European real estate: credit outlook diverges, sets apart investment-grade firms with prime assets

Europe’s real estate market will continue to diverge in credit quality amid residual investor nervousness about assets and owners exposed to refinancing risk, rising refurbishment costs, the uncertain economic outlook and adverse trends in demand.

By Philipp Wass, Corporates Ratings

Overall, improved financing conditions are likely to persist, as swap rates have remained stable and lending margins have decreased.

Secured financing remains accessible on reasonable terms. Depending on the issuer, banks are adopting different approaches to extend financing, ranging from topping up existing loans to insisting that partial debt repayments a prerequisite for any refinancing.

This has maintained a clear distinction in credit quality. Strong companies with high-quality assets and investment-grade ratings benefit from the better funding conditions, visible in the surge in first-half corporate bond issuance in Europe, and solid asset performance.

In contrast, more indebted companies, especially ones holding secondary office and retail properties, face falling asset values, higher leverage and limited access to financing. These pressures are increasing refinancing risks, particularly for issuers with debt maturing in 2025–26.

Capital values rise for owners of mixed portfolios in prime urban areas

Corporates holding diverse portfolios continue to benefit from increasing capital values on the back of continued rental growth momentum, particularly in urban areas where supply remains constrained, a trend that began in the second half of last year.

One cloud on their horizon is that rental growth for commercial assets has moderated since peaking during the inflation spike in 2022–2023, though stabilising prime yields are supporting capital values. Data centres have emerged as a standout segment, driven by surging demand from hyperscalers and AI-related corporate investment.

Asset quality increasingly important determinant for credit outlook

The gap between prime and secondary assets has widened. Prime properties are benefitting from stabilising yields and renewed investor interest, resulting in limited downward pressure on fair value and increasing transaction volumes.

Conversely, owners of secondary and lower-quality assets continue to struggle with liquidity and pricing. This leads to a squeeze on valuation, deteriorating leverage metrics and elevated refinancing risk.

Their outlook is also clouded by a widening investment gap as inflation pushes refurbishment costs higher, whether to adapt buildings to changing patterns in demand (working-from-home in office, e-commerce in retail), to meet tightening environmental regulations, or to reduce energy consumption.

Funding challenges intensify for high-yield issuers

Access to capital markets remains acutely divided between IG and non-IG issuers. Investment-grade issuers kept access to bond markets, with spreads stabilising at around 125bp or less over benchmark rates, and all-in funding costs falling to 3–4% for five-year maturities. This has restored the competitiveness of senior unsecured debt relative to secured bank financing.

European firms took advantage of more favourable market conditions with a continued high bond issuance in the first half of 2025 (up 17% YoY) though volumes seem to tail off in the third quarter amid the volatility in financial markets caused by the initiation of the US trade war.

Non-IG issuers, however, remain under pressure, facing funding spreads of up to 525bp, which keeps all-in funding costs at 7–8%.

Many of these issuers have shifted to secured structures to preserve interest coverage and cashflow. However, refinancing risk remains high, particularly for those with concentrated exposure to secondary office or retail assets.

Real estate ratings: diverging paths as IG issuer ratings stabilise; weaker HY issuers face pressure

Credit quality in the European real estate sector is becoming increasingly diverse. Investment-grade and strong non-investment-grade issuers have largely absorbed the impact of rising interest rates and falling property values. Many of these issuers, such as Vonovia, Aroundtown, Merlin Properties and Inmobiliaria Colonial, have continued access to financing and are pursuing organic or external growth which limits the downside to their ratings.

In contrast, weaker high-yield issuers are facing a perfect storm of liquidity shortfalls, refinancing hurdles, declining interest coverage and falling asset values. Many remain priced out of markets, leaving them exposed to a downward credit spiral.

To stabilise their finances, some of these firms will rely on strong support from creditors and shareholders, including one or more of the following: capital injections (e.g., Deutsche Konsum - proposed debt-to-equity swap), refinancing bulk maturities (e.g., Globe Trade Centre), and asset sales (e.g., DEMIRE).

Some of these measures may qualify as distressed exchanges under Scope's Credit Rating Definitions, reflecting the severity of the pressure.