European economic outlook

Activity

Weak activity data, including a disappointing retail sales outturn over November, confirm that the Eurozone recovery is in a fragile state. Growth in the fourth quarter will likely be very slow at best. Uncertainty arising from Trump’s trade measures will pose a further headwind to growth. With the restrictiveness of European Central Bank (ECB) policy being rapidly reduced, we don’t expect the Eurozone’s economy to drop into recession, though risks remain. Easing is already reflected in bank lending data. The negative fiscal impulse should also moderate over 2025. In all, we expect gross domestic product growth of 1.1% next year. 

Inflation

Eurozone headline inflation rose to 2.4% in December, given base effects in energy components. Core inflation remained at 2.7%. Disappointingly, services inflation rose a touch. However, this pick-up was driven by the most volatile services components: air fares and package holidays. Excluding these items, there was no increase in services inflation. Moreover, our in-house indicator of ultra-low import-intensity inflation shows domestically generated pressures easing in line with the softening of the labour market in large economies, such as Germany and France. We expect inflation to return to target in the early months of 2025, partly due to weaker services inflation.

Policy

The ECB cut by 25 basis points (bps) in December, and a consensus in favour of rapidly moving monetary policy settings to a neutral stance has formed among policymakers. Two key questions from here are how quickly rates will be cut, and whether policy needs to become outright accommodative. We think the ECB is more likely to keep lowering rates in 25bp rather than 50bp increments, and we don’t think the state of the economy warrants outright accommodation. However, weaker-than-expected growth, perhaps as the result of trade disruptions, would prompt the ECB to rapidly take rates into accommodative territory.

Key takeaway

While risks have increased, Eurozone economic growth of 1.1% and four interest rate cuts in 2025 would support an ongoing real estate total return recovery. 

Eurozone economic forecasts

Source: abrdn January 2025 
Forecasts are a guide only and actual outcomes could be significantly different.

European real estate market overview

In December 2024, our abrdn multi-asset investments houseview further upgraded global real estate to “+2 overweight” (maximum score +4), owing to the clearer improvement in return performance in key markets. While fixed income and real estate investment trust performance have been volatile in recent weeks, we remain confident in our expectation for an ongoing recovery in real estate total returns in Europe.

Market volatility and the global bond market tantrum were driven by multiple risk factors. As Trump's inauguration neared, fears of trade tariffs, inflationary policies, and uncertain foreign policy towards Greenland, Panama, Ukraine, and China unsettled investors. Meanwhile, low growth, high public debt and worries about fiscal policy pushed up long-term bond yields. Elections in France and Germany further added to the uncertainty in Europe's major economies. We have seen a cooling in market volatility in Europe since mid-January, and we believe inflation and interest rate cut expectations will return to drive short- and long-term interest rates in Europe.

Market momentum in European real estate continues. MSCI annualised European total returns increased to 0.7% in the third quarter of 2024. When the fourth quarter is reported, we expect a sharp increase in returns; a weak fourth quarter in 2023 will drop out of the data and a more positive quarter will be added in the fourth quarter of 2024. Indeed, Portugal, Netherlands, Sweden and Denmark all delivered total returns of more than 4% in the first three quarters of 2023. This compares with 3% for Continental Europe over this period. We expect full-year 2024 European returns to have reached 5%, representing stable capital values. 

We expect returns to improve further in 2025, as stable income returns are joined by modest capital growth. CBRE yield sheets in January 2025 show that 24% of markets are experiencing positive yield movements, with 72% being stable. All sectors and most regions are seeing improved capital market conditions, aside from poorer-quality offices. 
We see signs of bidding intensity emerging at the point of transaction. Green Street transaction price indices increased 0.2% quarter-on-quarter in December 2024, but by a stronger 1.2% in industrials and 0.9% in residential. Offices and retail are still seeing transactions below valuation, with offices falling 1.1% and retail 0.2% over the quarter. We believe the positive transaction pressure in industrial, core offices and residential property will feed into stronger valuations as the year progresses. 

Transaction volumes are now increasing too, reaching €50 billion in the fourth quarter and €175 billion over 2024. For the first time since June 2022, both annual and quarterly investment increased in December 2024. Greater transactional evidence should help price discovery and lead to better performance. 

An important feature that underpins our cyclical recovery thesis is ongoing rental growth in good-quality assets. European all-property rents increased by 4.1% over the year to September 2024, a slight moderation from 4.4% in June. Residential and logistics assets have outperformed but rents have increased across all sectors. Low supply persists and new construction orders are falling at a steady pace. High construction costs, high development finance rates and tight labour markets mean we believe that nominal rental growth will continue to beat inflation in 2025 and beyond. 

We have increased our European total return forecasts to 9.5% per annum over the next three years. And we have moderated growth expectations in some markets, given weaker economic growth forecasts. Netherlands, Spain, Denmark and Sweden are expected to outperform, while Ireland and Finland have been downgraded slightly and are expected to lag the recovery.  

European real estate sector trends

Offices

Europe’s office markets have delivered better operational performance than the headlines suggest. Most major markets (aside from the wider Paris region) experienced modest net absorption in 2024, as daily office use crept higher and office occupiers began to take decisions on their office requirements in a post-Covid world. 

