Office market shows strong performance in Europe

Commentary on European Offices, Savills Research, December 2017
Further information: Irma Jokinen, Research Manager, Realia Group Oy, Irma.Jokinen@realia.fi

Broadly based economic growth supports office space demand and rental growth throughout Europe. Office rents are already above their last peak in most locations in Europe but continue to rise. Availability of spaces meeting with tenants’ needs is limited suggesting further rental growth. In most European markets office vacancy rates have been falling since 2010 being at their historic low. One of the exceptions to this trend is Helsinki, where the vacancy rate is notably higher. However, recent office construction in Helsinki has been stronger in relation to most markets. Improved occupier demand and low interest rates attract investors in spite of lower return expectations. Most markets are expected to see yields softening in 2018 according to Savills’ yield cycle curve. Practices of yield monitoring as well as fees and taxes differ from market to market. Total transaction costs are highest in Ireland while non-recoverable costs are highest in Nordics and in the Netherlands.

Positive economic fundamentals boosted office market performance

Broadly based economic growth supports office space demand and rental growth throughout Europe. In recent years mainly private consumption and investment have contributed to economic growth. The growth factors are expected to remain largely unchanged in the near future. Unemployment fell to 9.2% in the second quarter, reaching its lowest level since early 2009. Euro area GDP has grown at a rate of about 2% in recent years. Inflation has remained lower than expected despite the improving economy, and the pace of inflation will remain below 2% in 2018. Source: Bank of Finland

In the EU area, the economic growth will slow slightly approaching the longer-term rate of growth in 2018. Source: Bank of Finland, Savills

 

Prime rents above their peak and still rising in 2018

Office rents are already above their last high in most locations in Europe but continue to rise. Competition for the best spaces is pushing rents up. Compared the current prime rental level in Helsinki with the previous peak, rents already exceed the last upswing, and there is scope for further rental growth. KTI’s index showed an annual increase of 3.5% in CBD prime office rents in Q3 2017. Due to long prevailing subdued economy and high vacancy rent levels in Helsinki were lagging behind the rent rise in other Nordic capitals. This year, the rise in prime office rents in Helsinki central locations has accelerated fueled by the strong economic growth.

Savills forecast that prime European office rents will grow by 4.7% on average in 2017. Top performers will be Oslo (33.3% yoy) and Berlin (11.3% yoy), followed by Madrid (10.7%), Stockholm (9.2%), Brussels (8.8%) and Amsterdam (8%).

Demand for good quality office premises in central locations has remained strong. Availability of spaces meeting with tenants’ needs is limited suggesting further rental growth in 2018, especially in the cities where rents are clearly below their past peak. In the peripheral markets the rental growth has been faster in late 2017.

Prime CBD office rental growth in Europe by regions Source: Savills

 

In most European markets office vacancy rates have been falling since 2010 being at their historic low. Average vacancy rate across Savills’ survey dropped to 6.9% yoy. Vacancy rates above 10% were recorded only in Helsinki, Madrid, Milan and Warsaw. Companies are forced to think of their space requirements well in advance as it takes 12-18 months to secure accommodation which often is not in their first choice locations. Next year’s occupier activity may also include a significant amount of pre-lets. Office development in many European cities has been limited in previous years. An exception to this is Helsinki, where new construction has been brisk. Occupier interest in sustainable, functionally efficient and flexible space is a driving force for active office development in Helsinki region. Sources: Savills, Realia

Savills’ view on Prime office rental cycle

 

Improved occupier demand and low interest rates attract investors

In the long prevailing low-interest rate environment the yield gap between property yields and bonds has remained high. Strong demand for real estate for several years has driven the yield requirements to a historically low level. Lower return expectations and lack of product press investors to focus on the management of tenants and on asset redevelopment.

Prime office vs 10y bond yield Source: Savills

 

Strong cities on focus in the late market cycle

In the late cycle where properties are expensive and rental growth is close to turning point sentiments are cautious about the future performance. The focus will be even more on high quality assets in strong cities that are more resilient to market fluctuations.

Savills’ view on Prime office yield cycle 

 

Transaction cost varies from market to market

Practices of yield monitoring as well as fees and taxes differ from market to market. Yields are quoted ‘Gross’ in 40% of the markets Savills monitor while the rest quote ‘Net’. Savills have harmonized prime office yields taking into consideration transaction costs such as fees, transfer tax and non-recoverable costs. Total transaction costs are highest in Ireland (17%), Belgium (15.6%), Luxembourg (11%) and some German regions. Total non-recoverable costs for the landlord are highest in the Nordics (7.5 - 8.0%) and the Netherlands (8.8%).

European net office yields for prime CBD offices Source: Savills

Savills note: The final ‘Triple Net Yield’ includes ‘Transfer Tax’ although in some of the markets (especially where the transfer tax is high) often property deals are structured as corporate or share deals

 

For further information, please open the link:

Savills Market report: European Offices, December 2017