Europe’s Fantastic Four

As I travel the U.S. meeting with our clients, it’s striking how little interest U.S. limited partners (LPs) have in investing overseas, especially in core real estate.

Since the Global Financial Crisis, this lack of interest has generally served U.S. LPs well, as returns in Continental Europe have lagged the U.S. by an average of 40 basis points (bps) per annum over the last 24 years.¹ However, there are reasons to believe the dominant trend over the last quarter century may be due for a reversal.

We see four pillars of value when evaluating markets: replacement cost, discount to prior peak, fund flows and cap rate spreads to the risk-free rate.

Each of these indicators suggests that Europe is a compelling commercial real estate investment opportunity right now.

• Replacement Cost: Both the U.S. and Continental Europe offer the opportunity to invest at meaningful discounts to replacement cost across various asset classes.
• Discount to Prior Peak: Europe begins to distinguish itself here. European Open-End Diversified Core Equity (ODCE) values are down 25% from their prior peak, whereas the U.S. is down 20%.
• Fund Flow: Currently there is more capital chasing U.S. deals relative to the size of the market than there is in Europe. Less capital competition equals more opportunity for value, again a positive for European real estate. For example, over the last two years, the ratio of U.S. to EU core real estate capital raises is 4.3 to 1, while U.S. transaction volumes have historically been only 1.74 times greater than in Continental Europe.² Dry powder as of year-end 2024 paints a similar picture.
• Spread to Risk-Free: The risk premium is also greater in Europe than in the U.S. In Europe, the cap rate is 4.1% versus 4.6% in the U.S.,³ while interest rates are 3.2% in Europe and 4.1% in the U.S. This results in a 90-bps risk premium in Europe compared with only 50 bps in the U.S. Because U.S. spreads are relatively tight compared to historical averages, Europe’s wider spreads suggest a more attractive opportunity for investors.

A possible rejoinder to this is that European occupier markets offer more limited growth prospects. CBRE Investment Management’s house view would suggest otherwise.

Five-year annual average rental growth is forecast to be 2.5% across the continent compared to 1.9% for the U.S. In real terms, the outlook is even better, as inflation expectations in Europe are lower than the U.S., at 2% versus 2.7% over the same period. Europe’s regulatory framework and relative age of its assets also make it inherently more supply constrained than the U.S.

Additionally, vacancies across the board in Europe are 6.2%⁴ versus 9.6%⁵ for the U.S., again suggesting a relative advantage for Europe in fundamentals. Further, increased defense spending could help spur economic growth in Europe to a level not seen in the last two decades.

Carry and diversification are other considerations.

Many U.S. investors historically shied away from Europe due to currency concerns. Today, one can hedge back to USD and get paid for it as the U.S. 10-year Treasury is 90 bps above the Eurozone average.

Finally, we think it is too soon to write off the benefits of diversification. In a world that is increasingly fractured, there’s value in not having all your exposure closely correlated to U.S. GDP growth.

All of this is not to say U.S. LPs, or foreign capital for that matter, should abandon U.S. real estate.

The U.S. remains the largest, most liquid market in the world, and there are plenty of interesting micro opportunities across geographies and sectors. Europe’s fractured and often more onerous regulatory regimes, many languages, smaller asset sizes and less developed capital markets can make it a more challenging market in which to execute.

However, there is clearly substantial room for U.S. investors to increase their core real estate exposure to Europe from their current near-zero status.

They say the only free lunch in finance is diversification. Today, the market is offering an enticing three-course lunch special: diversification, value and growth. U.S. LPs, the time is ripe to increase your European property allocation.