Traditionally, the European and North American real estate markets have mirrored each other, with trends in one region often predicting similar movements in the other. However, the current global economic climate, characterized by inflation, rising interest rates, and banking sector jitters, has disrupted this historical correlation.
This article delves into the key differences between the European and North American real estate markets, highlighting why a direct application of US trends to Europe might be misleading (as recommended here in an insightful piece by Motti Gruzman of Excelion on eureporter.co). Here’s a breakdown of the key factors that set these markets apart:
Rebased Values and Market Reactions
Europe’s real estate market has undergone a swift repricing to reflect the new economic reality. Valuers have adjusted prime yields and discount rates to account for rising interest rates, leading to a rapid correction in property prices. While deal flow has slowed down, transactions are happening close to book values, indicating confidence in current valuations and improved market transparency.
In contrast, North American property values have been slower to adjust. While a decline has been observed, it hasn’t been as significant as in Europe. This seemingly slower adjustment might be misinterpreted as resilience, but a closer look reveals a different story.
Investor Sentiment and Office Investment
Investor sentiment towards office space in the US is considerably weaker compared to Europe. Traditionally, office investments constituted nearly half of all commercial real estate activity in the US. However, this share has plummeted to a mere 20% in Q1 2023. Conversely, Europe and Asia have maintained a more stable share of office investment despite an overall decline. This disparity reflects investor skepticism about current valuations in the US office market.
Fundamentals and Rental Growth
Vacancy Rates: Europe boasts significantly lower office vacancy rates compared to the US, sitting at a healthy 7.6%. This low vacancy rate paves the way for potential rental growth in the European market. Major US markets, on the other hand, have witnessed a substantial rise in vacancy rates since the pandemic. Cities like San Francisco have seen vacancy rates soar from a pre-pandemic 3% to a staggering 30%, raising concerns about the obsolescence of many US office buildings, particularly high-rise towers that are more challenging to repurpose compared to Europe’s lower-rise buildings.
Rental Values: Despite economic headwinds, prime rental rates in Europe, especially for sustainable and amenity-rich spaces, continue to exhibit positive growth. JLL forecasts a promising 2.2% annual average rental growth for prime offices in Western Europe over the next five years. The US market, however, presents a less optimistic picture, with prime office markets expected to see a modest 1.9% growth by 2027.
Net Absorption: Europe’s office space net absorption remains positive, indicating that leasing activity is outpacing new supply. This means that more space is being occupied than is being added to the market. The US, however, is experiencing declining occupier demand and increased development, leading to negative net absorption.
Lease Incentives: Lease incentives in Europe are significantly lower compared to the US. This highlights a stronger bargaining power for tenants in the US office market. In contrast, European markets are better positioned to see an increase in net operating incomes despite rising financing costs due to lower lease incentives.
Flexible Working and Office Utilization
The concept of hotdesking, where employees don’t have assigned desks, has been more widely adopted in European offices compared to the US. This practice allows for a more efficient use of space in Europe. JLL data showcases this disparity, with US office occupancy ranging from 40-60% compared to a much higher 70-90% in Europe. This efficient space utilization, coupled with a quicker return to office work in Europe, positions European markets favorably for managing long-term demand for office space.
Conclusion: A More Promising Outlook for Europe?
The substantial repricing, lower vacancy rates, positive net absorption, and efficient office space utilization in Europe all suggest a potentially stronger position compared to the US market. While Europe faces its own set of challenges, including the possibility of further value corrections, its current fundamentals indicate it may outperform the US market in the medium term. North American real estate, burdened by financial instability, oversupply concerns, and high valuations, faces a more uncertain future. Understanding these nuanced differences is crucial for investors and stakeholders navigating the evolving global real estate landscape.
