Real Estate Outlook – Europe, Edition 2 - 2022

For many years, the main argument in defense of ever-lower property yields was that the spread over fixed income yields remained comfortably above historic levels. This is no longer the case, with the spread between government bond yields and prime office yields now below their long-term average in every major market. We expect performance to become polarized between the select few sectors and micro-locations where there is a genuine supply-demand imbalance and landlords can pass on some of the inflationary pressure to tenants. For the rest of the market, the record low property yields now look exposed to rising rates.

As inflation continues to exceed expectations, hitting 7.5% in the eurozone in April and 9% in the UK, the outlook for economic growth has weakened. Under the base case scenario, we are still not in recessionary territory although the risks of a persistent war in Ukraine driving a stagflationary scenario have risen over the last three months. Central banks are treading a precarious path in attempting to ease demand without contributing to a recession. Base effects mean that if wholesale energy prices stabilize or start to fall back, this will have a neutral or negative contribution to the consumer price index in twelve months’ time. This would provide a major contribution to bringing inflation back down to target levels. But the biggest concern is that higher wage settlements agreed in 2022, in-light of the current levels of energy-driven inflation, is resulting in second-round inflation effects. This could push high inflation well into 2023.