Total returns for European real estate fell dramatically in the third quarter of 2022, most markedly in the UK, according to the INREV Quarterly Fund Index, which tracks non-listed portfolios owned by institutional investors.

The overall total return for July to September fell to -1.6% from 2.61% during the previous three-month period, while capital growth declined by 429bps to -2.34%.

European real estate investment association INREV said this marked the lowest quarterly performance since the second quarter of 2009, in the aftermath of the global financial crisis (GFC).

It attributed the sharp correction to the ongoing energy crisis, triggered by Russia’s invasion of Ukraine, record high inflation and rapid interest rate rises across European markets.

INREV said that, while the correction was taking place across almost all markets, the scale of the decline was most acute in the UK, where the Q3 asset-level performance hit a low of -4.79%. The fall was more moderate in other core European markets, including France (-1.39%), Germany (-1.38%) and the Nordics (-1.3%).

For the majority of markets, quarter-on-quarter declines in performance stood between 280bps and 410bps, but it was significantly higher for the UK, at 844 bps.

INREV said this reflected the rapid and sharper monetary policy adjustments seen in the UK, which has recorded the highest interest rate rises in more than three decades, alongside the country’s “more pronounced real estate cycle, created by frequent valuations in the UK”.

The industrial/logistics sector, which has experienced strong performance in recent years, has experienced a dramatic correction, with total returns falling from 4.21% in Q2 to -4.06% in Q3.

INREV said this was not surprising, “given many years of consistent outperformance, sharp yield compression and relatively high rental-growth expectations in most geographies”.

The decline was most notable in the UK where Q3 industrial/logistics returns hit a low of -6.8% – an underperformance of 288bps compared to offices, the next weakest sector at -3.92%. In Germany, the difference in performance between the industrial/logistics and office sectors was even more pronounced at 381bps.

However, INREV said the fundamentals of the industrial/logistics sector, underpinned by the strength of e-commerce, should see occupancy rates remain relatively stable and high.

Residential was the best performing sector, with Q3 returns staying largely in positive territory across the three largest core markets, at 0.73% in the UK, 0.59% in France and 0.37% in Germany.

INREV said absolute levels of rents, business models and occupier affordability would be the “key differentiating factors for keeping certain real estate segments more resilient in the difficult operating environment”.

According to the INREV sentiment survey, 83% of respondents indicated that their assessment of investment risk had increased – for the fifth consecutive quarter. Moreover, the short-term performance expectations for European real estate were increasingly subdued, with 82% of investors and investment managers expecting a further slowdown in performance.

Similarly, as a result of deteriorating investment performance and growing risk, nearly half (46%) of respondents to the most recent survey were less confident about increasing their weightings to real estate.

INREV said that, while real estate might look unattractively priced compared to other asset classes in the short term, the correction in asset pricing was already beginning to crystalise, especially in the UK, setting up the potential for revival in investor demand later in 2023.

Iryna Pylypchuk, INREV director of research and market information, said: “This quarter’s findings paint a stark picture, but one that many in the industry have been expecting for several months.

“The current downturn is much more synchronised geographically, in contrast to the GFC when the UK was some six to nine months ahead of the continent in terms of repricing.

“The faster the correction takes place, the sooner non-listed real estate will be on an equal footing with the main asset classes, which should help to mitigate the denominator effect. However, until we see stability return to the geopolitical environment, inflation and interest-rate paths will remain difficult to assess, leaving downward pressure on performance across most asset classes, including real estate.”