No giant leap for French real estate in 2025

After two years of macroeconomic and geopolitical tensions, European real estate markets have been showing some signs of recovery in recent months. But while neighboring countries are showing signs of recovery, France is still marking time, and is likely to end 2024 with investment volumes still lagging behind. Could 2025 (finally) be the year of the rebound?

The inflationary surge that has disrupted all sectors of the global economy since mid-2022 and largely redrawn the contours of the real estate markets finally seems to be behind us. "Headline inflation in the eurozone is set to fall by more than half in 2024, from 5.4% in 2023 to 2.4%, before declining more gradually to 2.1% in 2025 and 1.9% in 2026," the European Commission predicted in a forward-looking note published on November 15.

In addition, the Commission expects GDP to grow slightly on the Old Continent: from 0.8% in the eurozone in 2024, it forecasts that economic activity should accelerate to 1.3% in 2025, before settling at 1.8% the following year. Against this backdrop of stabilization and sluggish growth, the Governing Council of the European Central Bank (ECB) cut its three key interest rates by 25basis points on October 23, the third such cut following those made in June and September.

For a real estate industry that has seen the value of its assets plummet over the past two years - "The adjustment of real estate values has never been so violent, not even in the 1990s," recalled Béatrice Guedj, head of research and innovation at Swiss Life Asset Managers France, at the most recent conference of the Institut de l'épargne immobilière et foncière (IEIF) - this stabilization of the macroeconomic environment can only be welcomed. "Between the high point in May 2024 and the expected landing at the end of 2025, key interest rates will have fallen by around 200 bp," notes Cevan Torossian, associate director of studies and research at Arthur Loyd, adding that "a less restrictive monetary policy is good for real estate because it brings oxygen to the economy and better financing conditions."

"Real estate professionals have a much more positive outlook than last year, but they remain very cautious," said Simon Chinn, vice president, Research & Advisory Services at Urban Land Institute (ULI), commenting on the results of the "Emerging Trends in Real Estate Europe 2025" study. The annual study by ULI and PwC shows that 50% of the 1,143 European professionals surveyed are confident of seeing an improved market environment in 2025 (vs. 33% in 2024), and 46% even anticipate an increase in their profits for the coming year (vs. 31% in 2024).

The Inrev Quarterly Fund Index, which tracks the overall performance of the European real estate market, confirms this renewed confidence. After plunging into negative territory in the second quarter of 2022, it posted a positive performance for the third consecutive quarter in the third quarter of 2024 (+0.59%). In the same vein, the latest Inrev Consensus Indicator confirmed the recovery of the unlisted European real estate investment market in mid-September, posting at 55.8 the third consecutive quarterly improvement since it passed the 50 mark in March 2024, the index's equilibrium point between growth and contraction. In addition, four of its five sub-indicators showed positive momentum, with the investment liquidity sub-indicator showing the strongest rebound, having risen from 32 to 59.5 in just one year.

All these encouraging signals contributed to abrdn's decision, for the first time since June 2022, to recommend an overweight allocation to real estate in its September Multi-Asset HouseView report. "There are a number of factors behind this view, but the most important is that the major correction in values is now behind us," explains Craig Wright, head of European real estate investment research. "And while there are uncertainties around geopolitics and what a Trump presidency might look like next year, we are entering this period at the bottom of the market"

After two dark years in which devaluation was the dominant trend across the vast majority of its sub-sectors, the real estate market has finally bottomed out, also believes Mike Bessell, managing director and regional investment strategist at Invesco Real Estate: "It's pretty clear that, barring a major shock, the correction in property valuations is over. European cap rates and yields have remained stable since March in the vast majority of the sectors we consider, and over that period many have even tightened after overcorrecting slightly."

When the bottom is reached, the only possible direction is up. And for Craig Wright, the main driver for a recovery in property performance in the coming cycle is likely to be rental growth driven by a mismatch between "the very low level of supply for good quality assets’ and ‘a pipeline of which the prospects remain very limited, with new orders in the construction sector falling by 20% year on year." Pointing out that "rents fell by around 8% on average in Europe after the global financial crisis, across all sectors." He also notes that "rents have risen by 8% since the most recent market downturn, which shows that the context is completely different."

Mike Bessell warns, however, that "GDP growth alone will not be enough to drive rents up sharply" and that as a result "we need to look at pockets where demand is strong and supply limited, and where we can add value to assets across the value chain."

This environment is all the more favourable that "investor sentiment towards property is changing and, although it is still difficult to raise funds, there will be more and more capital looking for a limited number of assets on the market," believes Wright. While he confirms renewed investor interest in real estate, Bessell remains cautious: "Many of our customers who were taking a wait-and-see approach 12 months ago now describe themselves as taking a step-by-step approach and moving forward without rushing, understanding that we are past the worst of the crisis, but that there are still issues to be addressed. These include access to finance, noting that ‘many banks, at this stage, are still trying to sort out the situation in their accounts before they start opening up to new opportunities."'

