High Interest Rate Clouds Hang Over European Real Estate Stocks; Strategists: Excessive Pessimism May Trigger a Dramatic Reversal

According to Zhitong Finance APP, as interest rates continue to rise, pessimism toward European real estate stocks is growing. Some strategists believe this creates conditions for a dramatic reversal in real estate stocks.

The STOXX 600 Real Estate Index in Europe has fallen by about 7% in 2026, and is expected to underperform the broader market for the third consecutive year. Although the sector has remained range-bound during this period, its performance gap with the STOXX 600 Index has surpassed levels seen during the global financial crisis.

European real estate sector significantly underperforms the broader market

Pervasive pessimism as rate expectations shift from cuts to hikes

Mislav Matejka and his team of strategists at JPMorgan said, “Expectations have shifted from rate cuts to possible hikes, exacerbating real estate investment woes as higher borrowing costs and a tighter financial environment put pressure on asset values and investor sentiment. The real estate sector is highly correlated with bonds and is often seen as a bond substitute, making it susceptible to upward shocks in bond yields.”

Pessimism has been persistent and deepened further over the summer. According to Bank of America’s September fund manager survey, European real estate is among the most underweight sectors, with a net 36% of investors holding below benchmark-permitted levels. This is the highest proportion in at least two years, almost triple that of July.

The sector’s high correlation with bonds explains this neglect. With major central banks tightening monetary policy due to inflation, as long as oil prices remain high and the economy stays resilient, policymakers have no reason to change direction. Currently, swap markets expect the European Central Bank to raise rates three more times by the end of June next year, and the Bank of England to hike four more times by the end of July next year.

Interest rate outlook is a coin toss, and reversals could be sharp

However, the aggressive rate pricing driving bond yields higher could also reverse sharply. Since the outbreak of the Iran war, oil prices have been a main driver of bond and equity market moves. Despite little progress in peace talks, any breakthrough could completely change the picture. Thus, with the interest rate outlook as unpredictable as a coin toss and market sentiment so negative, a sudden shift could cause a very dramatic reversal.

With the sector’s prolonged underperformance, some institutions now believe the pessimism has become excessive. Strategists at Deutsche Bank and Bank of America both rate real estate as “overweight.” Oversold prices may also offer support, as the sector’s absolute and relative valuations are well below historical averages.

Valuations of the European real estate sector are below historical averages

For Bank of America, part of its bullish thesis on real estate relates to how a “higher for longer” rate environment will affect the economy and risk assets.

Sebastian Raedler’s Bank of America strategy team noted: “Given the sector’s recent poor performance, we forecast, based on German Bund yields and the Purchasing Managers’ Index (PMI), that European real estate has about 15% upside in relative prices over the next few months. Given the sector’s local nature, when eurozone PMI outperforms the global PMI, real estate usually does better than yield expectations.”

Regional divergence: Germany hit by headwinds, UK gets a policy catalyst

The performance of real estate stocks varies by region, and local policy factors also differ. In Berlin, for example, a radical proposal to expropriate large housing portfolios has returned to the agenda, posing an additional threat to the sector. German real estate stocks are already among the worst performers in the European real estate index.

By contrast, UK homebuilders have just caught a break. The Labour Party’s willingness to revive the “Help to Buy” scheme is a timely boost for the previously struggling homebuilding sector — with mortgage approvals this week falling to a 32-month low. The market’s strong reaction to this news fully demonstrates the reversal effect policy changes can trigger.

“UK real estate stocks had previously been deeply undervalued. Now, they have gained a catalyst,” said Clive Beagles, co-manager of the UK Equity Income Fund at JO Hambro Capital Management Ltd. “The government’s new equity loan scheme is expected to revive new builds, unlock profit growth potential, and reshape the sector’s outlook. We believe this could be a winning formula for the UK stock market and active investors.”

Nevertheless, persistent risks in the UK may keep investors cautious in the near term. UK government bond yields remain at multi-year highs, raising refinancing costs, and many households are expected to face higher mortgage rates in the next two years. Meanwhile, Goldman Sachs analysts note that building cost inflation continues to outstrip price growth, putting pressure on profit margins.