The first quarter of 2024 has seen Europe’s real estate market navigating through a landscape marked by cautious optimism. Following a downward trend since Q3 2022, the sector is adjusting to a transition toward a higher baseline rate environment and adapting to the implications of increased inflation. With a corresponding higher baseline inflation level, real estate investment strategies need to, and importantly now, are adjusting to that new normal.

Capital Markets

European real estate transaction volumes reached €144bn in 2023, compared with €149bn in 2022. However, with interest rates looking to have peaked and inflation on its downward trend, 2024 volumes are projected to reach north of €177bn, approx. 20% year on year increase. In Ireland, the trend has been more pronounced with just under €2bn in transactions in 2023 compared to an average of €5bn over the previous 4 years. This delta in Ireland is attributable to being a smaller capital market with less liquidity, despite having one of the strongest performing economies in Europe.

If 2023 was the year of price exploration and discovery, 2024 is the year where common ground is starting to be found between buyers and sellers. Some of the contributing factors include; realism in seller expectations, stabilisation of base rates making debt underwriting easier, reduction in the 5 year swap rate (a key tenet of real estate investment deals) and all encompassed by the strong underlying performance in the economy.

In Ireland, a number of core investment deals have traded in Q1 representing green shoots in the recently starved core-capital space. 40 Molesworth Street, a majority office leased asset with a 6 year WAULT to break has traded at yield of just in excess of 5.20% setting the bar for core office deals as we move into Q2. Meanwhile, in Adamstown, Carysfort Capital and their partner TPG/Angelo Gordon sold 104 apartments and houses with stabilised rental income for a yield of c.4.75% to German Fund KGAL. While two swallows do not make a summer, these deals demonstrate capital markets transactions are there to be done for the right product in the right locations.

Often in downturns, both components of real estate valuations – rental income and yield – are negatively impacted. However, in the current cycle, most of the negative value impact has been in the outward movement of yields as a function of spreads to sovereign bond yields. Interestingly, with the strength of the underlying economy and job market, rental values have remained resilient in most sectors and have grown in others, namely Logistics, Hotels and PRS. The well-documented outlier are commercial offices, with more on that later.

‘Wave of Refinancings’

To date, expectations of widespread distressed opportunities have not been forthcoming. Our take from meeting over 60 investment groups in the last 4 weeks is this; there is ‘plenty’ of capital raised but accessing it is difficult and the appetite of managers to deploy it remains cautious. That said, conversations at MIPIM were more constructive and realistic focused on specific deals than they have been in the preceding 12 months.

Newmark the global commercial real estate advisor has noted that in the US alone there will be USD $2.0tn of refinancings in real estate in the next few years and estimate that USD $670bn of those will be troubled. In Germany, there is significant distress amid a lack of investment and liquidity shortfalls as economic growth slows down. This is further exacerbated by the more aggressive lending that has been a feature of the German market in recent years.

On the flip side, jurisdictions which struggled in the GFC including Spain, Italy, Portugal and Ireland – who implemented structural change to lending practices – are in a healthier state, where real estate leverage levels were at more muted levels entering this down cycle. This is providing more headroom as real estate values have come under pressure. We have been seeing evidence of this in the Irish market where refinancings are taking place for the most part in non-distressed scenarios. While there have been a few recent receivership appointments in the office space in Dublin, for the most part, promoters have utilised LTV headroom and additional equity contributions to refinance assets with current lenders or indeed with new lenders keen on entering the Irish market. We are currently in discussions with numerous international lenders and debt funds who are keen to deploy capital into Irish real estate deals.

Housing Investment

According to Eurostat, European house prices saw their first decline in a decade in 2023, with the EU experiencing a 0.3% drop and the eurozone seeing a 1.1% decrease, driven by declines in several northern EU states. Meanwhile, the Irish residential market along with some southern European nations have experienced growth. The significant supply vs demand imbalance in Ireland coupled with artificially low mortgage rates and counter cyclical State investment in housing is helping to keep the Irish housing machine growing as we seek to reduce the delta created by many years of under investment in housing here.

