Europe’s commercial real estate market is facing a difficult second half amid rising interest rates and uncertain economic conditions.

Investment into the sector reached €157 billion (US$160 billion) in the first half of 2022, the strongest ever H1, according to data published by real estate company CBRE. The growth was driven by an especially strong first quarter.  Investment, however, declined 9% year-on-year to €71 billion by the end of June 2022. The slowdown was due increased borrowing costs and economic uncertainties, according to the latest edition of Cerulli Edge.

There may be further corrections in asset pricing over the next six months, with poorer-quality assets in weaker locations hardest hit and well-located assets with strong environmental, social and governance (ESG) credentials likely to outperform, Cerulli Associates says.

European property shares fell 29% in Q2 2022, nearly double the losses of European equities. Of particular concern are areas where low funding costs over the past decade have left yields low in absolute terms and in some cases below the marginal costs of funding.

“Sentiment around listed European real estate deteriorated significantly over the first half of 2022,” says Cerulli director Fabrizio Zumbo. Inflation has triggered a hawkish pivot across central banks in Europe, causing yield expansion that challenged not only valuations but also business models, particularly in high-growth segments such as residential and logistics real estate.

An analysis made by Cerulli of the distribution of commercial real estate investments in Europe between 2016 and 2021 by asset class shows that multi-family property investment has risen significantly over the past five years, mostly at the expense of retail.

“Investors are aware of wider economic concerns around inflation and rising rates. Real estate investment trusts tend to reprice six to 12 months ahead of the direct market, with reduced holdings reflecting their sentiment toward the outlook for real estate,” says Zumbo.

The outlook for the sector rests on whether real estate companies will be able to appropriately plan and execute their asset disposal programmes without significant discount to book value and whether landlords will be able to pass on part of the inflation uplift in increased rents, he adds.