Investors will need to embrace active asset management to capitalise on a bifurcated recovery. Christopher Walker reports
The past two years have seen commercial real estate markets struggle to adjust to the new reality of higher interest rates and challenging macroeconomic conditions. But all of that could now be about to go into reverse.
Real estate is sensitive to interest rates and, having been negatively impacted by recent rate rises, it is now expected to be one of the beneficiaries as they come down over the next 12 to 24 months. That makes 2025 a year of opportunity in most players’ minds.
A report by David Roberts, head of real estate strategy at Macquarie Asset Management, uses data from Preqin to show that real estate funds that deployed capital following periods of elevated volatility – including in the aftermath of the global financial crisis and the early 1990s recession – generated the highest internal rates of return.
“A similar returns pattern is expected for new fund vintages emerging from this cycle,” says Roberts. “Rising stress levels – particularly in the US and Europe – are creating opportunities to acquire new buildings and sites at discounted prices from developers struggling with refinancing risks, high construction costs, and lower sales prices. [Overall], the combination of lower interest rates and healthy global growth is likely to be particularly powerful for this asset class.”
Charles Allen, head of European real estate at Fiera, agrees. “Seasoned investors who have lived through market cycles will be alive to the fact that vintages in market downturns are always some of the strongest. To put it bluntly: when values are down, value can be found.”
According to LaSalle Investment Management, “European market evidence is crossing thresholds that point to a new cycle”. For example, in 2024, rents for new commercial leases across LaSalle’s European portfolio grew 2.7% relative to expiring past rents, representing a return to an above-inflation pace. “Expected go-forward returns for the overall European property market are at their highest level in a decade,” LaSalle says.
An area of concern, however, is the old continent’s economy. “We have sluggish economic growth in Europe,” says Keith Breslauer, managing director of Patron Capital. “It won’t be plain sailing.”
Political instability in two of Europe’s largest markets – France and Germany – combined with stretched public finances across the continent mean economic growth prospects are poor. Germany is suffering from “structural and cyclical economic headwinds, and we don’t see that changing in 2025”, says Mahdi Mokrane, head of investment strategy and research at Patrizia.
But, according to LaSalle, “as capital slowly returns to the market and yield spreads exceed long-term averages, the [European] real estate outlook has diverged from the region’s weak pace of economic growth due to a combination of supply barriers and asset quality polarisation”.
AEW’s updated relative value analysis makes a very comprehensive forecast of likely five-year returns. It signals a green light to investors, with 92% of the 168 European markets covered classified as “attractive” or “neutral”. This is based on a 9% per annum average expected rate of return. Benelux is ranked top, but 18 of the 20 European markets are classified as “attractive”.
“Prime yields have stabilised across all five core sectors since Q1 2024 and AEW’s yield forecasts confirm that the post-2021 repricing has come to an end,” says Hans Vrensen, AEW’s head of research and strategy in Europe.
As for the UK, a consensus forecast run by the Investment Property Forum (IPF), which collates predictions from 17 real estate investment organisations, points to five-year average total returns of 7.7% between 2024 and 2028.
Capital Economics, however, revised down its equivalent forecast to 7.2% in response to plans for fiscal loosening announced in the UK government’s October Budget. In an analysis of IPF’s Consensus Forecast, Matthew Pointon, senior commercial real estate economist at Capital Economics, said the government announcements “led us to push up our forecast for interest rates and cut our expectations for consumption growth”. The 7.2% figure reflects “our view that property yields will see virtually no compression over the next few years”, he said.
Where there is consensus, however, is that any recovery in European real estate will not be straightforward. In fact, it is likely to be K-shaped, reflecting a bifurcation of performance between the best performing assets and those destined for continued decline and obsolescence.
“This is now materialising across the UK and Europe,” says David Hedalen, head of private markets research at Aviva Investors. “We expect this bifurcation across sectors and asset quality to be a defining trend in 2025, with some assets recovering in value, while others continue their decline.”
A simple focus on beds and sheds?
A laser focus on ‘beds and sheds’ – or residential and industrial – has become a common portfolio theme for many real estate investors, and these two sectors continue to enjoy a fair wind going into 2025.
Greg Minson, global head of real estate asset management at Intermediate Capital Group, maintains his “strong conviction” for the European logistics market. “The sector’s supply-demand imbalances, coupled with post-pandemic preferences for on and nearshoring and the rapid growth of e-commerce, have intensified competition for prime, well-located warehouse space,” he says.
