Guest Post by Ivo van Breukelen, managing partner at The Proptech Connection

With interest rate cuts on the horizon, we're witnessing a rekindling of market dynamics potentially sparking a revival in transaction activities in some of the major European markets.

‍2024 so far has been a year of both challenges and opportunities in most markets. The industrial sector continues to shine as a prized asset class, with low vacancy rates driving up prime rents. Meanwhile, the office market is seeing renewed interest in value-add prospects, though with some nuances in rent trajectories.

‍Economic Snapshot: Recovery Taking Hold

The euro area and the UK have emerged from their recent economic slump, with Q1 2024 showing positive GDP growth. This marks the end of the recession that plagued both economies in the latter half of 2023, signalling a turn towards recovery. While we consider the euro area as a singular homogeneous region, it is important to acknowledge the country-level differences.

‍The European Central Bank and the Bank of England are expected to implement additional rate cuts. The ECB led with a 75 bp reduction in June, followed by the BoE with a 50 bp cut in August. These moves are anticipated to catalyze a series of positive developments in the real estate sector, including lower debt costs, lower yields, and potential price growth.

‍Economic forecasts paint a picture of modest but steady growth. The euro area is expected to grow by 0.6% in 2024, while the UK economy is projected to expand by 0.3%. Inflation has largely remained within the target range. However, if pressures persist, the rate cuts may be slower than expected.

Real Estate Outlook

Commercial. There is a clear trifurcation emerging between prime, secondary, and tertiary assets. Investor appetite for traditional office spaces is waning, with a growing focus on assets ripe for repurposing or repositioning in major European cities.

‍There is a marked preference for amenity-rich buildings with strong ESG credentials in prime locations. Gradual interest rate cuts are anticipated to increase confidence in the office sector. Despite falling behind APAC, return-to-office mandates will likely increase further boosting demand.

‍Upward pressure on rents in core CBD markets across the UK, France, Germany, and Benelux is likely to continue, but at a more moderate pace due to reduced inflationary pressures and redevelopment costs and growing Grade A supply.

Office Re-Entry Levels

Retail. The retail sector is showing signs of a steady recovery. With inflation normalizing, disposable incomes are expected to stabilize, though the impact of recent high inflation will still be felt in 2024. Euro area retail sales volumes rose by 0.7% y-o-y in March, the first positive annual growth since September 2022. Looking ahead, sales volumes are forecasted to grow by 1.3% in 2025.

‍Investor interest is increasing in retail parks for their stability and in high-quality shopping centers, especially those with mixed-use potential. Retail leasing activity is also gaining momentum as retailers compete for prime spots. However, declining vacancy rates in top locations are expected to push rents up, with rental growth across prime high streets in Europe projected to average 2% annually over the next three years.

Logistics and Industrial. The industrial sector is emerging as the most coveted asset class for investors. Take-up fell by 21% y-o-y in Q1'24, however, take-up levels are approaching pre-pandemic levels. Low vacancy rates are expected to be sustained throughout the year due to a softening under-construction pipeline which will increase upward pressure on prime rents. Gradually lowering interest rates will also put upward pressure on prices. As a result, investment activity is expected to increase following a rise in volumes in Q1'24.

‍Alternative Sectors

The aging population in Europe is fueling demand in the life sciences sector, leading to growth in healthcare services. Increased funding, R&D spending, and favorable tax incentives are positioning the life sciences industry for substantial expansion.

‍Interest in data centers continues to grow, driven by AI, rising data traffic, increased digitization, widespread 5G adoption, and greater use of cloud services. EMEA operational IT data center capacity rose by 10% from H1 2023. However, challenges such as limited power availability and developable land are constraining growth in mature markets, pushing investors to consider secondary markets like Oslo, Milan, Berlin, and Madrid.

‍With an improving macroeconomic environment, capital is expected to flow into alternative sectors such as life sciences and data centers, which are demonstrating strong fundamentals.

Conclusion

The current trajectory of Europe’s real estate market reflects a period of recalibration and strategic pivoting, driven by shifting economic signals and evolving investor priorities.

‍With rate cuts on the horizon, there is a window of opportunity for investors to re-enter markets with strong fundamentals, particularly in sectors like industrial and alternative assets that offer resilience and growth potential.

‍However, the complexities of affordability, ESG requirements, and structural changes in demand necessitate a more nuanced approach. Investors who can navigate these dynamics, leveraging local insights and adopting flexible strategies, will be best positioned to capitalize on this transitional phase, balancing risk with the promise of sustainable returns.

Ivo van Breukelen is managing partner at The Proptech Connection

‍