Asked to speculate about what would happen after he died, Louis XIV quipped, “After me, the flood.” But now that some latter-day sun kings in London and New York have been hauled feet-first out of their own hall of mirrors, what seems more likely to happen to European real estate is not a flood, but a drought.

By most measures — lending capacity, occupancy rates, rents, and prices — the real estate sector seems likely to run fairly dry for the next few years, as the European Union braces for what most forecast will be a tough recession.

“There are very few countries across Europe that we think are going to come out of this entirely unscathed,” says Ed Stansfield, property economist for Capital Economics in London.

Cool Britannia turns cold

A few years ago, British property investors felt that they were ahead of the curve in creating Europe's most dynamic property market. Just as it took the lead on the way up, the UK now seems to be taking the lead on the way down.

UK commercial property values have fallen 20% over the last 16 months, says Stansfield, who believes they will need to drop another 15% to 20% before they reach a trough. He may be conservative: Derivatives based on the Investment Property Databank's UK commercial property index, a financial instrument used by investors to hedge their property risk, have now priced in a 45% peak-to-trough decline.

But while the UK may be in the worst shape, Stansfield believes that very few countries won't be hurt by the current crisis. “The idea that Europe hasn't really participated in the credit boom and therefore doesn't have the same problems to unwind is probably true, but the perception is overdone,” he says.

Other analysts agree. Thomas Beyerle, director of research and strategy for DEGI, a Frankfurt-based European property investment company with an $8.7 billion portfolio, forecasts a total drop in continental European values of as much as 20%. Not surprisingly, Beyerle expects a continued preference for high-quality properties. In general, he sees well-stabilized buildings in CBDs as the best bet.

So who will be buying? The leveraged buyout players who wielded such power a year ago aren't doing much these days besides selling what they can. Certainly investment banks are out of the game.

But Beyerle says that some institutional investors, particularly insurance companies, are now actually looking to increase their real estate allocations. After all, once you've seen a stock portfolio chewed in half, a 20% decline in property value doesn't sound half bad.

Different this time?

People usually say “this time it's different” only when they're on the upward slope of a boom. But this time, gloomier observers are saying it on the downward slope, fearing not just a recession but a long-term Japanese-style malaise. Stansfield doesn't go that far, but he does say tighter credit may lead to a much less buoyant market.

Clearly, European banks will be more careful now in their loans than in the last few years, whether they are motivated by tighter regulations, higher capital withholding requirements, or the galaxy-wide allergy to structured finance.

Private equity also seems on its way out, if only because so many of the biggest lenders and buyers of the last cycle are gone. At the moment, anyway, one of the biggest trends seems to be growth in cross-border equity partnerships.

“With significantly more equity needed to get deals done, investors are teaming up or taking on equity partners to complete transactions,” reports Real Capital Analytics, which estimates that 39% of all intercontinental transactions now involve joint-venture partnerships.

But Beyerle is skeptical that big leverage is gone for good. “It will take some time, one or two years, but this will come back under another label,” he says. “This is part of capitalism's story.”

Bennett Voyles is a veteran commercial real estate reporter and NREI's Paris correspondent. For questions or comments, readers can e-mail him at benvoyles@yahoo.com.