European Markets Overview

One of the biggest falls in investment volume since the Global Financial Crisis (GFC)

The prolonged period of near-zero interest rates, a ten-year global norm, ended far more abruptly than many anticipated in 2022. In the space of six months, the world’s central banks normalized monetary policy back to the period before the GFC, delivering a cold hard shock to Europe’s real estate investment markets.

Total investment in Europe was €248.3bn for 2022, down 14% on 2021. This was a year of two halves, with the second half characterized by a deterioration in activity, resulting in a 76% decrease in transaction volumes in Q4 compared to the same period in 2021, which was far larger and quicker than that which occurred in the GFC period in 2008.

In terms of sectors, offices (€90bn) and logistics (€54bn) bore the brunt of the slowdown in 2022, each falling by 21% compared to 2021. The alternative sector declined by 14% to €27bn. Retail, the most battered sector of the pandemic, remained relatively stable at €34 billion, down 2% compared to 2021, largely due to strong growth in H1. The UK posted the largest investment volume at €64bn but also the biggest annual decline at -19%. It is followed by Germany at €54.1bn (-16%) and France at €27.9bn, with an increase of 1%. Many other countries also posted annual increases, including Belgium (€8.6bn, 177%), Spain (€12.9bn, 29%), and Italy (€10.9bn, 25%), largely due to the strong H1.

The UK posted the largest investment volume at €64bn through also the biggest annual decline at -19%. It is followed by Germany at €54.1bn (-16%) and France €27.9, with an increase of 1%. Due to the strong H1 many other countries also posted annual increases despite the Q4 collapse. These included Belgium at €8.6bn (177%), Spain at €12.9bn (29%) and Italy at €10.9bn (25%).

H2. The European composite yield for retail stood at 3.6%, only 20 bps having witnessed the most increase during the pandemic. Logistics composite yields (16 markets) suffered the most, expanding by 70bps to 4.2%, the sharpest price correction of all sectors.

The new macro-financial backdrop for European real estate that emerged over 2022 is likely to give way to a year of greater stability as interest rate rises slow to a stop. The market is emerging from a period of pricing discovery led by the prime end of real estate. Much of the repricing for the best quality property has now taken place, though for secondary assets considerable uncertainty may exist over 2023.

Very active very selective office demand

Yields poised to take new positions in 2023

A large factor in the collapse of transactional volumes in Q4 lies with pricing mismatch. Against such a rapidly shifting backdrop of interest rate rises and bond yield escalation, fewer investors were willing to test the waters on acceptable pricing. This prompted one of the biggest yield decompressions in some markets. At the aggregate, the composite office yield for Europe stood at 3.8% for the 16 top markets at the end of 2022, which expanded by 60 basis points since the start of 2022, with sharp increases over

It was a good year for take-up, with around 9.17 million sqm of letting transactions in Europe’s 17 main markets, in line with the long-term average for take-up, which was 12% higher than 2021. The good lettings activity meant the occupational market diverged from the performance in the investment side of real estate over H2 2022. Dublin (63%), Warsaw (48%), and London (45%) witnessed good take-up over 2022. Cities where volumes exceeded 10-year averages included Milan (+38%), Cologne (+11%), Hamburg (+9%), and Warsaw (+7%).

The European occupational market may be quieter in 2023 than in 2022 due to companies focusing on cost control amidst the economic outlook and persistent inflation. Hybrid working is also gaining momentum in Europe, which could reduce demand for office space in 2023.

Lettings in 2022 focused on securing modern, adaptable spaces with high environmental standards, favoring them over second-hand spaces. Pursuing the 'less but better' ethos associated with new working practices comes at the expense of second-hand ('grey,' especially) spaces put on the market. Consequently, the European vacancy rate remains static at 7.1%, unchanged from 2021. At the city level, the picture is more variable, reflecting the balance of modern-to-old stock and pipeline. German cities remain the ones with the lowest vacancy rate overall, led by Berlin at 3.2% (-20bps over 2022).

