Is European retail real estate heading for a renaissance?

It’s a new economic environment. But European retail investment is showing signs of bottoming out.

It’s true that the numbers are not perfect. Year-on-year European retail investment fell by 39% to €18 billion for the first three quarters of 2023.

However, it’s worth noting this was better than the broader commercial real estate market, which saw a 52% year-on-year fall in the same period. In addition, European retail investment volumes reached €4.9 billion in Q3 2023, signalling a potential stabilization of the retail investment market as the decline was limited to a 3.9% drop compared to the previous quarter.

Longer term, once financing conditions stabilize and confidence in a solid economic recovery strengthens, the retail sector is poised for growth in investment and market share.

Higher margins more flexible for achieving desired returns

Prime shopping centres and retail parks could appeal to investors seeking high-quality European real estate assets. The European weighted yields for prime shopping centres and prime warehouse retail parks stood at 6.15% and 5.76% respectively in Q3 of 2023. In contrast, the weighted prime yield for European offices and industrial assets averaged 4.33% and 4.8% respectively.

For investors who remain uncertain about the prospects for strong rental growth across wider commercial real estate, quality shopping centres and retail parks offer higher margins, more flexibility and lower risk for achieving desired returns. Well-connected retail assets near or within growing conurbations and with affordable or re-based rents would likely be of most interest.

Recent rent correction offers room for growth

While prime retail rents across Europe have typically demonstrated resilience against economic downturns, they fell in many locations during the pandemic. By Q3 of 2023, prime high street rents across the region were down by 12.7% on average from their 2019 levels, while prime shopping centre rents were 11% lower on average.

That’s not to say that there were no pockets of resilience and rental growth. Luxury pitches, such as London’s Bond Street and Munich’s Maximilianstrasse, demonstrated resilience, while some prime high street locations and prime shopping centres across Europe have seen +10% growth in prime rent levels on a year-on-year basis. In addition, some of Europe’s best retail warehouse parks benefitted from strengthening retailer demand throughout the pandemic and during the first three quarters of 2023, pushing up rents.

The better-than-expected sales in 2022 and the drop in rents in several locations across Europe have softened the impact of high inflation on the affordability of rents. Most rents continue to be paid, despite increases in energy prices, service charge costs and other expenses.

In the short term, the affordability of rents will be closely watched as inflation remains high in large parts of Europe. However, once inflationary pressures ease and retailers’ profits recover, strengthening retailer demand for space in the most sought-after locations is expected to push more rent levels upwards again.

Quality retail assets appear attractive

Will retail real estate investment bottom out during the second half of 2023 and recover in 2024? This remains to be seen as the short-term economic outlook remains uncertain. Assuming inflation across Europe continues falling beyond 2023 and financing conditions stabilize, the outlook is positive.

Well-positioned retail assets that fulfil a dominant role in their respective catchment area and well-connected retail assets that service local neighbourhoods are currently attractively priced. Together with prospects for future rental growth, particularly if rents have been re-based, retail investments are expected to follow.