Europe’s property investors are looking down both oil barrels right now at the prospect of further interest rate increases from the European Central Bank before the end of the year, as the ongoing energy-price shock pushes inflation higher.

It’s a reversal of the trends that saw the ECB act faster and more decisively than the Fed and the Bank of England to bring down rates, juicing the appeal of continental European real estate at a time of global uncertainty.

Worries about fiscal deficits in big European economies such as France are also pushing up the cost of borrowing for buyers in the eurozone.

For real estate investors, the distinction between a temporary inflation shock and a sustained increase in borrowing costs will be critical. Even if the ECB stops raising rates, higher government bond yields and swap rates could shift capital away from property. Prospects for 2027 sit on a knife-edge.

"The interest rate situation is no longer just noise but simply part of the day-to-day challenges,” said CBRE Investment Management Head of Transactions for EMEA Direct Real Estate Jan-Willem Bastijn.

A recent Reuters poll highlighted that of the 73 economists surveyed, 64 expect a December hike from the current 2.5%, 40 expect the deposit rate to peak at 2.75%, but another 24 expect it to reach 3%.

Likewise, Jens Eisenschmidt, chief Europe economist at Morgan Stanley, said the ECB was likely to remain on its quarterly adjustment path, pointing towards another increase in December, although he warned that a further hike in March was possible.

The immediate impact is likely to be felt most acutely by owners refinancing loans originally agreed when interest rates were exceptionally low. A resulting gap between buyers' and sellers' price expectations has been holding back transactions once again.

Bastijn said that most of the more troubled refinancing has already worked its way through the system, but he does stress that a likely uptick in rates means there is no room left to put off decisions.

“It’s the end of the kicking the can down the road,” he said. “Banks are going to simply ask, ‘So, you are waiting for what?’”

Despite the uncertainty, real estate investment has largely been unmoved by macro issues so far, with Savills' preliminary third-quarter investment estimates, published on 1 October, putting European transaction volumes for the quarter at approximately €46B. While that was down 6% year-on-year, investment during the first nine months nevertheless reached €156B, up 4%. The firm said activity remained concentrated on prime assets, with uncertainty lengthening due diligence and delaying transactions.

Nor is the picture uniform across the continent. Investment across the UK, Germany and France was down 8% over the first nine months, but it was up 34% in Central and Eastern Europe, 25% in the Nordics and 20% in Southern Europe, Savills said.

For the larger core economies of Europe, the prospect of rate hikes points to a continuation of the slow investment market of the past few years.

“The UK is probably in a better position because yields have already moved and are closer to bond yields, but if the latter rise in Europe, then markets like France, the Benelux and Germany are going to be especially challenged because that gap will be bigger," Income Analytics CEO Matthew Richardson said.

“The lack of capital growth means that, currently, real estate is an income play, and that puts it directly in competition with government bond yields, and right now, Treasury bonds are typically paying more for a secure and liquid investment. So that really concentrates the sector on opportunities with strong rental credentials and the potential for rent reversion.”

Richardson pointed out that bond yields are actually still pretty low compared to pre-2008 averages. And for Bastijn, the current situation marks a return to the investing principles that were common before real estate was turbocharged by central bank policy.

“To my mind, it just sharpens the focus on the best assets in the best locations," he said. "It’s about what you might call ZIP code investment, homing in on the best properties with good income potential.

Interest rate increases are not going to alter the appeal of markets with a good balance of supply and demand, like the German build-to-rent market or the living sector in the Netherlands, he added, because both face huge demand.

Barings Head of Real Estate and Strategy Paul Stewart said in a note to clients that he believes real estate debt liquidity and lender appetite remain strong, with plenty of capital chasing limited deals. That said, he noted that geopolitics is shifting lender sentiment towards a more cautious stance.

He speculated that renewed uncertainty will moderate the pace of the transaction volumes recovery but also extend the opportunity to acquire at attractive pricing.

Among the asset classes, offices are likely to remain particularly polarised. Prime buildings in central business districts can benefit from limited new supply and occupiers upgrading to better-quality space. Secondary offices with high vacancy, leasing incentives and substantial refurbishment requirements face a much harsher investment case.

European REITs could also face renewed rating pressure if borrowing costs rise further and property valuations fall, although the sector is much better positioned than during the 2022-2023 downturn, according to S&P Global Ratings Real Estate Sector Lead, EMEA Franck Delage.

He estimated that a 100-basis-point increase in refinancing costs above its current assumptions for 2026 and 2027 could put eight issuers, around 14% of those rated, at risk of breaching interest coverage thresholds, based on eurozone long-term government bond yields averaging 3.6% in both 2026 and 2027.

However, the impact would be less severe than in 2022-2023, when negative outlooks and CreditWatch listings peaked at 33% of European issuers, and S&P said REITs had already absorbed more than 200 basis points of refinancing cost increases over the past three years, while deleveraging and rental growth had strengthened balance sheets.

A lot depends on how quickly the U.S. and Middle East conflict resolves, Richardson stressed, and should that wrap up more quickly, then there may only be one rate rise.

“In the meantime, I think we’ll see a big focus on core. What we might see is some secondary positions under pressure when it comes to refinancing, and that may mean more extend-and-pretend. But because debt provision is so diverse now, I don’t think we’ll see a bank crunch as in 2009/10,” he said.

“There’s no reason to believe that there is going to be another bloodbath in the market, and the one advantage that real estate has over bonds is that it is possible to asset-manage, drive rents and improve tenants, while investors can also look for those pockets of rental growth.”