| According to studies, returns will likely increase further in 2023 and stabilise in 2024. |
Thereafter, the market will revive selectively by asset type and geography, led by the countries where appreciation has been most acute. According to BNP Paribas RE, logistics (now highly revalued) and residential will lead the market, both supported by strong rental growth prospects.
Rental growth prospects remain at the centre of near-term investment allocations. Indeed, rent growth is expected only in sectors that have performed well over the past five years, such as offices and logistics, while retail may start to recover, and residential growth should be sound.
Tighter financial conditions and uncertainty about when the interest rate cycle will end caused European residential investment to fall 62% in H1 2023 compared to H1 2022 and 55% below the five-year average.
Spain was the only country to record an investment increase over the period. In the Nordic countries, Germany, and France, investment activity dwindled more than the European average, while it seems to be holding up better in the Netherlands and the UK. Increases in mortgage rates and government bond returns test the investment market by reducing the risk premium and the risk-adjusted return on real estate.
For transactions to resume, prices need to readjust to the real economic and monetary environment. Refinancing is the main risk that could force some investors to sell in the short term due to the price adjustment and, thus, the increase in the loan-to-value ratio. However, investors remain very interested in residential assets due to the significantly increased demand in the rental sector due to declining affordability as mortgage rates and house prices soar. Moreover, large cities face severe housing shortages and obsolescence, while new household formation will continue to grow over the medium term.
The volume of real estate transactions in Europe in the first quarter of 2023 dropped by 10.7% year-on-year. House prices on the continent recorded their second consecutive decline in the same period, i.e., -0.7% after -1.4% in the fourth quarter of 2022. Over the past six months, house prices have declined by -2.1% in Europe. The most affected countries are Germany (-7.8 %), Luxembourg (-5.6 %), Finland (-5.2 %), Sweden (-4.4 %) and Denmark (-4.0 %), the same countries that recorded a larger decline than the maximum of the last two years.
House prices fall in Europe… but not everywhere…
City-wise, according to our affordability report, all markets (except Rome and Brussels) are significantly overvalued. As a result, house prices are falling in 20 out of 28 cities, having peaked in the last two years. House prices fell by more than 10% in Frankfurt (-16.2%), Copenhagen (-12.7%), Amsterdam (-12.7%), Brussels (-10.4%) and Munich (-10.1%).
Southern European cities, such as Vienna and Warsaw, are the most resilient, as house prices have not yet adjusted and continue to rise. However, the trend could reverse by the end of the year. Concerning the underlying factors mentioned above, second-hand house price growth is expected to be negative over the next five years before gradually recovering from 2025. Overall, house prices are expected to fall by 9.5% in the Netherlands, 6.8% in Germany and France, -5.9% in the UK, -4.4% in Spain and -2.9% in Italy by the end of 2022.
Changing financial conditions affecting households have boosted the demand for rental housing in large cities.
| Rental growth reached +8.2% year-on-year in Europe in the first quarter of 2022: |
the highest average annual growth since 2010. The imbalance between supply and demand in the rental sector is significant due to housing regulatory uncertainties that have contributed to a drastic reduction in rental supply, for example, in Berlin, Barcelona and Valencia.
Moreover, capping rent increases to around 2%-3% to avoid indexation to inflation has pushed landlords to pass on the loss of income in new contracts. Tenant demand has also shifted towards more efficient housing to avoid skyrocketing energy bills. The next challenge could be a ban on renting out energy-inefficient housing, as is already the case in France and the UK. Such a regulation would significantly increase the pressure on rental housing availability.
The buy-to-let ratio indicator shows that, in most markets, renting is the best option for households wanting more space. In Stockholm, London, Munich, Hamburg, Paris, Frankfurt, Lyon, Copenhagen, Prague and Oslo, renting offers twice as much space as a household could afford to buy. Since the pandemic, renting is cheaper than buying in several southern European markets, including Barcelona, Madrid, Milan, Lisbon, Rome and Seville.
Rental values are expected to continue to rise, driven by inflation, a recovery in household disposable income and a lack of supply relative to rental demand. Southern European rental markets should continue to expand and record significant rent increases driven by improving labour markets, strong income growth expectations and high potential rental market depth.
| Residential rents will continue to rise over the next five years, driven by increasing rental demand, |
given economic conditions and the reduced ability of households to buy homes. Similarly, the current energy efficiency regulations proposed by the European Commission could be impactful. They could reduce the number of available rental units and improve the supply of rental properties, putting upward pressure on them. Thus, rent could increase by as much as 13.5% in Spain, second only to 18% in the Netherlands and 15.5% in the UK. This is followed by 10.5% in Italy, 9% in France and 7% in Germany.
The uncertainty of the real estate market is most acute in this segment, which is undergoing profound changes on several fronts: price adjustments following the largest increase in financing costs in decades, work patterns that continue to suggest lower demand for space and a regulatory framework that will continue to increase obsolescence. These problems have put the sector into a period that could be described as “suspended animation”: alive but with reduced activity. Price stagnation will be resolved in the first half of 2024 when monetary policy reaches its final rate in the current cycle. As for occupancy, demand remains focused on the best units, continuing the dynamics established post-pandemic, reflecting occupiers’ desire to downsize and occupy buildings that meet energy standards.
The year 2022 saw the biggest correction in the logistics market due to rising financing costs. Also, logistics recovery this year has been much faster in some countries than in other real estate sectors. A steady and widespread recovery is expected for the rest of the year. The resulting increase in rental values, sometimes quite substantial, affects tenants unevenly. Investors will need to take this into account when letting.
The sector has experienced one of the longest declines in history, driven by profound structural changes in our shopping habits. Retail’s share of European investment activities has shrunk considerably over the years, and prices have adjusted sharply as a result. The effect has been uneven across this broad sector. The downward cycle should have reached its bottom, as evidenced by the limited impact of the current interest rate cycle on prices. Moreover, rental growth is again being observed in some areas. This raises the question of whether the sector now merits an investment opportunity.
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