Europe’s Office Market Recovers, but Unevenly: UK Leads Charge, While France and Germany Lag
The long-dormant European office real estate market is showing signs of life, with the United Kingdom leading the recovery. In the first half of 2024, the UK accounted for nearly a third of all European office transactions, a significant increase from its five-year average. This surge comes on the heels of a prolonged downturn, marked by post-pandemic workplace shifts and rising interest rates. Analysts are optimistic about the second half of the year, predicting further investment activity as interest rates continue to fall and investors seek opportunities in a dislocated market.
Key Takeaways:
- The UK is leading Europe’s office market recovery, accounting for 29% of total European office deals in the first half of 2024, a five percentage point increase from its five-year average.
- The recovery is primarily driven by the UK’s early conclusion of the general election, the Bank of England’s initial rate cut, and higher returns, particularly in London.
- Other European markets, including Ireland, the Netherlands, Spain, Italy, and Portugal are also showing signs of momentum.
- France and Germany are lagging behind due to political flux and lackluster growth, with a wider than usual gap in price expectations between buyers and sellers.
- Investors remain concerned about office occupancy rates, but companies are gradually returning to the workplace, with attendance levels expected to increase.
- "Grade A" office spaces, those that are modern, functional, and environmentally friendly (green buildings), are in high demand, while older buildings may face pressure to upgrade or face higher vacancy rates.
Europe’s Divided Recovery
The UK’s office market was the first in Europe to experience a contraction after reaching its peak in 2022. But the early resolution of the July general election and the Bank of England’s first rate cut brought much-needed clarity to the market and fueled the rebound, particularly in London.
"London is leading the way a bit, partly because it repriced earlier and quicker and more significantly," said Kim Politzer, head of research for European real estate at Fidelity International.
This rebound is attributed to higher returns, with average annual office yields in London exceeding 6% of property value this year, compared to approximately 4.5% in Paris, Stockholm, Berlin, and Hamburg. As the European Central Bank continues its rate cutting cycle, reducing debt and boosting liquidity, the recovery is expected to spread to other European markets.
"One of the biggest things that’s been holding back liquidity in the European real estate market has been interest rates and financing," said Marcus Meijer, CEO of Mark. "A downward path on interest rates is going to start to open that up."
Leaseability Concerns Remain
Despite the positive trends, concerns remain about office occupancy rates, although they are higher than in the US, and European companies are returning to the workplace at a faster pace.
" European office take-up, as measured by square meters, was down 17% in 2023 compared to the pre-pandemic average," according to Savills, highlighting a lack of expansion or even downsizing by tenants. However, this trend appears to be reversing, with nearly two-thirds (61%) of companies reporting average office utilization of 41% to 80%, a significant increase from last year, according to CBRE. Almost a third (33%) expect attendance levels to increase further.
This shift in workplace trends points to a burgeoning demand for modern, functional, and attractive offices, leading to a disparity between high-demand "Grade A" spaces and other buildings. CBD properties with excellent access to public transport and local amenities are particularly sought after, attracting a diverse range of tenants.
" Micro-locations dependent on proximity to transport connections, but also the proximity to highly amenitized areas from an F&B (food and beverage) or leisure point of view, that’s key," said Savills’ Burke.
Green Premium Emerges
This demand for high-quality spaces is further compounded by a growing focus on green buildings and increasing energy efficiency requirements across the UK and EU. Grade A offices, often newly built or renovated, dominate leasing activity in London, making up more than three-quarters (77%) of the market in the second quarter of this year, according to Cushman & Wakefield.
Fidelity International states in a report that green credentials are becoming a key factor for investors, who are willing to pay a " green premium" for buildings that meet stringent environmental standards. This will likely lead to an influx of investment in green properties while putting pressure on landlords who fail to upgrade their buildings.
" Those Grade A green buildings are in short supply and generally lease up while still being developed or refurbished," said Politzer.
The limited supply of new developments is expected to further boost the demand for high-quality offices in the coming years.
"Looking ahead, the constrained development pipeline suggests a tapering of new office space entering the market. This should lead to a gradual decrease in both overall and grade A vacancy rates over the coming year, and fuel rental growth, particularly at the top end of the market," said Andy Tyler, head of London office leasing at Cushman & Wakefield.
While the future of the European office market remains bright, the uneven recovery highlights the need for further adaptation and investment to respond to evolving demands and secure the long-term health and viability of this crucial sector.
