikes, as opposed to economic recession) rents in all sectors have continued to rise in both nominal and real terms. All Property rents have risen some 8.5% over the two years since the downturn began in June 2022.  

Average rents across all sectors rose by 4.3% in the year to March 2024. European and UK logistics rents increased by an average of 7%, residential rents by 6% over the same period. Even office rents beat inflation, with 2.8%-growth. Prime office rents in Munich increased by a staggering 17% [4]. So, not only are investors able to source attractive yields in core real estate again, but those cash flows are also growing year-on-year too.

Looking ahead, a reduced development pipeline is likely to mean this cycle is characterised by above-average rental growth for some time. Structurally, we will be creating less new property as materials become harder and more expensive to source, and policy adjusts to promote the improvement of existing buildings rather than the addition of new ones.

Cyclical pressures are also weighing on construction. European construction order books contracted by 18% [5] in the year to May 2024 and residential development is set to fall to just three housing units per 1,000 people next year – the lowest level in over a decade. This is in response to high financing and construction costs, developer insolvencies and a lack of appetite for development strategies.

4. Sustainability divides the best from the rest. There’s compelling evidence that performance is increasingly linked to sustainability factors. A recent study by INREV and the Global Real Estate Sustainability Benchmark (GRESB) shows that by simply participating in GRESB, funds had a stronger chance of outperforming those that did not, implying that sustainability is now just part of good asset management [6]. There are higher correlations between total return performance and environmental scores in GRESB, suggesting that the material improvement to a building’s environmental impact has a positive impact on performance – good news for core assets that beat minimum efficiency standards.

5. Debt accretive for core assets again. Debt is readily available for core real estate, and debt pricing is improving. Clearing banks have been profitable through the higher interest-rate period and they have cash to lend. This has created competition for assets amongst lenders, driving margins lower. With the five-year Euribor swap rate currently trending stable at around 2.8% (down from 3.5% in October 2023) [7], the all-in cost of fixed loans is well below current prime yields. With values showing tentative signs of improvement, leverage should gradually begin to add to the performance of core real estate.

Final thoughts

After the global financial crisis, real estate distressed sales and negative news headlines continued for several years beyond the point that real estate had already stabilised and begun to recover.

The latest downturn brought dislocation and disruption which will take time to resolve. However, the noise does not reflect the performance of core real estate. Investors need to separate the headlines from the fundamental factors that are driving high-quality, sustainable and future-fit real estate performance.

With valuations now stabilising and rents rising, our total return forecasts are pushing higher. We’re forecasting European real estate to return 9.1% p.a. over the next three years, led by the residential and logistics sectors with 10.8% a year each, student accommodation with 10.0% per annum and hotels with 9.4% a year (see Chart 2).

Are these potential returns something you can afford to ignore?