That supply-demand point in ‘sheds’ is a strong one. Crispin Gandy, CEO of Argo Real Estate, says: “New urban logistics development opportunities continue to be curtailed by alternative use competition and planning allocations for the available land, together with higher build and finance costs that are making redeveloping many existing sites unviable. This continues to lead to an undersupply of quality urban logistics space… at a time when there is strong occupier demand driven by long term e-commerce growth and companies onshoring.”
Overall, Vrensen predicts rental growth for logistics at 2.3% over the next five years. He expects good rental growth in residential of 2.5% between 2025 and 2029.
But simply adopting a singular focus on ‘beds and sheds’ might not be sufficient in the future. “It is now becoming too simplistic to capture the more complex dynamics of the market,” says LaSalle, which suggests the moment could be right for certain out-of-favour sectors to make a comeback.
Europe’s office markets, for example, are leading the way in adaptation to hybrid working, helped by their largely mixed-use, mid-rise character, which creates distinctive opportunities. “A rebalanced office sector is not a distant next buyer prospect for many of Europe’s markets – it’s happening now,” says LaSalle. “This is evident in return-to-office figures as well as property fundamentals.”
Vrensen predicts offices offer the highest returns of all sectors in the prime end of the market – at 10.9% per annum over the next five years. Benelux and France combined edge out the UK for highest projected prime total returns at 10.3%. AEW projects 2024 to be the peak for office vacancy rates, which it expects will come down to 6.8% by the end of 2029.
Retail back on the menu?
According to Elmar Schoonbrood, Co-CEO of European retail property owner Multi Corporation, footfall and sales have been above pre-pandemic levels for the higher-quality retail assets in Europe, while the rate of retailer failures has levelled out.
“On top of that, from a financing perspective there is a greater appetite from institutions to lend to retail businesses,” he says. “After what has been a challenging decade, there is finally cause for cautious optimism about the future of the retail sector.”
But the bifurcation – or K-shaped recovery – is playing out here. Schoonbrood says that, across the 15 countries in Europe where Multi operates, “it is clear that both consumers and tenants are prioritising the most attractive sites”.
Taylor says: “In many ways, the extreme bifurcation in demand we observe within the office sector has already been played out across the retail market, with many high streets ravaged by a combination of online sales, competition from out-of-town retailing and the impact of COVID on work patterns in town centres.”
Mark Smith, head of regeneration at Praxis, agrees. “We believe consistently improving operational performance alongside historically high entry yields make the retail sector one of the most compelling investment opportunities in 2025.” Over the past year, his retail portfolio has seen positive footfall growth, particularly in city centres, and leasing volumes are up 30%. “Well-located, well-connected schemes with the right tenant mix remain more resilient than ever,” Smith says.
Nevertheless, investors should be wary of getting too carried away with the retail recovery story. According to Vrensen’s numbers, both prime shopping centres and high street retail are expected to have below average rental growth of 1.3% pa between 2025 and 2029.
K-shaped recovery calls for active management
The bifurcation increasingly evident in every sector and every country in the region points to a dominant theme – active asset management.
A focus on tenant experience will continue to drive demand to the premium assets and locations, and “further widen the chasm between best-in-class and stranded assets,” says Barry Jessup, managing director, Socius. “Carbon saving and repurposing will be the saviour of the stranded assets, but only after heavy discounting.”
This is very clear in the UK. City centre placemaking projects such as King’s Cross, Leeds, Birmingham and Manchester have “continued to attract best-in-class corporates”, according to Taylor, proving “creating relevant and resilient real estate requires a highly active approach to investing”. He adds: “Increasingly, we will see a trend towards an integrated operating model being adopted by successful long-term investors in real estate.”
That means offices linked to living and retail space, all managed effectively. “Offices increasingly need to be treated as operational real estate to maximise their value,” says Ben Henry, acquisitions director at Fusion Group. “The best performing and most attractive living sector assets will be those that feature hands-on asset management.”
Technology will be important. Faisal Butt, managing partner at Pi Labs, says: “Real estate value creation will have to come from driving operational efficiency – and to stay ahead of the game, owners need to quickly identify which AI startups can best drive asset performance. 2025 will be a year where the AI winners start to emerge.”
Real estate investors face substantial opportunities in Europe in 2025 – but they will not be able to take a passive investment approach if they are to succeed.
