The European Property Bust; Germany is a sobering harbinger for Europe; with the labor force peaking, vacancy rates are high, and demand for office space is slack.

Byline: M. Leanne Lachman (Lachman is an executive in residence at Columbia Business School and a governor of the Urban Land Institute Foundation.)

In Europe's major cities, residential and commercial real estate has shared in the remarkable worldwide price explosion of recent years. Yet buyers are still "paying to play," assuming that abundant global capital will keep migrating to Paris, Berlin, Barcelona and Rome, and bolster future values. No one worries about Europe's dismal demographic prospects, which will sharply reduce real-estate demand.

This doesn't matter for speculators. But those looking for long-term growth in Europe need to remember that bad demographics can and likely will undermine otherwise prime locations. (Sorry, Rome.) All of Continental Europe faces declines in population and, more important for the real-estate market, working population. Europe's labor force, ages 15 to 64, will peak in 2010 and then decline by 25 percent to 2050. Not all nations will be undermined equally. Italy's population peaked six years ago. Germany's will peak in just four years, and Spain's in 14. France, on the other hand, won't begin to lose population until 2035 because its birthrate is one of Europe's highest, thanks to its expanding Muslim community. And Britain's working population is expected to grow slightly through 2050, so it will not be affected by the coming transformation as dramatically as the Continent.

When demographic growth stops in one country after another, demand will dry up. The European Public Real Estate Association has warned, startlingly, that most real-estate sectors in Continental Europe will evolve into "replacement markets" over the next couple of decades. What that means is that, with the population fated to shrink, neither job growth nor an increase in the number of households will generate demand for new construction. The only reason to build at all will be to replace old buildings that fall prey to demolition, fire, vandalism or obsolescence. That will produce very modest activity across all major sectors--residential, office and retail.

In theory, a replacement market can remain stable only if an existing building is demolished every time a new one goes up. In reality, Europe's market is not that brutally efficient. The likely scenario is that vacancy rates will rise, while rents, investment yields and property values fall: depreciation instead of appreciation.

German office markets face this situation today. Vacancy rates are stubbornly high so instead of raising rents, ...