On the supply side, rising construction costs are constraining development and slowing delivery of new stock (see Figure 2). In Germany, for example, supply levels have consistently fallen short of the government’s targets by a wide margin: Only 295,000 new housing units were delivered in 2022, once again well below the government’s annual target of 400,000.⁴ This gap is expected to continue widening as developers postpone or cancel approved construction projects due to rising costs for financing and materials. This dynamic is playing out in a market that is experiencing record immigration levels, resulting in a historically low residential vacancy rate of 1.9% as of Q1 2023.⁵

It’s no surprise that these factors are putting upward pressure on rents across the region, particularly in markets with more landlord-friendly regulations, such as the U.K., Finland and Belgium. In the U.K., rent growth reached 10% in 2022, roughly in line with inflation, and is forecast to outpace inflation over the next four years.⁶ These attractive fundamentals in the U.K. should support pricing power across the spectrum of rental housing—multifamily, single-family, co-living/flexible living and senior housing—as renting continues to be cheaper than buying.

Other markets, such as Germany and the Nordics, have a deep existing institutional rental housing sector and have historically been more difficult for institutional investors to enter at compelling pricing. However, these markets are now experiencing capital markets stress as the historically low cap rates are being repriced due to much higher interest rates.

The structural shift in the housing market away from owning to renting is being exacerbated by demographic trends, as demand for alternative, tailored and transient forms of housing rises. Across Europe, the number of young people (15-19 years old) is forecast to rise ~6% by 2027,⁷ which is bolstering the student housing market and driving a need for higher quality and institutionally managed accommodations. France, Germany, Italy, Spain, Portugal and the U.K. are all home to some of the world’s most prestigious universities, which continue to draw interest from a burgeoning pool of international students. However, most don’t have enough beds to accommodate escalating enrollment, causing a significant supply/demand imbalance (see Figure 3), particularly for purpose-built stock meeting modern occupational standards.

Many of Europe’s top-tier cities have dire student housing provision rates, including Rome (2%), Lisbon (4%), Valencia (5%) and Milan (6%).⁸ Even in the U.K., Europe’s most mature market for purpose-built student accommodation (PBSA), strong demographic tailwinds continue to support the long-term outlook, with an estimated 16% increase in full-time undergraduate numbers between now and 2030.⁹ With high occupancy levels alongside an influx of domestic and international students, PBSA is well positioned as a resilient asset class with an upward rent growth trajectory. In our own platforms, which span Germany, France, Spain and Portugal, we’re seeing low double-digit rental growth across markets.

A similar story holds true in the co-living segment, which can offer relatively flexible and convenient options for renters in European markets at competitive pricing. As the aging student populations enter the workforce, they are met with the same affordability challenges of other demographics. The growth of this segment would allow operators to cater to a broader market, including both students and young professionals who may be willing to trade apartment size for a prime location near city-center attractions and job opportunities. We expect this evolution to create consolidation opportunities to build scaled, well-managed platforms in the co-living segment.

Learn about Student Roost, the PBSA platform we built in the U.K., here.

In addition, the relaxing of travel restrictions and reopening of international borders have driven a meaningful recovery in global tourism, particularly into European leisure destinations. Inbound tourists from the U.S. and Asia are expected to provide a material boost to occupancy in 2023 and beyond, as these key regions are still well below their prior peaks (see Figure 6). These travelers also tend to stay longer than tourists from shorter-haul markets.

While demand is robust, the supply side remains at record lows due to the higher cost of land, rising construction costs and labor shortages (see Figure 7), with new supply at only ~3% of total stock¹⁷ and expected to increase by less than 10% over the next five years. Focusing on the luxury and upper upscale segments, which are exhibiting the strongest relative ADR growth, we see an even more prominent shortage in the availability of luxury hotels. For instance, almost one in three hotels in the U.S. qualifies as upscale; by comparison, just one in 10 European hotels can say the same.¹⁸ With these dynamics at play, we expect outsized demand for luxury hotel experiences and believe opportunities in this segment will be fruitful in the current environment.

Furthermore, hotel ownership in Southern Europe is fragmented; as a comparison, branded upscale/luxury hotels hold ~30% market share in the U.S., compared with only ~13% in Europe.¹⁹ And as branded hotels achieve occupancy and RevPAR premiums relative to non-branded hotels, we see local resources, scale and experience as key to successfully identifying and executing asset rebranding, and in turn creating best-in-class operations that drive revenues.

Many owners of hotel assets struggled through the pandemic and borrowed heavily to meet cash flow shortfalls, forcing them to delay required capital improvements in their assets. This may result in distress in a sector where capex investment drives success (the average capex reserve for hotels is estimated to be 32%, higher than other core sectors).²⁰

Ultimately, we believe uneven recoveries across hospitality segments will create opportunities to acquire mispriced assets at attractive bases. We saw this during the pandemic, when we acquired a Spanish hospitality portfolio at a 29% discount to comparables. Opportunities like this arose because many value-add investors bought hotels shortly before the pandemic and found their business plans interrupted due to closures, refurbishment delays and increased construction costs. We expect situations like these to continue to unfold and, coupled with debt maturities, create further opportunities to buy hotels from transitional owners.

We suspect that a similar dynamic is playing out across broader continental Europe, where media-related demand is rapidly growing alongside minimal supply. For example, Spain is becoming a gateway to non-English speaking markets, leveraging high-quality content coupled with the maturity of the local production industry.

We see entertainment as an undersupplied, anti-cyclical and growing asset class and have already begun to capitalize on this sector. We have invested in performance venues and soundstages in the U.S. and are looking to apply a similar playbook in Europe, where the market is nascent but growing.

