High debt costs suggest European office price correction

Unlike US office markets, prime assets in key European cities did not experience a correction during the pandemic. Prime yield remained flat for the most part, with some compression even evident in selected locations during 2021. As a result, prime yields in European office markets now look in need of adjustment by 10bps-75bps relative to the all-in interest rate, assuming a low-risk interest coverage ratio and a reasonable LTV are to be maintained.

What you will learn:

• Our analysis suggests a 10% correction is needed on average for the major office markets in Europe to compensate for the higher cost of debt.
• We believe that investment-vintage risk is currently elevated since we expect office yields to move above current levels for some time due to structural issues.
• We remain cautious about the outlook for the office sector. European office total returns are expected to be 5.3% over 2022-2026, 3.4ppts lower than 2015-2019 and the second-worst performing sector within our coverage over the next five years, only ahead of hotels.