Germany & France: the sick men of Europe

Over the last year, the European non-listed real estate market can be characterised by continued negative performance. With increased economic headwinds, the German economy on course to shrink in 2023, and higher for longer interest rates expectations, it’s no surprise that the market has seen a significant decline in capital growth of -11.58% over the last four quarters[1].

But there are some first signs of clarity and light at the end of the tunnel as interest rates seem to be close to peak, and inflation is starting to slow. This is translating into subtle optimism amongst investors. In fact, the mood on the ground at EXPO Real was more positive, or realistic, than expected. The strapline ‘survive until 2025’ sums it up - whilst market participants are expecting further pain, there are no stark changes in sight.

According to the INREV Pan-European Quarterly Asset Level Index, there are tentative glimpses of recovery on the horizon. In Q2 this year, the UK achieved a total return of 0.08%– pushing it into positive territory for the first time in a year. However, this is yet to trigger an uptick in the transactional market, suggesting that buyers may be waiting for further pricing corrections.

However, the Q2 2023 performance for Germany and France slid down further after already weak Q1 results – registering at -1.84% and -1.63%, respectively. These results were greatly influenced by the strong negative performance of offices, to which both markets have an above average allocation.

Net sentiment towards offices has been in negative territory over the last six quarters, with many investors looking to further reduce their allocations. Hybrid working across Europe has meant that aggregated demand is down, resulting in a bifurcation in the office market with a strong focus on location. In addition, ESG-related costs are high as more stringent regulation requires significant capital investments to make buildings more sustainable. Combined with difficult market conditions, this leaves the future of the office sector hanging in the balance.

Residential performance is more of a mixed bag. In Q2, it worsened and remained in negative territory for France and Germany – while improving for the UK and the Netherlands. German residential construction has been under notable distress. According to the Ifo Economic Institute, high input and financing costs have eroded profit margins, driving project cancellations to previously unseen levels.

Retail performance has also improved for the UK and the Netherlands, while worsening for France and Germany. That being said, the overall trajectory for this segment is perhaps looking more optimistic than can be said for offices. The trajectory is complex and varies notably from one geography to another, as well as by subsector. The next quarters will be sure to tell us more about this.

The trajectory of recovery may continue to differ widely across Europe. However, as inflationary pressures subside, alleviating the need for further interest rate hikes, we should expect a normalisation in real estate pricing and valuations. But there’s no doubt that there is still some pain to come as we navigate through the last months of 2023 and into 2024.
 

[1] INREV Quarterly Fund Index, four quarters to the end of Q2 2023