Recent European valuations data from MSCI for Q2 confirmed that capital values are still falling, but at a slower pace than they were last winter. This raises the question as to whether we have reached a turning point in this downturn. Our view is that European commercial real estate (CRE) is not out of the woods yet, despite things looking better than before the summer. There are five key headwinds that will weigh on a quick recovery: tight credit conditions, rock-bottom sentiment, high debt costs, inadequate risk premia, and stagnant economies. 

Tight credit conditions will place further pressure on debt re-financings and the feasibility of using debt leverage for new transactions. The ECB bank lending survey has remained in tightening territory since the banking troubles in March, as indicated by business loan terms. The relationship between credit conditions and capital growth suggests that values should have fallen more over recent quarters than has been the case. Credit conditions imply that capital values should have fallen nearly 4% per quarter this year, rather than the 2% that was recently reported.

Investor confidence plays a big role in market activity. Recently, real estate sentiment has been at a record low, presenting a second headwind to valuations. We use the sentix global real estate sentiment index to track investor confidence which has a reasonable relationship with capital growth historically, particularly at big events. Following this relationship, we would expect a capital decline of 15% so far this year, rather than the reported 4%.