European Economic & CRE Outlook Q3 2022: Shifting Sands

Since Q1 2022, the energy crisis triggered by the invasion of Ukraine by Russia has not only added an additional source of uncertainty but has impacted growth across Europe significantly. High inflation is no longer a short-term phenomenon. With elevated inflation combined with Central Bank’s tightening cycles, demand is set to be much weaker. A recession is now inevitable. The euro area will enter a recession in the fourth quarter of 2022 until the first quarter of 2023. On an annual basis GDP is set to grow 2.9% and 0.5% in 2022 and 2023, respectively - a 2.6% cumulative downward revision from 3.4% and 2.6% since the previous forecasts. Risks to growth remain skewed to the downside.

2022 is a tale of two halves. Generally, most property markets performed well in the first half of the year. There has been a noticeable slowdown in transactional activity with the Q3 volumes down by 37% in comparison to the levels seen a year ago. This slowdown has been felt across all sectors. With a lack of transactional evidence, and the uncertainty surrounding the outlook, buyers and sellers are anticipating the market to adjust.

Due to the rising cost of debt and with prime yields across some markets at historically low levels we have significantly revised our yield outlook. There is variation by property type and location.

The logistics sector has led the re-pricing adjustment with significant outward shifts in yields taking place in Q3 alone. The sector is expected to witness outward movement in yields proportional to the compression witnessed over 2017-2021. The re-pricing in logistics is front-loaded in 2022 in most mature markets.

The strong investor interest in the asset type and the strong dynamics in the fundamentals will result in yields compressing ahead of the retail and office sector.

Prime office yields are also expected to move out, second to the outward movement witnessed in logistics.

The retail sector underwent some painful adjustments during the pandemic as it adapted to the rapidly changing consumer behaviours. This in effect will help the sector withstand the upcoming recession and recalibration in real estate, therefore the fallout for the sector relative to offices and logistics will be less.

The strong rental momentum has resulted in upward revisions to prime rental growth, particularly for 2022.

Out of 47 office markets in our coverage, 21 registered y/y growth in Q3 2022 (strongest in Prague, Amsterdam, London West End, and Italy). The remaining markets (13) recorded stability in rents.

Retail rents are a mixed picture. Some markets are set to record their last year of decline in 2022, while a few continue to witness rental adjustment in 2023.

Lack of supply and higher construction costs has led to strong rental growth across a number of logistics markets. Out of 36 logistic markets covered, eight registered y/y growth of above 20% in Q3 2022 (strongest in West London, Birmingham, and Prague).

Across Europe, we have made downward revisions to our prime rental growth forecast in 2023. Download the report to get more insight.