Developers are struggling to keep up with the strong demand for offices across Europe as take-up and rents soar and vacancy rates drop to record lows.
Despite the geopolitical turmoil and stock market volatility over the past 12 months, there seems to be no sign of a slowdown in the demand for office space across Europe. PropertyEU’s survey of leading office developers shows most have consolidated or increased their building programme in the past year and all the leading players have major projects in the pipeline.
Together, the 13 companies in our pipeline ranking have over 6 million m2 of office space planned between now and 2020, more than double the amount completed in the last three years. Pressure on yields in the core markets is driving rents up to record levels and prompting some developers to cast their net wider in search of better returns. But with occupancy rates continuing to fall in defiance of expectations, demand for office space continuesto rise faster than supply.
Skanska, the company which tops our ranking this year, has successfully established itself in the fertile CEE region which accounted for around 70% of its total office development in the three years to 2017. Altogether the Swedish investor-developer completed 288,400 m2 of projects in Poland, the Czech Republic, Hungary and Romania, as well as 121,021 m2 in its Nordic ‘home’ region. Though the figure for CEE has fallen slightly against last year’s figures for the equivalent period, the company has a colossal pipeline amounting to 1.37 million m2, including major developments in Krakow, Stockholm, Warsaw and Lódz.
A similar story is told by HB Reavis, which ranks fifth in our ranking on current projects but has over 900,000 m2 of developments either planned or under construction over the next three years, topped by the 277,000 m2 New Nivy scheme in Bratislava, which will comprise a retail centre and two office towers.
PARIS LEADS ON TAKE-UP
France remains the hub of European offi ce development, with the country’s largest developer Altarea Cogedim taking third place in our ranking with a portfolio made up entirely of French schemes such as the 43,600 m2 Euromed Center in Marseille. With large-scale developments in the pipeline in Bordeaux, Toulouse and Paris, where it is refurbishing the Tours Pascal in the capital’s La Défense financial district, it continues to be one of the most active players in the sector. Take-up of offices in Paris increased by 13% year-on-year in Q1 2018, according to Savills, making the French capital the front runner among Europe’s major cities. But falling yields are prompting both investors and developers to look beyond the core markets. Cushman & Wakefield reported in April that European office yields had fallen to 4.46% overall and were as low as 3.1% in Germany.
However, the ripple eff ect is already being felt further up the risk curve. Adrian Karczewicz, head of divestments for Skanska CDE, told PropertyEU in March that yields had dropped to 4.5% in Prague, below 6% in Hungary, and even Bucharest has hit 7.5% and is falling. ‘Everything depends on the central banks in Europe and the US,’ he said. ‘If the interest rates stay at this level for the next two or three years we will still have a very good round on the real estate markets.’
ADDING VALUE IN CORE MARKETS
For developers, the challenge is to add value in the oversubscribed core markets. According to Savills, office take-up reached 3.1 million m2 in Q1 2018, 22% above the 10-year average. The upside, according to RCA’s analysis of pricing trends in January, is that a scarcity of Grade A stock is prompting investors to take a share of the risk of development, for example by forward-purchasing buildings under construction. ‘At this moment in the cycle yields are very low and it’s difficult to extract value everywhere in the asset classes,’ says Nathalie Charles, head of development and European country teams at AXA IMRA.
‘In core locations today there is so much pressure because of the input of capital that only a differentiating product can really preserve the long-term view.’ Historically low vacancy rates are another advantage for developers, as it feeds demand from tenants for new office buildings. Google, Amazon and L’Oreal have all commissioned major new head offices in recent years and the trend for smarter, greener, more user-attractive buildings is creating opportunities for forward-thinking developers. Modern complexes now include facilities such as gyms or communal spaces for staff and visitors that were unheard of a decade ago. AXA’s Charles says occupiers today expect more sophisticated workplaces and developers are working hard to deliver them. ‘In the past tenants had their own facilities, but that was only possible if you were a very large tenant,’ she says. ‘Where the market has clearly evolved is the fact that in larger projects we can now offer a lot of amenities which can represent 10 to 15% of the surface area, which tenants are very happy to have because they are included in the common charges and they don’t need to manage them.’
One potential game changer that is looming large is the Brexit effect, though so far the impact has been more modest than many analysts initially feared. While a handful of international firms, such as HSBC, are moving their headquarters from London to other European capitals such as Paris or Dublin, the much-vaunted ‘Brexodus’ has not materialised. Indeed, investment volumes in London went through the roof on all fronts in 2017, overtaking Germany as Europe’s number one real estate destination, though there are signs that the market is cooling off as the exit date of March 2019 nears. And investment from Asia appears to be holding up after a year in which Chinese and Hong Kong buyers snapped up two of London’s landmark skyscrapers, the Richard Rogers-designed Leadenhall Building, nicknamed the ‘Cheesegrater’ and the ‘Walkie Talkie’, for big-ticket prices. In the first half of this year, Asian investment in City of London offices hit a record volume of £3.39 bn (€3.85 bn), according to Savills, outstripping activity for the same period in 2017.
Nonetheless, rents are slowing and their are signs that London’s fundamentals are softening, according to market experts. ‘When you compare London fundamentals to other markets, it’s not looking as attractive,’ Richard Divall, head of cross-border capital markets at Colliers International, told the Financial Times recently.
A more tangible trend has been the relocation of head offices from central business districts (CBDs) to more affordable locations as tenants come under pressure from rising rents. With prime CBD rents now 2% above their 2010 peak, according to Savills, and peripheral locations some 70% cheaper, occupiers are more willing to trade a prime location for better facilities and more space in secondary cities.
Consequently, Europe is showing strong polarisation between locations such as Brussels, where rents rose 5% in Q1 2018 while take-up fell by 19%, and the likes of Manchester and Vienna, which saw take-up increase by 110% and 69% respectively. But with vacancy rates now below 5% in a third of locations and prices at a premium, the demand for new office space is likely to continue as long as Europe’s economies remain buoyant.