The demand for top-quality space has drained an already tight market, albeit one with an active pipeline. This leaves European markets cleaved between scarce good space and an abundance of lower quality offices (the units abandoned in 2022). This dynamic resulted in further widening between prime and average rents across Europe in 2022. Modern CBD-centered units, the segment with the best energy standards and lowest availability, drove prime rents in 2022. All cities witnessed growth. The strongest increases were seen in London (+19%), Warsaw (+13%), Milan (+11%), and Dublin (+9%).

The performance of secondary rents is now trailing that of prime rents. Older buildings are highly exposed to energy regulations that make units more expensive and far less attractive to occupiers. The European Commission proposes upgrading Energy Performance Certificates to at least Grade F by 2027.

The UK is further ahead, and in 2023, legislation will forbid letting of units below Grade C. Some properties not at this standard may start leaving the stock as energy-obsolescent buildings, a new market feature likely to become increasingly common from 2023 onwards.

Retail held up better than expected

Investment in retail survived the crash better than other sectors due to particularly healthy H1 sales, and ended the year only 2% down. The greatest challenge has been in the occupational sector where inflation and the cost of living crisis present immense operational challenges. Many brands have struggled to absorb the cost increases without cutting into their margins and, therefore, had to increase the prices of their products. Mass-market brands such as Zara, Uniqlo, and Mango increased the prices of their products by 8% on average in Europe. Luxury brands took the same direction. Nonetheless, retail sales were healthy in Europe in 2022. Many retailers reported solid turnover (Zara, Fast Retailing, SMCP, LVMH, Kering, Prada, and Hermès). The level was driven by a strong recovery in international tourism, and footfall in places of mass consumption sustained the occupier base.

There is bifurcation in rents between different retailing segments, though. Recovery in footfall and spend is insufficient in mass-market areas to support rental growth. Over 2022, declines occurred in the high street segment of some cities. London witnessed a drop of 26%, with Amsterdam (-7%) and Paris (-6%) also declining. Berlin was flat. In contrast, rents for units in luxury streets increased. London by 2%, Berlin by 10%, and Paris by 14%. This highlights the role that inflation plays in where consumption goes, having differing effects. As inflation is likely to continue over 2023, it implies that food discounters and other value retailers will see continued trade as consumers struggle with the cost of living. At the other end, the luxury market will probably continue to expand with new units, particularly as high-end travel picks up.

The slowdown continues to be selective, with the most severe in Poland (-22%), the UK (-18%), and France (-13%). In contrast, the Netherlands (3%) and Spain (8%) both saw increases by the end of the year. The problems of securing suitable space have not gone away even with a slower economy. Consequently, vacancy in the logistics sector continues to operate at historic lows with the European average still below 4%. There are few speculative developments in any country.

Scarcity continues to shape the outlook for logistics

Although the volume of European investment declined by 21% in 2022 to €54bn, nearly €15bn, investment remains greater than the average annual amount recorded between 2017 and 2020. The market continues to attract buyers even with severe yield decompression largely because of the rental growth prospects.

The total letting volume for the six leading markets reached 26.9 million sq m in 2022, down 10% in the six leading European markets. This compares well with the exceptional volumes recorded in 2021. The lettings market volume in Europe remains above its 5-year average, and the market looks likely to hold up well despite economic slowdown.

The scarcity issues drive the rental prospects that attract investors. After a decade of flat growth, rents started to increase meaningfully across Europe in 2022. The average European growth was 12% over the year for 48 markets. Very large rental increases occurred in the UK, especially the Birmingham market (38%), London (19%), Warsaw (33%), and Prague (31%). Massive increases in construction costs led to significant rental growth in Hamburg, Munich, and Cologne during 2022. Persistent inflation, rising construction and labour costs, as well as the shortage of land, may continue to push rental increases over 2023.

Samuel Duah, PhD, Head of Real Estate Economics at BNP Paribas Real Estate