Overview
There’s an old adage that says, “America sneezes and the world catches a cold.” But in real estate, although trouble in the US market is infecting the world’s outlook on the sector, regions such as Europe are in fact looking far healthier.
Indeed, the weakening picture of vacancy rates globally (topping 15 per cent) is driven almost entirely by poor performance in the US market where rates remain at 20.2 per cent - the highest level recorded in recent years. By contrast, European vacancy rates remain much more stable at 7.6 per cent.
The net absorption rate - which measures the space being taken up by new leases versus the number of buildings available to tenants - has also been positive in Europe for the last seven quarters[1]. At the beginning of the year it was the highest it’s been for more than a decade.
While lease incentives - sweeteners offered by landlords to prospective tenants - are not yet down to pre-pandemic levels (currently 10.3 per cent of lease value compared to 7 per cent in 2019), it’s another indicator that is moving in the right direction. There is also little evidence of defaults across Europe, although there are signs that shifting regulation in the region is increasingly dividing the market there, fuelling demand for more sustainable buildings.
A bitter – but necessary – pill to swallow
The only metric where the European commercial real estate market falls behind its US counterpart is on valuations. In the 12 months to the end of March 2023, continental European property values fell 13 per cent, while those in the UK were down by 22 per cent[2]. By contrast, valuations in the US had fallen only 2.4 per cent year on year.
But rather than suggesting an underlying steadiness of the US sector, the figures instead illustrate how that market is yet to deal with the reality of the macroeconomic environment. In other words, there is more pain to come in US real estate where, despite rising rates and weaker fundamentals, there have been no significant capital write downs.
Valuers in Europe on the other hand have undertaken a mechanical adjustment to increase prime yields and discount rates, leading to a rapid market repricing. Similarly, the European market has already dealt with the new reality of hybrid working and is ahead of the US in reducing the number of desks per worker. There are on average as few as 60 desks available per 100 staff in Brussels, for example, with 70 in Paris, and 80 across Amsterdam, London, and Madrid[3]. In the US, where fixed desks for employees remains the norm, the ratio is more like one-to-one.
Rates still threaten
We believe valuations are stabilising in Europe. Sales are being agreed at or close to book values, building confidence and improving market transparency and efficiency. Liquidity from overseas - by tradition a bigger source of funding for European deals than in the US - is supporting investment volumes and price discovery.
While Europe is benefitting from a supply-demand imbalance for commercial assets at the moment, it does not guarantee that the region is immune to what may lie ahead. If a deep recession hits and interest rates continue to rise, cracks could emerge across both the investment and rental markets. But Europe’s lead on the road to recovery puts it in a stronger position than the US to weather such storms. And its head start should be a boost to confidence in the region.
[1] According to data provided by JLL.
[2] According to data provided by JLL.
[3] According to global occupier data provider Colliers
