European real estate highly sensitive to bond yields & inflation

A recent Oxford Economics report reveals that European city real estate is highly susceptible to local government bond yields and consumer inflation, with demand fluctuations having the least impact on prices. 

Property - Oxford Economics

This analysis, conducted using their advanced Real Estate Economics Service (REES), which now covers 100 global cities, integrates city-level property forecasts with their Global Economic Model. This integration allows investors to better understand how local property markets react to global economic shifts, offering a critical advantage in today's volatile climate.
The study, which mirrors a previous U.S. report but shows greater variation due to Europe's diverse economies, simulated property returns in response to shocks in employment, inflation, and bond markets. This is particularly relevant given Europe's current challenges, including political risks, changing immigration, fiscal issues, and trade shifts.
Key findings show that a 1% decrease in national employment typically correlates with a 1% drop in city property capital returns. A 1% increase in inflation nearly doubles that impact, leading to a 1.9% decline. Most significantly, a 1 percentage point rise in national bond yields can reduce capital returns by 5.4 percentage points, though this relationship isn't perfectly linear.
Felipe Camargo, lead global economist at Oxford Economics and author of the report, explained: “Our integrated macroeconomic modelling at the city level demonstrates that European property values are particularly exposed to fluctuations in bond yields and inflation. In contrast, demand shocks tend to have a comparatively limited impact on prices. By applying country-specific shocks, our modelling captures the unique structure of each economy, which drives markedly different real estate outcomes and explains a great deal of the variation in projected returns.” 
Mark Unsworth, director of Global Real Estate Economics, added: “In a fluid and shifting global policy environment, understanding how macroeconomic shocks feed through to city-level real estate is an important component of portfolio risk mitigation that can help shape asset allocation and provide timely advice to stakeholders.” 
Separately, Oxford Economics' latest home buyer affordability index, the UK housing market, which was significantly overvalued by 33% in late 2022, has seen its valuation gap shrink dramatically to just 4%. This improved affordability over the last three years is likely the reason behind the recent increase in UK mortgage activity and house prices.
Given the ongoing tight housing supply, Oxford Economics anticipates a steady rise in house price inflation in the coming years.
Chief UK economist Andrew Goodwin stated: “We think the big improvements in affordability are now behind us. Pay growth is slowing, and financial market pricing already anticipates further rate cuts, suggesting limited room for swap rates and mortgage rates to fall from their current levels. However, with further affordability gains expected to be modest, mortgage activity is likely to plateau from early 2026 at levels similar to those seen before the pandemic.”