A survey of major office employers by Savills showed that over the last two years, companies have increased their daily office attendance. It was over 65% during midweek in December 2024, from a low point of 59%, marking a steady increase in attendance. JP Morgan has mandated a full return to offices from March and other companies, such as Amazon, are moving back to a more office-based culture. One of Donald Trump’s first executive orders was to mandate full-time office attendance for all federal government employees. We believe there will be a surprising shift away from home working as 2025 progresses and labour market conditions ease. 

Offices made up the largest share of total investment in 2024, at 24%. The sector was supported by a large portfolio transaction involving the acquisition of business parks in France by Blackstone. However, interest in core offices is increasing sharply, which is reflected in pricing trends in central business districts. Rents in high-quality buildings in core locations are rising rapidly and investors are seeking to buy into the potential rent reversion in these locations. Prime yields in Paris’s central business district have fallen from 4.5% to 4% in January 2024.  

Logistics

After a post-pandemic breather when take-up eased, logistics occupier market activity appears to be stabilising. Occupancy rates across the top 30 markets are close to 95% and Savills has reported that vacancy rates fell marginally in the fourth quarter. Premium-quality warehouse availability and warehouses in city fringe locations are still scarce. New supply is projected to decrease further, dropping below 5% of total stock in 2025 and approaching closer to 4% by 2026.

Logistics rents grew by 5.7% year-on-year, as at September 2024, though this was slower than the 11% growth in 2022. Rental growth is expected to outpace inflation in 2025, given limited supply in prime locations, yet secondary stock won’t experience the same amount of tenant competition.

Investor sentiment in logistics remains high and competition for prime logistics assets is often intense. Logistics investment represented 23% of the total in 2024, with investors now focusing on both core and value-add opportunities. Surprisingly, prime logistics yields have been slower to fall than in core offices and residential, despite the strong bidding intensity, but CBRE has now moved most logistics yields lower by between five and 15 bps in January 2025. We believe this trend will accelerate as the year progresses and start to affect valuations more broadly.    

Retail

Retail has been one of the best-performing sectors in the last year, given its high-income return and improving fundamentals. Investors are still cautious about the sector. And, at €32 billion, it only constitutes 18% of total capital invested, compared with more than 25% in 2015. Diversified fund allocations to retail have fallen from a peak of over 30% to 15% in 2024. 

Parts of the retail market are returning to favour, with retail parks being a key focus for investors. Low levels of development, improving occupier fundamentals and relatively positive consumer trends have supported the segment’s revival. MSCI data shows net-operating income per square metre has been stable in the segment for the last two years, following a significant drop since 2015 (-24%). This suggests landlords are having an easier time maintaining cashflows and controlling costs. The vacancy rate for retail warehouses in Europe averages 3.9%, dropping to as low as 2% in the UK. 

Retail warehouse yields are set to see compression in the coming months. We have seen strong bidding intensity on recent deals, with MSCI data showing transaction yields falling from 7.7% in December 2023 to 6.9% in December 2024. CBRE is yet to move retail warehouse yields lower in Europe during this cycle, although it has cut UK retail park yields from 7.1% to 6.6% in the last 12 months. We expect a similar trend to start to come through in Europe too. 

Living

The rented residential market's fundamentals are the strongest among sectors, with vacancy rates in Europe's top 30 cities stable at around 3%. This tight market is causing ongoing rental growth in some cities, averaging 6.3% annually, as at the third quarter of 2024. We project European residential rents will increase by 3.2% annually over the next three years.

Low new supply supports sector resilience, with EU construction orders down 16% year-on-year in December 2024. Data from Green Street shows that net new housing supply in Europe will be below the rate of household growth until 2028. However, with housing development targets consistently missed, it’s unlikely that 2028 will represent a change in the supply situation.  

Residential transactions are picking up after low activity, comprising 23% of all deals in 2024. With upcoming large portfolios and Vonovia re-entering the transaction market, deal-making is expected to rise. Investor surveys show residential as the preferred sector, enhancing overall liquidity potential. Student accommodation is a key target for a range of investors, but a lack of investment opportunities is holding back transaction volumes, which should lead to positive valuation trends in the segment during 2025. 

Outlook for performance and risk

The outlook for European direct real estate returns has improved, despite a modest increase in the risk backdrop. Yield spreads have been volatile, but at the start of 2025 they were 260bps, on average. The margin between prime real estate yields and long-term bond yields is now only 10 bps weaker than in September 2024. With income growing through indexation and rental growth, we believe that direct real estate remains good value and will draw capital back in during 2025. 

We forecast European all-property total returns of 7.9% in 2025, with three- and five-year annualised total returns of 9.5% and 8.7%, respectively. Returns are income-driven, with rental growth and yield impact both contributing to improving capital growth performance. We favour the UK, Netherlands, Spain, Denmark, and Sweden in the near term. 

We no longer anticipate any further falls in prime European all-property values. Secondary assets, particularly weak offices, have not repriced enough and will suffer further valuation declines, although the pace of decline is clearly slowing. Stabilising yields and continued healthy levels of income growth should support an improvement in momentum this year. 

The main risks to our outlook are a steeper yield curve where investors attribute greater sovereign risk, squeezing real estate yield spreads, and a much sharper economic slowdown across continental Europe. Neither is our base case, and we believe there could be downside risks to interest rates that would support asset values and could drive yields lower than forecast. 

In terms of strategy, core pricing remains attractive, particularly when considering income growth potential. However, value-add strategies should benefit from stronger underwriting on exit yields in a lower-rate environment. We favour overweight allocations to logistics, rented residential, hotels, student accommodation, modern retail warehousing, core offices, and alternative segments like data centres.