European commercial real estate: Selectivity key amidst market headwinds

The European commercial real estate sector is confronting significant headwinds from tightening financing conditions and a challenging economic climate. After attracting substantial investment during the era of low interest rates, the market is now contending with factors like weak economic momentum, increased risk of tenant defaults, and higher interest rates impacting debt servicing and refinancing.

Sharp increases in construction costs are discouraging new developments and raising expenses for maintaining and upgrading existing properties. However, subdued construction activity during the pandemic has limited new supply, mitigating price pressures and leading to a divergence between prime and non-prime assets and locations.

According to a report by Allianz Trade, commercial real estate prices in major Eurozone economies are expected to fall by 10-15% between 2023 and 2024, with significant variations across countries, segments, and asset quality. The office segment, particularly in non-prime locations, is anticipated to undergo price corrections. Europe is expected to fare better than the US, with remote work being less prevalent.

Limited new supply and rising interest rates are supporting rental levels. Beyond the resilient office sector, logistics and data centers are identified as growth areas. The hotel sector is also becoming more attractive due to a strong recovery in tourism, especially in France and Spain. The retail segment is expected to remain fragile as consumers continue to shift towards online purchases.