The European real estate market is being negatively impacted by rising interest rates, an energy crisis, and geopolitical uncertainty, but the situation is far from grim, according to Christoph Schmitt (Partner, Audit) and Livio Gambardella (Partner, Head of Real Estate) of BDO Luxembourg.

In early October, BDO Luxembourg attended EXPO REAL in Munich, Europe’s biggest annual trade fair for real estate and investments. The experience offered a solid overview of the sentiments that have swept over the whole sector, Mr Schmitt says. Originally, the focus was supposed to be on ESG – including affordable housing and climate protection – and interest rate policy. That plan changed significantly with the start of the war in Ukraine. The conflict prompted an energy crisis and deep uncertainty that has exacerbated the effects of interest rate hikes, which the ECB has raised twice this year and will likely do again by the end of October. The focus at EXPO REAL naturally shifted to these new developments, issues about which Mr Schmitt and Mr Gambardella share their insight.

A swift cooldown in the market

Activity in the investment market has cooled rapidly. Transaction volume declined significantly between March and June. For example, the second quarter was the weakest for the German real estate market, in terms of transactions, since 2016, according to research carried out by the real estate services company Savills.

Many sellers have taken their assets off the market because the original asking price no longer seems achievable.
Christoph Schmitt

Christoph SchmittPartner, AuditBDO Luxembourg

"Investors who operate with a high level of debt seem to have halted their purchase plans, and investors backed by a high level of equity capital are waiting to see how prices and the general market develop, as mapping of the current price level is not easy at present. Many sellers have taken their assets off the market because the original asking price no longer seems achievable.” explains Christoph Schmitt, Partner, Audit, BDO Luxembourg

All market participants are now dealing with an environment which has changed completely within a few months and become much more complex. The market is currently balancing itself between changing financing conditions, the prevailing price expectations of sellers, and increasing capital pressure in the market.

A need for caution and but not panic

Prices will continue being impacted by high inflation and interest rates as well as significantly increased building costs. Consequently, we believe that focus of the European real estate industry will recenter on core and quality assets.

Clearly, financing conditions have deteriorated. The days of cheap money seem to be over, and we’re returning to a more normal financing environment .
Livio Gambardella

Livio GambardellaPartner, Head of Real EstateBDO Luxembourg

As a consequence, certain institutional investors have turned their back on real estate and are eyeing bond markets. Despite this reservation about real-estate investment, a rise in yields does not mean that property values will necessarily fall. We must keep in mind that if properties are occupied by tenants who can bear indexation or pass on the additional costs, higher future rental income should increase the current yield and compensate for a higher level of the initial yield for which the property was acquired.

Overall, there is not enough empirical data to allow European real estate investors and sector participants to have a clear view as to where things are heading. Currently we do not have sufficient comparable values, such as concluded transactions which are expected to be available only in the fourth quarter of 2022. On that note, as of yet, there is no evidence for general doom and gloom. However, in this market climate, it is important to exercise caution and discretion. The market is in an orientation phase. Although topics like ESG and climate protection are not the top priority right now, we are certain they will continue being key future trends which are already transforming the real estate industry.

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