What's Happening
The European commercial real estate (CRE) sector is recovering from two years of pressure on valuations from rising interest rates. At the same time, political and geopolitical risks remain high.
Two regional wars are ratcheting up in intensity and the potential triggers for a broader conflict are considerable, as are the implications for Europe if the U.S. unilaterally reduces its support for either the North Atlantic Treaty Organization (NATO) or Ukraine. The fallout of such a reduction in support could trigger risk aversion among investors, leading to:
- A flight to quality;
- A disruption to supply chains, with severe repercussions if there is a significant disruption to oil supply; and
- A shift in European governments' spending priorities.
At a more domestic level, the political situation in Europe could become more volatile and undermine investor confidence. This is particularly true of France and Germany, which could both hold elections next year. After France's centrist alliance lost its majority following this year's election, the now minority government is struggling to pass the 2025 budget. The political landscape in Germany is similarly fragmented, with the country heading toward snap elections on Feb. 23, 2025.
A material escalation of political and geopolitical risks could disrupt the European CRE sector's recovery. More specifically, an escalation could hinder European CRE companies' ability to dispose of assets quickly, stabilize valuations, and increase rents or maintain occupancy levels if the situation places tenants under long-term financial strain.
Why It Matters
Investors' risk aversion would delay the recovery in transaction volumes. The health of the CRE investment market generally depends on the political and geopolitical context. In 2022 and 2020, transaction volumes in Europe fell by 57% and 38% respectively in the six months that followed the start of the interest rate increases linked to Russia's invasion of Ukraine and the COVID-19 pandemic lockdown. In the U.K., transaction volumes fell by 45% in the six months following the Brexit vote in June 2016 compared with the same period in 2015.
Transaction activity is an important consideration for real estate companies as it sets a benchmark for their portfolio valuations, which, in turn, affect their loan-to-value ratios. Transaction fluidity also enables real estate companies to reduce debt leverage by allowing them to dispose of assets when they need to. Transaction volumes in Europe are recovering from the low levels of 2022-2023, but in the first nine months of 2024, they were still 41% lower than the five-year average according to U.K. real estate services company Savills.
A large expansion in government bond yields could derail the recovery in asset valuations. Political and geopolitical developments that create uncertainty or put increasing pressure on governments' budgetary decisions could affect government bond yields. Even though central banks may lower rates to fight weaker economic growth, higher government yields due to perceptions of greater sovereign risk could weigh on semi-annual asset revaluations as property appraisers use these yields as risk-free rates in their property yield assumptions. This could be particularly true of low-yield assets, such as residential assets, whose risk premiums (the difference between the risk-free rate and the property yield) are tighter.
That said, credit markets remained relatively stable when geopolitical tensions rose in 2024. In addition, all real estate asset classes have already undergone a large repricing over the past 24 months, adjusting to the new rate environment (see "European REITS: The Great Repricing Continues," published on July 18, 2023, and "Most European REITs' Valuations Should Bottom Out In 2024," published on July 10, 2024).
Rated CRE companies' yields are now almost 100 basis points higher than their low average level on June 30, 2022. Recently, government yields have eased ahead of expectations of policy-rate cuts. We forecast that the 10-year German bund yield will remain slightly higher than it is currently, at around 2.4% in 2025 and 2026, but significantly lower than its peak of close to 3.0% in October 2023. This supports our base-case expectation of stable asset values.
What Comes Next
Negative economic consequences could drag on tenant demand. A more hostile and uncertain global environment could further erode Europe's economic security, weigh on consumer confidence, and bolster savings at the expense of consumption and growth. Stagnating growth would be detrimental to corporate credit performance and could imply lower demand for CRE.
The office property segment would be hit particularly hard, as tenant demand and overall leasing activity are generally vulnerable to economic recessions, weaker corporate sentiment, and rising unemployment, which often lead companies to downsize. Retail and logistics real estate firms are also vulnerable to supply chain disruptions and declining consumer confidence as these affect retailers' sales and ultimately their need for physical space or their capacity to afford higher rents.
Related Research
- Credit Conditions Europe Q1 2025: Fusion Or Fission?, Dec. 3, 2024
- Economic Outlook Eurozone Q1 2025: Next Year Will Be A Game Changer, Nov. 26, 2024
- Industry Credit Outlook Update Europe: Real Estate (REITs), July 18, 2024
- Most European REITs' Valuations Should Bottom Out In 2024, July 10, 2024
- European REITS: The Great Repricing Continues, July 18, 2023
This report does not constitute a rating action.
| Primary Credit Analyst: | Franck Delage, Paris + 33 14 420 6778; franck.delage@spglobal.com |
| Secondary Contacts: | Nicole Reinhardt, Frankfurt + 49 693 399 9303; nicole.reinhardt@spglobal.com |
| Marie-Aude Vialle, Paris +33 6 15 66 90 56; marie-aude.vialle@spglobal.com |
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