• Though a correction in values is firmly underway for European commercial real estate markets, we believe the worst is yet to come. This also means the best buying opportunities are not just around the corner. 
• The gradual ramping up of higher debt costs on portfolios is a limiting factor for a quick recovery. By the end of 2025, we estimate that the all-in interest rate for a hypothetical portfolio could reach around 3.7%, which is on par with 2013 levels – that’s just four years to unwind eight years of debt cost reductions. 
• This may force interest coverage ratios to acutely low levels. Owners facing a refinancing shortfall in 2023 will need to add more equity, seek new equity investors, or default – with poorer quality assets looking most exposed.
  
  

We expect advanced economy policy rates to peak this year as supply-chain bottlenecks ease and inflation falls back to near-target levels, which should gradually alleviate pressure on real estate pricing. We still think that supply-side developments will push down core inflation, particularly in goods, where easing bottlenecks, inventory unwinds and lower commodity prices should all weaken pipeline price pressures.

Despite that, recent ECB communications have become more hawkish, suggesting that both inflation and policy rates could stay high for longer – above our own baseline view. According to the ECB’s December projections, eurozone inflation will average 6.3% in 2023 and remain above 2% until 2026. Using the ECB inflation and output projections as inputs to our Global Economic Model suggests policy rates will reach 3.3% by end 2023 and 2.3% by end 2024.

The key transmission channel for real estate is the cost of debt. Our updated analysis on the yield shift implied by debt costs (for a leveraged buyer using 50%-60% LTV) indicates that a pricing correction is firmly underway (see chart).