While we saw c.32,000 new homes delivered in Ireland across all tenures in 2023 and year on year commencements in Q1 2024 at peak levels for the last 15 years, many challenges persist in the housing sector. Two of the most significant being the dysfunction in our planning system and the lack of scale in the housebuilding sector, both of which hinder large institutional capital from investing here. The continuing tendency by various governments to make policy change to housing which may have political wins attached, often have unintended consequences of deterring patient, international capital, essential to ensuring we can deliver the housing we need. There is no more obvious an example of this than the current rent control policy being implemented via the Rent Pressure Zone legislation here. Nearly all institutional investment groups we have met this quarter, who represent considerable global PRS portfolios, have pointed to this single policy as a key barrier for investment in the Irish residential sector. Capital investment is global, and we should be under no illusion that Ireland is seen as just another potential investment location, and if the risks outweigh the returns (capped in this case), then the capital flows elsewhere.

Taking the temperature

Generally, European investors are showing a more diversified investment appetite than some of their US peers, with a significant interest in both core and opportunistic assets. While core assets in prime locations remain attractive for their stability and income generation, opportunistic ventures such as value-add opportunities and redevelopment projects also garnered attention, particularly from PE and Value-Add fund managers. Emerging markets and secondary cities are presenting some unique opportunities for investors willing to take on higher levels of risk.

Across the board, returns required from core to opportunistic strategies moved upwards by 2.5% or more in 2023 compared to 2022. This was primarily to attain higher risk-adjusted investor returns that attracted LP capital relative to allocating to other non-real estate investment classes. This translated to equity & opportunistic returns moving from 15% IRR towards 20% IRR. However, this year we are hearing some investment groups in this space back speaking of 15 – 17% net IRRs indicating slightly lowered return expectations which is positive from the perspective of those seeking to raise capital or source equity partners in larger schemes.

The scale of investment funds continues to pose challenges for mid-sized investment deals in Ireland. Large funds with the most appetite to deploy capital in this phase of the cycle, have minimum deployment tranches of €50Mn – €75Mn which makes it difficult for them to source suitable deals here. Similarly for promoters and sellers of assets, assembling large enough portfolios to access such funds has its own difficulties. That said, we cover in excess of 300 investment groups that are active, or are keen to become active, in Ireland and have a variety of scale and investment priorities.

Sectors in Favour

The trend line in 2023 was ‘Beds and Sheds’ and from recent global meetings in 2024 that has become ‘Meds, Beds, Sheds, Hotels and Data’. In addition to this, a number of investors are back looking at retail and there are some value-add investors back looking at offices! This expansion in the number of sectors that investors are willing to participate in is a testament to the strength of the economy but also an increased appetite to take risk as underlying market conditions settle.

There is no doubt that offices are grappling with the tug-of-war between return to office champions and those who have become accustomed to the convenience of working from home. While there’s been a considerable shift in the way we work throughout the week, what is emerging is that office occupiers require space for peak demand in the middle of the week and as a result significant downsizing of offices is not a trend likely to be seen across the board. Rightsizing is happening but many employers in a growing economy are also planning for increased headcount as topline increases and with this, they are planning for more office space. On this front, offices in Europe have fared much better than their US counter parts as cities in Europe are more compact, most people did not move thousands of miles from cities (as was evident in the Sunbelt in the US) and commutable city living is a core tenet of European culture. With this, office vacancy levels are back to very low levels in core cities in Europe. However, Dublin is an outlier with considerable available space from large-scale developments coming to completion in 2024 and 2025 which will take time to get taken up. In the medium term, office investment in core, high-grade ESG, prime locations will outperform and will remain attractive to the hundreds of global investment groups seeking this asset class.

As Europe’s real estate market navigates through uncertainties, the first quarter of 2024 reflects a trajectory of cautious optimism. Investors are increasingly prioritising stability, income generation, and risk mitigation in their investment strategies.

While challenges persist, opportunities exist across various sectors, with investors adapting to evolving market dynamics and emphasising sustainability as a cornerstone of investment strategies. Those with a nuanced approach and strategic foresight at local level, will stand best-placed for resilient growth in the quarters ahead as they take on first-mover advantage in their location of choice.