According to Wright, a renewed appetite for property could have "a knock-on effect on valuations, which we are already starting to see" and, combined with improved funding conditions, "improve market liquidity over the next year." Convinced by the ability of its assets to deliver stable, and even growing, cash flows for the best assets in the best locations, Abrdn forecasts an annual return of 9.3% for European real estate over the next three years.

In detail, the British management company is particularly optimistic for logistics (11.1% per year), residential (10.3%) and hotels (10.1% per year), with retail (8.1% per year) and office (8% per year) slightly behind. Wright even predicts that "2025 will probably be one of the best vintage years for new investor allocations to property since after the global financial crisis."

What's the chance of reviving a European real estate investment market so sluggish that investment volumes fell by 46% last year, according to CBRE? At the end of the third quarter of 2024, the brokerage reported a 1% increase in committed volumes on a continental scale over the last 12 months, to almost €182 billion. This renewed interest had particularly benefited Italy (+48%), Spain (+14%) and the UK (+14%)... but not Germany (negative 11%) and even less France (negative 23%).

According to Cevan Torossian, "the French investment market is gradually emerging from the 'perfect storm,' caused by a sudden rise in interest rates that changed all the matrices, an explosion in construction costs, and strong doubts about office assets, which have long dominated asset allocations."' While ImmoStat reported only €7.8 billion deployed in the first three quarters of the year in French commercial real estate (office, retail, business and logistics), Arthur Loyd forecasts a landing of €10 to €12 billion for 2024. A far cry from the €34 billion invested in 2019, and possibly even lower than the €11.5 billion committed in the first half of 2022 alone.

"The year 2024 will be the low point in the cycle, and it's my conviction that the hardest part is probably behind us," reassures the associate director of studies and research, who points out that "the French 10-year OAT is now hovering between 2.90% and 3.10% depending on the day, allowing the real estate risk premium to stabilize."

According to Nicolas Verdillon, managing director of investment properties at CBRE France, "we can indeed hope for a rebound in 2025, but we must be cautiously optimistic, as we are in an extremely ambiguous and narrow market." He too notes that "a lower cost of money should normally enable us to have a little more theoretical financial volume and to use the leverage effect on profitability." However, he adds that access to credit is likely to remain complicated in the short term, as "banks will continue to be hampered over the next 18-24 months by issues of debt maturity, covenant compliance and loan default management."

In the same vein, he notes that despite the rate cuts enacted by the European Central Bank (ECB) and a falling five-year swap, "the real estate risk premium is not improving much, notably because the French budget deficit is heckling our 10-year OAT." For him, at around 150 basis points, the risk premium currently found on the Paris prime office has certainly recovered from the 75 basis points observed at the end of 2022, but remains well below the 10-year average of between 200 and 250 basis points.

Capital directed towards property in general, and office space in particular, is being deployed with "a hyper-polarization in terms of both locations and the fundamental qualities of operations," he observes: "Whatever the asset class, the market is therefore willing to reduce the risk premium as long as it identifies perfect rental security." As a result, Nicolas Verdillon predicts that while certain markets will perform well in 2025 - "we can see, for example, that yields have begun to compress, from 4.5% to 4.25% on the best office property" - the market should continue to overestimate risk, as evidenced by the 300 bp difference recorded between a prime Paris tertiary asset and a building in the northern inner suburbs." "As soon as your product is not prime, it is permanently affected, which blocks secondary location transactions, all asset classes combined," he adds.

For all that, we can hope that "more money will go into real estate in 2025, notably because the market is better educated and better structured to diversify the deployment of its capital than it was 18 months ago," rejoices Verdillon, noting however that this new capital will often be directed more towards value-add or core+ strategies.

"We've seen a real flurry of activity since the beginning of October, possibly because a window of opportunity has opened up between the sharp drop in financing costs - for the first time in two years, we're seeing investors financing under 4%! - and relative political stability, even if it only lasts a few months," observes Cevan Torossian, whose investment advisory colleagues report greater competition, both in Paris and on regional markets. "There's a realignment between sellers' and buyers' expectations, which had been holding up the market for a long time," he continues. "The fact that we've gained a certain degree of visibility on the macroeconomic and political fronts, even in the short term, means that things can settle down and we can return to the market more openly, particularly for value-added office assets, logistics or smaller volumes in the regions." Although a return to the €25 to €30 billion targeted not so long ago is out of the question, he believes we can look forward to a relative increase in investment volumes to between €13 and €16 billion by 2025.

Simon Chinn notes that "the sector is anticipating a slow, hesitant recovery rather than a major rebound," with several professionals interviewed by ULI and PwC estimating that the recovery of European markets could stretch out over a period of three to five years. Recalling that "in the 1990s, the decline in investment volumes lasted six to seven years," Nicolas Verdillon also anticipates only a slight rebound for the coming year: "It's positive to see that investment volumes are picking up again in most European markets, but it's clear that we won't be back above the €25 billion mark before the end of the decade.