Weak dollar, strong real estate

The US dollar’s smile is fading. This concept of the dollar smile refers to the US currency’s tendency to perform well in times good and bad, with more middling returns appropriately in the middle of that spectrum. The theory is that investors will want to own dollars either when the US economy is strong or when it struggles, as a risk-on trade and as a safe-haven asset. Today, it’s possible to argue that we are at either extremity: equities are back near their all-time heights, and yet the effects of tariff-related uncertainty continue to weigh on numerous economic datapoints.

Whatever one’s perspective on the real macro environment, one fact is undeniable: the dollar is not prospering. The US Dollar Index, known as the DXY, lost around 9% versus a basket of other currencies through the first half of this year. More pain could lie ahead: Morgan Stanley predicts the DXY will weaken by another 9% over the coming year, expecting the euro to reach $1.25 and the pound $1.45 by mid-2026 (from early June levels of $1.14 and $1.35 respectively).

This unusual state of affairs has been noted by Christine Lagarde, President of the European Central Bank (ECB), among many others. In a speech on 26 May, she observed that there have been 34 cases of simultaneous sovereign debt and financial crashes globally since 1970, but that through all this the US had “remained immune to such twin crises”. The pattern broke in the aftermath of the ‘Liberation Day’ tariff announcements on 2 April, when the US dollar, government bonds and stocks all dropped in synchronicity. “When doubts emerge about the stability of the legal and institutional framework, the impact on currency use is undeniable,” surmised President Lagarde.

Solid foundation

None of this implies the end of dollar dominance, of course. It still accounts for more than half of foreign currency reserves, half of global payments, and 80% of foreign exchange transactions. Dollar and other US assets are therefore still likely to represent significant portions of investors’ portfolios. Yet the dollar’s loss of sheen and the headwinds it still faces are powerful contemporary reminders of the longstanding importance of diversification.

It is in this regard that we believe European real estate offers numerous attractions at this market juncture. First, it is not only denominated in the European currencies that are forecast to strengthen against the dollar, but also receives rent and so can pay income in those currencies. This is an increasingly important consideration as interest rates, and in turn yields from money-market funds, have come down sharply in Europe over the past year.

Second, a related point is that European real estate benefits not just from this relative appeal versus other income-generating investments, but from the downwards trajectory of interest rates too. Interest rates affect real estate through their relationship with cap rates (these reflect the return investors are willing to accept from property investments, and are usually calculated as a property’s annual net operating income divided by its market value); in broad terms, lower interest rates are associated with better cap rates and thus higher returns from real estate. The ECB has now cut rates eight times in a year, the latest by a quarter-point to 2% now inflation is below the Bank’s 2% target for the first time in eight months. All else equal, this is highly supportive for local real estate.

This is not hypothetical. The recent experience here in Switzerland provides persuasive evidence. The Swiss National Bank was the first G10 central bank to switch from hiking to cutting, lowering rates four times in 2024; the SXI Real Estate Funds Broad Index – a benchmark of listed real estate strategies focused on Swiss properties, normally known for its demure returns – rallied 20%. Given the ECB’s actions (and those of the Bank of England and other non-euro authorities), we believe it is reasonable to expect a similar reaction in broader European real estate markets.

We should nonetheless acknowledge that, in confirming the ECB’s latest move, President Lagarde did advise the Bank is nearing the end of its current easing cycle. This moderates the aforementioned tailwind from rate cuts. However, it gives rise to a third attraction worth highlighting: the growing optionality that this new dynamic creates for European real estate.

From here, rates can go up, down or remain steady. If they rise – the most unlikely scenario given disinflationary trends and economic weakness – we would not be too bullish but investors in European real estate may stand to gain from an even stronger euro (the single currency climbed on President Lagarde’s comments about the cycle’s end) and, insofar as hikes reflect economic vigour, higher occupational demand. In the more probable case of a steady rate landscape, value creation and income generation will be the key determinants of performance. And if further cuts are necessary to stimulate a sagging economy, this simply reinforces the positive effect on cap rates.

The art of selection

Naturally there is still plenty that could go wrong for investors in European real estate – especially the risks of buying the wrong assets in the wrong locations for the wrong prices – but we are confident that the range of likely outcomes is skewed to the upside.

To maximise the chances of success even in these relatively benign circumstances, real estate investors should be disciplined and vigilant across the three axes for being wrong set out above. The economic turmoil makes location and sector choices of paramount importance. For instance, the potential for long and severe tariffs on trans-Atlantic trade make us especially cautious on industrial and office assets exposed to auto manufacturing – in the Wolfsburg area, say. Sustainability also remains a key theme in Europe, with buildings that are energy inefficient headed for obsolescence given occupiers’ insistence on low operating costs even before rising regulatory standards are taken into account.

Investors can instead continue to focus on properties whose resilience comes from a local mismatch between supply and demand. Residential opportunities in undersupplied growing cities are one example, as are last-mile logistics hubs where high ecommerce demands contend with restrictions on allowing new warehouse developments. To be more specific, on the residential side, Stockholm’s population is growing at around 2% a year but housing supply is not keeping pace, in part due to expensive building materials and the high cost of capital. In logistics, we can look to the Netherlands, where we see near 0% vacancy rates due to the fact that land availability is extremely constrained while demand is strong as the country is a continental freight hub.

“Moments of change can also be moments of opportunity,” President Lagarde said in her recent speech. “The ongoing changes create the opening for a global euro moment. This is a prime opportunity for Europe to take greater control of its own destiny. But this is not a privilege that will simply be given to us. We have to earn it.”

”In real estate, we fully agree and are committed to earning that privilege of performance for investors.