As interest rates continue to climb, bearish sentiment toward European real estate stocks has grown increasingly heavy. Some strategists believe this has set the stage for a dramatic reversal in property shares.

The European Stoxx 600 Real Estate Index has fallen about 7% in 2026 and is on track to underperform the broader market for a third consecutive year. Although the sector has remained range-bound during this period, its gap with the Stoxx 600 has exceeded levels seen during the global financial crisis.

European Property Sector Significantly Lags the Broader Market as Pessimism Spreads and Rate Expectations Shift from Cuts to Hikes

JPMorgan strategists Mislav Matejka and his team said: "The shift in rate expectations from cuts to possible hikes has intensified the plight of real estate investment, as higher borrowing costs and tighter financial conditions put pressure on asset values and investor sentiment. The real estate sector is highly correlated with bonds, often viewed as a bond substitute, and is vulnerable to rising bond yields."

Pessimism has persisted for some time and intensified over the summer. Bank of America's September fund manager survey showed that European real estate was one of the largest underweight sectors, with a net 36% of investors holding below benchmark-allowed levels. This is the highest proportion in at least two years, nearly triple the level in July.

The sector is highly correlated with bonds, and it has been shunned not without reason. Major central banks are tightening monetary policy due to inflation, and as long as oil prices remain elevated and economies stay resilient, policymakers have no reason to change course. Currently, swap markets expect the European Central Bank to raise rates three more times by the end of June next year, while the Bank of England is expected to hike four times by the end of July next year.

The Rate Outlook Is Like a Coin Toss, and a Reversal Could Be Violent

However, the aggressive rate pricing driving bond yields higher could also reverse quickly. Since the outbreak of the Iran war, oil prices have been the main driver of bond and equity movements. Although peace talks have made little progress, any breakthrough could completely change the picture. That is why the rate outlook is as unpredictable as a coin toss, and when sentiment is this bearish, any sudden shift in direction could trigger a very sharp reversal.

The sector's prolonged underperformance has led some institutions to believe that pessimism has become excessive. Strategists at Deutsche Bank and Bank of America both rate real estate as "overweight."

Deeply oversold prices could also provide support, as the sector's absolute and relative valuations are both well below historical averages.

European Property Sector Valuations Below Historical Averages

For Bank of America, part of the bullish case for real estate lies in how a "higher for longer" rate environment will affect the economy and risk assets. The Bank of America strategist team led by Sebastian Raedler said: "Given the recent underperformance of real estate, we forecast about 15% relative price upside for real estate over the coming months based on Bund yields and PMI projections. Considering the domestic nature of real estate, when the eurozone PMI strengthens relative to the global PMI, real estate tends to outperform rate expectations."

Regional Performance Diverges: Germany Faces Headwinds, UK Sees Policy Catalyst

Real estate stock performance varies markedly by region, and local policy influences 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 property stocks are already among the worst performers in the European real estate index.

Conversely, UK homebuilders have just received a breather. The Labour government's willingness to restore the "Help to Buy" scheme is undoubtedly a shot in the arm for the previously downtrodden housebuilding industry — mortgage approvals had just hit a 32-month low this week. The market's strong reaction to the news fully demonstrates the reversal effect a policy shift can trigger.

"UK real estate stocks had been severely undervalued. Now, they have a catalyst," said Clive Beagles, co-manager of the JO Hambro Capital Management Ltd. UK Equity Income Fund. "The government's new equity loan scheme is expected to revive new build activity, unlock earnings 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 could keep investors cautious in the short term. Gilt yields are at multi-year highs, which is pushing up refinancing costs, and many households are expected to face higher mortgage rates over the next two years. Meanwhile, Goldman Sachs analysts noted that construction cost inflation continues to outpace price growth, putting pressure on margins.