In this paper, we lay out the case for investing in European real estate, particularly relative to US real estate, in the coming decade. While US real estate outperformed in recent years, all investors know that past performance says little about future returns, and the next decade may look very different than the prior one. With worries about a looming US recession, fears of inflation, and the S&P 500 down about 20% year-to-date (and the FTSE 100 down just 5%), we believe now is the time for investors to double down on diversification, especially with respect to geography. As we demonstrate below, we believe Europe now represents a particularly attractive place to invest.
First, in Section I, we present an abridged history of the last 15 years of commercial real estate markets in the US and Europe. We show that, although US real estate outperformed European real estate at the aggregate level, this outperformance was concentrated in capital value growth in a select group of high-growth secondary cities, especially in the southern and western regions of the country, and high-growth real estate sectors, including industrial property and several alternative asset classes. The lesson should be plainly obvious: real estate capital value growth is largely about supplying a growing but unmet demand for space in a specific, underserved sub-market.
Then, in Section II, we examine this pattern of growth in more depth, suggesting that this outperformance of US real estate markets depended upon a specific set of circumstances, which may not persist in the coming decade. In particular, we argue that these circumstances comprised: (1) a rapid expansion of US-based high-growth technology sectors, which now seem likely to face significant headwinds in the medium term; (2) a wave of population growth in US secondary cities, a trend that no longer has much runway left for continued expansion; and (3) a surge of investment flows into alternative real estate asset classes, which, as a result, now provide minimal return premia relative to the returns generated by traditional asset classes. In sum, the low-hanging fruits of US real estate markets have already been picked, implying that the pace of growth achieved during the last decade will be difficult to sustain in the future.
In comparison to US real estate, we demonstrate that European real estate is (1) relatively well-insulated from a slowdown in high-growth technology sectors; (2) likely to benefit from continued migration to European secondary cities; and (3) poised for significant compositional growth driven by alternative real estate sectors, which have yet to mature in Europe. As a result, we believe that European real estate has a relatively strong decade of capital value growth ahead.