Despite a challenging macroeconomic picture, European real estate has begun to acclimatise to higher interest rates and will offer some of the world’s most attractive supply-demand dynamics next year, according to the Insights, Strategy and Analysis (ISA) Outlook 2024 report published by global real estate investment manager LaSalle Investment Management.
Last year’s report predicted European macro headwinds and a stall in capital markets activity, but also strong real estate market fundamentals. Looking ahead, the 2024 ISA Outlook for Europe describes how investors that are ready to move out of waiting mode, with realistic expectations for operating income growth, can find compelling new investment opportunities.
This year’s report identifies five trends that differentiate Europe and earn the region’s real estate assets an important place in investors’ property portfolios:
- Europe’s city centre vibrancy and occupier demand have strongly rebounded
- The region’s firms and individuals are taking the lead in decarbonization
- Skilled migration is supporting growth
- Expansion of the EU’s single market is regaining traction
- The high prevalence of inflation-index commercial leases in the EU has helped the region’s property cash flows to better keep pace with inflation
These trends are driving demand in particular for logistics and rental housing, as well as superior performance by offices in the ‘super-prime’ segment.
Macro challenges but appealing supply-demand dynamics
Having defied expectations of a recession in 2023, Europe still faces elevated recession risk. Inflation has begun to abate but proven comparatively stubborn, particularly in the UK, inducing higher policy rates from the ECB and Bank of England. As the delayed impact of rising rates begins to bite, European property markets enter 2024 searching for a clear peak in interest rates – as well as an end to the war in Ukraine.
Europe’s occupational fundamentals are coming off the boil of recent years, with rental growth set to cool to its lowest level since 2020 next year. However, we expect that average rent growth should remain positive, especially for logistics and rental housing – even in an economic downturn – helped by low vacancy rates relative to history.
In logistics, while demand has cooled across Europe and vacancy is ticking up from extremely low levels, a shrinking construction pipeline means that the long-term revenue growth outlook remains very bright. The scope for further e-commerce market penetration is, conversely, a headwind for European retail. However, assets such as outlet centers with turnover-linked leases have lifted revenues in line with nominal sales growth.
Investors in Europe can access strategies rooted in barriers to supply, arising from Europe’s high (and rising) constraints on development. Nowhere does this apply more than in the residential sector, where the undersupply is chronic, while migration powers long-term demand growth. Surging student demand and rising mortgage rates are causing people to rent for longer and until later in life, boosting demand further in Purpose-Built Student Accommodation and rental housing specifically.
Opportunities on the leading edge of offices
European city centers are returning to their pre-Covid levels of vibrancy, attracting office occupiers and capital to more central locations. To better understand how this spectrum of office quality is evolving, we recommend going beyond ‘bifurcation’ alone in segmenting the market. The widening gaps between leading and lagging offices are determined by a range of many factors like location, design, amenities and sustainability.
In London, “super-prime” office buildings command significant rent premiums to “prime” averages. Since 2019, the UK capital’s median office relocation was from a non-BREEAM-rated EPC-D building to BREEAM Excellent / EPC-B or better. Across Paris and London, new offices’ vacancy rate is c.2%, three times less than for second-hand offices. Notably, centrally located, modern offices in Paris and Munich have defied subdued transaction levels and remain liquid, with sales attracting respectable bidder pools.
Alternative lenders gain momentum
Outside of these pockets of investment activity, alternative lenders are well positioned to solve capital stack equations in 2024, filling gaps created by banks’ reduction in LTVs to provide debt financing that generates attractive risk-adjusted returns.
Dan Mahoney, Head of European Research and Strategy at LaSalle, said: “What we are seeing in Europe is real estate markets beginning to acclimatise to the higher-rate environment and gradually shift out of the waiting mode that has chilled transaction volumes in 2023. The continent’s distinct combination of rebounding city vibrancy, high supply barriers and compelling conditions for debt make it an important allocation in global real estate portfolios.”
Brian Klinksiek, Global Head of Research and Strategy at LaSalle, added: “Significant unknowns remain in the global real estate market as we head into 2024, including interest rates, geopolitical tensions, and whether major economies may tip into recession. While it’s very difficult to time markets, data on previous down cycles suggest that it’s often during unsettled periods that savvy investors can find strong value in real estate, making this a potentially strong vintage for investment.”