Even though the European Central Bank (ECB) made its first interest rate cut in June 2024, interest rates in the Eurozone are still high – and it is still uncertain whether, when, and to what extent further measures will follow. Currently, inflation in the Eurozone is still above the target of 2%. Despite the challenging market conditions, however, the European real estate investment market is showing signs of stabilization.
A general decline in transaction volume
In the wake of the interest rate hikes, real estate transaction volume decreased significantly in many European countries between 2022 and 2023. In France, for example, various reports show that the transaction volume fell by 40 to 50 percent in 2023 compared to the previous year. Some sources even noted a decline of up to 70 percent. Other European countries also recorded significant losses: In Spain, the investment volume fell by 45 percent, in Germany by 50 percent, and in the Netherlands by almost 60 percent.
In addition to the drop in transaction activity, the European real estate market experienced a reduced willingness to buy, which led to higher initial yields. Between the second quarter of 2022 and the first quarter of 2024, prime yields for residential properties in major European cities rose by over 130 basis points. The increase was particularly strong in countries where rising financing costs, currency devaluations, and insolvencies of real estate or construction companies caused high levels of uncertainty. In Amsterdam, for example, prime yields climbed by 230 basis points. In Germany, Munich and Berlin recorded increases of 190 and 200 basis points, respectively. Vienna also experienced a significant rise of 200 basis points, which was presumably influenced by the insolvency of the Signa Group. The Parisian business districts of QCA and La Défense also recorded significant increases in prime yields of 130 and 165 basis points, respectively.
Prime yields in the top European office markets [VISUAL]
In contrast to other European cities, Geneva and Copenhagen recorded a comparatively moderate increase in prime yields of 75 basis points. This is mainly due to two factors. Firstly, investors in these countries pursue a long-term investment strategy and have lower levels of debt than in other regions. Secondly, these countries benefit from above-average employment growth, which ensures a continuously high demand for office space. In Switzerland, low volatility also contributes to stable prime yields.
Rents and vacancy rates: Different trends
The majority of rents in the top office building locations in major European cities showed an upward trend, growing by 25% in Vienna, 14% in Munich, and 7% in London. Only Geneva recorded a decline of 2%. Despite new working models such as home offices and flex desks, which could in principle lead to a reduction in office space demand, prime rents rose due to several factors. Firstly, rents generally tend to increase in times of inflation. Companies also continue to strive for the best available locations. Lastly, the limited potential for building new space in prime locations restricts the supply.
Prime rents in the top European office markets [VISUAL]
Vacancy rates for office space vary considerably in major European cities. Locations that have invested heavily in new buildings over the past five to ten years, such as Dublin and Helsinki, experience particularly high vacancy rates.
Vacancy rates in the top European office markets [VISUAL]
New investment opportunities arise after price adjustments
Since the interest rate hike in 2022, the office investment markets have undergone significant corrections in some areas, which raises the question of whether interesting investment opportunities could follow. As is so often the case in the real estate sector, the answer is highly location-dependent. Nevertheless, many major European cities appear to have reached the end of their correction phase. This assessment is based on an analysis of current real yield differentials and their comparison with the average values of the last ten years.
To calculate the difference between the prime yields of office properties and the yields on 10-year government bonds, we subtracted the average inflation rate over the last five years from the nominal yields on government bonds. This average inflation rate serves as a proxy for expected inflation (both past and present). In contrast, we did not adjust prime office yields for inflation, as real estate yields are generally considered inflation-resistant. The resulting difference between the prime yield and the inflation-adjusted yield on government bonds shows the real premium that office properties achieve compared to government bonds. This premium reflects the property-specific risk.
The data reveals that the actual yield differences, determined in the aforementioned manner, are above the average values of the last ten years in most of the metropolitan areas reviewed. This suggests that some cities’ markets may have overreacted because of the prevailing uncertainty, which is now creating interesting investment opportunities. In Paris in particular, the current real yield differential is above its ten-year average, indicating that the correction phase may have ended and we can expect an increase in investment activity.
Given the current landscape, where many European cities have completed their correction phases, the present moment offers a potentially lucrative opportunity for real estate investors. The elevated real yield differentials observed in several major metropolitan areas suggest that the market may have overreacted to recent uncertainties, leaving prime office properties undervalued. For investors, this situation presents a chance to capitalise on these mispricings before the market fully adjusts.
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Written with Dr. Robert Weinert and Dr. Corinne Dubois of Wüest Partner
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