Along with this shift, we are seeing an increased focus on automation, resilience and sustainability, which will further drive demand for high-quality, future-proof logistics facilities. Logistics assets resemble infrastructure investments in that they are low maintenance and can be used for a long time without significant capex. Yet they play a critical role in the overall supply chain network because they directly link physical goods to the end consumer.

Our experience shows that logistics tenants tend to be data driven and are incentivized to find the best location, which is often difficult to replicate given land constraints. A landlord needs to understand the tenant’s business and supply chain, as well as the market, to offer a product that meets the tenant’s needs. We have found that landlords with proprietary market intelligence and a local presence are best positioned to meet these needs and command premium rents.

Tenants are willing to pay these rent premiums in exchange for the ease of working with successful operators—landlords with whom they have existing relationships, who can offer speed and certainty of execution. We believe that landlords who can quickly adapt to their tenants’ evolving needs, and offer build-to-suit spaces in desired locations, will ultimately grow market share alongside their tenants.

From a supply perspective, land constraints and high replacement costs are limiting availability in key European logistics corridors. New starts have begun to slow as debt becomes more difficult to obtain, which should limit new space and keep vacancies low in 2023 and beyond. While cap rates are expanding, Europe’s historically low vacancy rate of approximately 3%²³ should continue to support rent growth as tenants are forced to bid pricing higher in order to occupy the properties. Many logistics properties in European markets also benefit from the direct pass-through of inflation in the form of lease indexation. In some markets, this is a straight annual adjustment. In others, it’s tested over a longer time or once certain hurdles are reached, but is eventually captured by resetting to a higher base rent. Thus, the well-leased assets in strong markets are positioned to outpace inflation through market rent growth.

While rental growth has been strong, trends in Europe generally lag those in North America, where year-over-year rent growth exceeded 20% in 2022. Consequently, we see additional upside potential across continental markets in the near term (see Figure 10). Over the last 10 years, yields compressed and effectively created a subsidy to tenants such that rents did not need to increase to justify building logistics sites. Meanwhile, construction costs increased, mainly driven by increased regulations. Now, the fundamental demand for prime assets remains, but the rental level necessary to justify new build alongside increasing yield expectations is significantly above 2022 rental levels. We are already seeing over 20% growth in core markets like Paris and Berlin and expect similarly outsized rent growth for assets that are best-in-class and located in key logistics hubs.

Furthermore, certain transaction types, such as sale-leasebacks, present an attractive opportunity amid the lending market disruption. Many companies need cash and are using their own assets to raise capital at very attractive terms (i.e., high yielding with long contracts and creditworthy tenants) for the buyer. Timing is everything here; once the capital markets stabilize, companies will be less motivated to rotate out of balance sheet assets to unlock liquidity.

Current infrastructure can and will serve as the foundation for net-zero carbon emissions. Reports have indicated that 80% of 2050’s projected global building stock already exists, accentuating the importance of refurbishing assets for long-term sustainability.²⁴ However, it will be a steep uphill climb, especially in mature European markets with aging buildings.

Approximately 80% of offices in the U.K., for instance, fall short of an Energy Performance Certificate (EPC) rating of B—the minimum starting in 2030.²⁵ In the residential sector, which contains some of the oldest housing stock in Europe, about six in 10 homes (13 million in total) fetch an EPC rating of D, far below the government’s 2025 target of C for rentals.²⁶

For assets at risk of stranding, many owners do not have the capital, expertise or appetite to retrofit, and the development of new green buildings will slow due to macro headwinds. Early adopters can take advantage of these dynamics. Further, many assets require capex and a skilled team to make them not only leasable but also financeable. Many landlords are finding themselves hindered by higher rates, lower LTVs for new loans, or lower values—if lending is available at all. This inability to raise the cash for capex often leads them to have to sell.

We see these opportunities in many urban central business districts in Europe, where the opportunity exists to develop or redevelop mixed-use assets for higher and better use, as well as prime office properties with the amenities and ESG credentials that tenants and core investors are demanding.

The green premium

According to a survey of commercial real estate managers, more than half of respondents indicated that property values for “sustainable” buildings are up anywhere from 16% to 28% thanks to a “green premium.” Rents are rising too, as certified office buildings in Europe have seen an average rent premium of 21% in recent years.²⁷ Anecdotally, we are also finding that leasing velocities are generally higher and vacancy rates lower in certified buildings. In other words, tenants understand the benefits of an efficient and more sustainable building—and are willing to pay more for it.

In the medium term, however, we believe green premiums will erode but “brown discounts” will become more punitive as regulatory deadlines around emissions and energy efficiency get closer. This presents an opportunity to purchase assets in prime locations at a discount.

^Endnotes:

<sub>1. Savills OCM 31 March 2023
2. Savills, March 2023
3. BNP, German Residential Real Estate Market, Q1 2023
4. DeStatis May 2023
5. Vonovia Q1 2023 Interim Report
6. Savills UK 2023
7. Savills European Student Housing 2022
8. Savills European Student Housing 2022
9. Savills European Student Housing 2022, Knight Frank Student Housing 2023
10. World Economic Forum, 2022
11. Savills, September 2022
12. EY Survey, 2022
13. Cushman & Wakefield, 2023
14. Savills “Life Sciences: Trends & Outlook” March 2023
15. Cushman & Wakefield, 2023
16. Savills, September 2022
17. Green Street Pan-European Hotels, February 2023
18. Greenstreet Prospects for Hotel Demand Recovery, April 2023
19. Green Street Pan-European Hotels, February 2023
20. Green Street Pan-European Hotels, February 2023
21. Eastil Secured, February 2022
22. Knight Frank, May 2023
23. Savills, March 2023
24. JLL, November 2022
25. Knight Frank, 2022
26. React News, Jan 2023
27. Environmental Leader, 2022</sub>

^Disclosures

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