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LONDON — Britain is leading the recovery in Europe's long-sluggish office property market, with overall investment in the sector expected to continue to pick up in the second half of the year.
The UK saw office transactions worth €4.1 billion ($4.52 billion) in the first six months of 2024, accounting for almost a third (29%) of all European office transactions, according to August data from international real estate company Savills.
This represents an increase of five percentage points compared to the average share of transactions in the region (24%) over the last five years and exceeds transactions in France with €1.8 billion (13%) and Germany with €1.7 billion (12%).
The increase comes against the backdrop of a prolonged downturn in the office sector, which suffered the twin impacts of post-pandemic job relocations and the move to higher interest rates. Overall, European office investment transactions fell 21% year-on-year to €14.1 billion in the first half of the year, Savills data shows – a 60% drop from the five-year first-half average.
However, industry analysts predict that activity will pick up between September and the end of the year as interest rates continue to fall and investors look for ways to capitalize on price fluctuations.
“First half transaction data is lagging market sentiment, but we are confident that indicators for the future are positive,” Mike Barnes, associate director in Savills' European commercial research team, told CNBC by email.
Europe’s divided recovery
The UK property market was the first in Europe to experience a significant decline after peaking in 2022.
However, the early conclusion of the general election in July and the Bank of England's first interest rate cut brought some clarity to the market and gave additional momentum to the recovery, especially in the capital, analysts said.
“London is leading the way a little bit, partly because it has adjusted prices earlier, faster and more clearly,” Kim Politzer, head of European real estate research at Fidelity International, told CNBC by phone.
This upturn is partly due to higher yields. According to MSCI data, average annual office yields in London have risen to over 6% of property value this year. In contrast, in Paris, Stockholm and German cities such as Berlin and Hamburg, the yield value is around 4.5%.
The recovery is now expected to spill over into other markets as the European Central Bank continues its cycle of rate cuts, reduces debt burdens and increases liquidity.
Modern architecture in the La Défense district, on July 13, 2024 in the La Défense district of Paris, France.
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“One of the biggest factors 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 trend in interest rates will enable this,” he added, pointing to a positive outlook for the next 12 to 18 months.
Ireland and the Netherlands, which often closely follow the UK's performance, are now showing momentum, according to Savills. Solid economic growth and higher office occupancy rates in Spain, Italy and Portugal also point to strength.
“From an office take-up perspective, Southern Europe looks particularly robust,” said James Burke, director of Savills’ global cross-border investment team.
In France and Germany – both of which are struggling with political upheaval and sluggish growth respectively – the recovery is yet to be clearly felt. Tom Leahy, head of EMEA real estate research at MSCI, said this is partly due to a persistent “gap in price expectations” between buyers and sellers in those countries.
“It's bigger than ever. The markets are very illiquid right now,” Leahy said by phone, noting that further price adjustments are to be expected.
Concerns about rentability
Still, office occupancy rates remain a concern for investors. While the return to work in Europe has been robust compared to the US – with vacancy rates overall at 8% and 22% respectively, according to JLL – overall occupancy still has some way to go.
According to Savills, office space occupancy in Europe, measured in square metres, is down 17% in 2023 compared to the pre-pandemic average, suggesting a lack of expansion or even downsizing among tenants. This trend has intensified this year: according to CBRE, almost two-thirds (61%) of companies report average office occupancy of 41% to 80%, up from half (48%) of companies last year. Almost a third expect occupancy rates to continue to rise.
A divide has now emerged between rich and poor as tenants demand more modern and functional buildings to lure their employees back to work. As a result, properties in the central business district (CBD) with proximity to public transport and local amenities are in high demand and can attract a wide range of tenants.
“Micro locations depend on proximity to transport links, but also proximity to areas with a high quality of life in terms of restaurants and leisure, that’s key,” says Savills’ Burke.
This comes against the backdrop of a wider move towards greener buildings in line with new energy efficiency requirements across the UK and EU.
Grade A offices – typically those that have been recently built or refurbished – accounted for more than three-quarters (77%) of office leasing activity in London in the second quarter of this year, the highest level ever, according to a report published in August by property firm Cushman & Wakefield.
In a June report, Fidelity said that building green credentials could now become the “single most important feature” in the new investment phase. Landlords whose buildings meet these requirements can charge a “green premium” and command higher rents, Politzer said.
“These Class A green buildings are in short supply and are typically leased while they are still being developed or renovated,” she said.
This will likely lead to “opportunistic players” investing in green real estate, Politzer said, while those who don't upgrade may come under even more pressure. In the meantime, a lack of new developments is expected to lead to further growth in high-end office real estate in the coming years.
“Looking ahead, the constrained development pipeline suggests a reduction in the number of new office spaces coming to market. This should lead to a gradual decline in vacancy rates both overall and in Grade A over the course of the coming year, and should drive rental growth particularly at the top end of the market,” Andy Tyler, head of London office leasing at Cushman & Wakefield, said in the report.