European commercial real estate investment tumbled last year to its lowest level since 2012, with investment in German real estate crashing by 54%, according to the latest Europe Capital Trends report from MSCI Real Assets.
The volume of completed transactions in 2023 halved from a year earlier to 166.1 billion euros, sparing no market or sector, the report showed. Property sales declined 43% in October through December from fourth-quarter 2022, to 41.1 billion euros. That left Europe’s overall investment activity in commercial real estate more than 60% lower than at the peak registered in June 2022.
The findings of this report, while perhaps not coming as a huge surprise to active market participants, nonetheless represent a stark depiction of the so-called 'price expectation delta' in Europe, and how far apart these purchase price expectations really are in some of Europe's biggest cities, and in particular, the German A-cities.
Tom Leahy, Head of EMEA Real Assets Research at MSCI, said: “Our pending transactions data point to a continuation of the subdued activity with property values still falling for the most part. The painful adjustment to higher interest rates is taking longer in real estate than for other asset classes – a reflection of the time required to transact and the illiquid nature of heterogeneous property assets. We are seeing only certain pockets of the overall market showing signs of bottoming out.”
Price Expectations Gap
The MSCI Price Expectations Gap highlights how much further prices may need to adjust for a return to more normal levels of transaction activity. Some of the largest differences in pricing centre on the office sector, a result of the impact of hybrid working and buildings needing to meet higher environmental standards. MSCI’s model indicates a pricing differential of -41% for offices in Germany’s A-Cities, -28% for Paris and -48% in Amsterdam, underscoring the extent to which asking prices would need to fall to meet the discounts demanded by buyers.
While every type of real estate registered lower transaction volumes, offices remained the largest sector in Europe, even as the number of properties sold sank to a record low. There were €43.9 billion of offices sold in 2023, down 59% from a year earlier.
And offices remained the sector with the largest discrepancies in price expectations between buyers and seller, not just due to the sharp rise in interest rates, but also to the economic downturn - and structural distortions such as the European ESG regulation and the changed and shrunken demand for space due to home offices. Big global investors have effectively frozen further buying of offices, faced with the unquantifiable risks of hybrid working and heightened environmental standards.
Paris ended the year as Europe’s top investment destination, overtaking London. Seven of the 10 largest single property sales last year took place in the French capital, led by luxury goods chain LVMH’s purchase of its flagship store at 150 avenue des Champs-Elysees. The acquisition, for €1 billion, reflects a broader pattern of occupiers buying the buildings they were previously renting. These larger transactions limited the contraction of the French market as a whole to -38% last year, for a sales total of €26.7 billion.
Distress in Germany
The U.K. remained Europe’s largest investment market even as the challenges for the office sector led a 42% fall in overall transaction volumes. In Germany, activity was the slowest since 2010, with a 54% decline to €27.9 billion. The country’s valuation system does not encourage rapid adjustment to values, or 'marking to market', contributing to the -31% price expectations gap for offices nationwide, says the MSCI report.
Germany also accounted for 55% of the assets in a position of distress at the end of 2023, according to the MSCI Real Capital Analytics database. The main sources of concern are the loan-to-value and loan-to-cost metrics employed by German banks during their lending boom in the low interest rate era that followed the Global Financial Crisis, says MSCI's Leahy.
Further useful research from German market research firm Bulwiengesa seems to confirm the relative stability in office values outside the top cities. (See our interview in this issue with CLS Holdings' German CEO Rolf Mensing on secondary and tertiary locations.) Bulwiengesa says the 'particular volatility' of office properties in the A-cities led to a loss in value of 18% in 2023, whereas the so-called D cities from Aschaffenburg to Zwickau, on the other hand, suffered much less (-3%).
MSCI's Leahy concluded: “We may have a little longer to wait for a recovery in dealmaking in Europe’s markets. If central bankers decide to bring interest rates back down again, this will certainly bring welcome relief. There remains, however, a more fundamental question of real estate’s place within investors’ portfolios relative to other asset classes, notably bonds, now the record low interest rate environment is finished. This will impact allocations to property assets and dictate investor expectations for future returns.”
