European Real Estate Outlook 2023

We are entering a period in which real estate market conditions are expected to "stabilise" in the second half of 2023 — meaning real estate markets will find a new equilibrium.

Forecasts

While market equilibrium often refers to supply-demand balance, when we speak of fundamentals here we mean the balance between buyer and seller expectations.

Since the Q3 2022 forecasts, we have witnessed a period of resilience, renewed fears of a possible financial crisis, and reassurances from central banks.

The baseline scenario remains broadly unchanged: growth surprised to the upside, with some markets avoiding a "technical" recession, but underlying growth remains weak.

Against a backdrop of anaemic growth, high interest rates, and tighter lending conditions, investment is expected to remain subdued and to accelerate only in the second half of 2023.

Risks

Downside risks include sticky core inflation (and therefore the risk of higher rates) as well as further tightening of lending conditions following recent banking sector turbulence. If greater clarity on the interest rate outlook emerges sooner than expected, investment momentum could strengthen and yield compression could begin earlier. This represents an upside risk.

Correction

Given the sharp yield corrections since the second half of 2022, commercial real estate valuations are moving toward fair value. Property yield spreads over ten-year government bond yields are narrower than they were in the post-GFC period when base rates were near zero. They now stand at 153 basis points as of Q1 2023: for comparison, the 30-year average is 208 basis points and the average from 1992 to 2010 was 122 basis points.

Further repricing will continue in the first half of this year. Prime yields across all sectors will continue to move outward as higher debt costs feed through in 2023, albeit to a lesser degree than in 2022. Retail yields are the exception and are expected to move out by +44 basis points this year versus +24 basis points in 2022. For office and logistics yields, we expect increases of +54 b.p. and +40 b.p. respectively in 2023.

Prime real estate

Although these figures are not very different from the previous forecast, prime real estate rental growth was elevated in 2022 despite weak economic growth — for European prime offices (5.5%) and logistics (14.5%). This was largely driven by an undersupply of high-quality space in both sectors.

In some markets we expect the undersupply to persist, as higher capital costs delay construction starts. Both sectors face obsolescence challenges as decarbonisation accelerates. This will lead to a further widening of prime-versus-secondary market spreads.

European prime real estate rental growth is expected to moderate in 2023 across all sectors, averaging 3.3% for offices, 7.3% for logistics, and 0.4% for retail.