LONDON — The U.K. is leading a recovery in Europe’s long subdued office real estate market, with overall investment in the sector expected to pick up further in the second half of the year.
Britain recorded 4.1 billion euros ($4.52 billion) worth of office transactions in the first six months of 2024, accounting for almost one-third (29%) of total European office deals, according to August data from international real estate firm Savills.
That marks a five percentage point increase on its five-year average (24%) share of transactions across the region, and surpasses France’s 1.8 billion euros (13%) and Germany’s 1.7 billion euros worth of deals (12%).
The spike comes amid a prolonged downturn in the office sector, which suffered the dual impacts of post-pandemic workplace shifts and the move to higher interest rates. Overall, European office investment transactions in the first half of the year fell 21% year-on-year to 14.1 billion euros, Savills data showed — a 60% decrease on the five-year H1 average.
But industry analysts now see activity gathering pace from September to year-end, as interest rates fall further and investors seek opportunities to capitalize on dislocated pricing.
“The H1 transactional data lags the market sentiment, but we’re confident that indicators for the future are positive,” Mike Barnes, associate director in Savills’ European commercial research team, told CNBC via email.
Europe’s divided recovery
The U.K. real estate market was the first in Europe to undergo a significant contraction following its peak in 2022.
However, the early conclusion of the July general election — along with the Bank of England’s initial rate cut — have brought some clarity to the market and added steam to the rebound, primarily within the capital, analysts said.
“London is leading the way a bit, partly because it repriced earlier and quicker and more significantly,” Kim Politzer, head of research for European real estate at Fidelity International, told CNBC over the phone.
Higher returns have partly driven that uptick, with average annual office yields in London rising to above 6% of property value this year, according to MSCI data. That compares to around 4.5% in Paris, Stockholm and German cities, such as Berlin and Hamburg.
The rebound is now seen filtering into other markets as the European Central Bank continues its rate cutting cycle, reducing debt loads and boosting liquidity.
“One of the biggest things that’s been holding back liquidity in the European real estate market has been interest rates and financing,” Marcus Meijer, CEO of Mark, told CNBC’s “Squawk Box Europe” on Thursday. “A downward path on interest rates is going to start to open that up,” he added, pointing to positivity over the next 12 to 18 months.
Ireland and the Netherlands, which often closely follow the UK’s trajectory, are now showing momentum, Savills said. Solid economic growth and higher office occupancy rates in Spain, Italy and Portugal also point to signs of strength.
“Southern Europe is looking particularly robust from an office take up point of view,” James Burke, director in Savills’ global cross border investment team, said.
In France and Germany — which have been battling political flux and lackluster growth, respectively — the recovery has yet to flesh out. Tom Leahy, head of EMEA real estate research at MSCI, said that was partly due to an ongoing “gulf in price expectations” between buyers and sellers in these countries.
“It’s as wide as it’s ever been. The markets are very illiquid at the moment,” Leahy said over the phone, noting that further repricing could be expected.
Leaseability concerns
Office occupancy rates nevertheless remain a concern for investors. While Europe’s return to the workplace has been robust versus the U.S. — with vacancy rates totalling 8% and 22% respectively, according to JLL — overall utilization has some way to go.
European office take-up as measured by square metres was down 17% in 2023 compared to the pre-pandemic average, according to Savills, suggesting a lack of expansion or indeed downsizing by tenants. That was seen picking up this year, with nearly two-thirds (61%) of companies reporting average office utilization of 41% to 80%, versus half (48%) of firms last year, according to CBRE. Almost one-third expect attendance levels to increase further.
Meanwhile, a divide has emerged between the haves and the have nots, as tenants demand more modern and functional buildings to help lure their staff back to the workplace. As such, central business district, or CBD, properties with close proximity to public transport and local amenities are of high demand and can attract 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,” Savills’ Burke said.
It comes on the back of a wider shift toward greener buildings amid incoming energy efficiency requirements across the U.K. and EU.
Grade A offices — typically those that have been recently constructed or renovated — accounted for more than three-quarters (77%) of London’s office leasing activity in the second quarter of this year, the highest level on record, according to an August report from real estate firm Cushman & Wakefield.
In a June report, Fidelity said that buildings’ green credentials could now become the “single most important trait” in the new investment phase. Landlords whose buildings meet those requirements will be able to charge a “green premium” and command higher rents, Politzer said.
“Those Grade A green buildings are in short supply and generally lease up while still being developed or refurbished,” she said.
That will likely spur investment from “opportunistic players” into green properties, Politzer said, while those that fail to upgrade could come under further pressure. Meantime, a dearth of new developments is expected to drive further growth in high quality offices over 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,” Andy Tyler, head of London office leasing at Cushman & Wakefield, said in the report.