At first glance, the prospects for office landlords might appear grim. The after-effects of the Covid-19 pandemic, the impact of the Russian war of aggression in Ukraine, high inflation and a huge hike in interest rates all conspired to torpedo the economic recovery in 2022, with the result that economists now expect a recession in the current year. Accordingly, many companies are holding off when it comes to renting office space. Not only that, but working away from the actual office – whether at home or in other places – became in­creasingly accepted practice during the pandemic.

You might think the logical consequence would be a collapse in demand for office space, and falling rents. But that has absolutely not been the case. “Despite the increasing economic, financial and geopolitical uncertainty, the rental markets continue to flourish,” reports Laurent Boucher, CEO of BNP Paribas Real Estate Advisory. According to provisional figures collated by his firm, take-up increased by almost 10 percent across all European office markets in 2022. 

The yield spread between core and non-core will widen.

The office is still essential for interaction and inspiration

Rents are likewise still on an upward trajectory. According to figures from JLL, in the third quarter of 2022 the European office rent tracker, which tracks premium rents, was up 2.2 percent on the previous quarter. Rents rose in 18 of the 23 European major cities surveyed. How can these figures be explained? On the one hand, there is considerable evidence that recent fears of a slump in economic activity were overstated. Predictions for 2023 talk ­merely of a “mild” recession, says Laurent Boucher, pointing to forecasts that eurozone GDP will fall by 0.1 percent in the current year. 

Moreover, the view widely taken in the early stages of the pandemic that changes in the world of work would make conventional office space largely redundant does not appear to have been borne out by events. “The office is still essential for social interaction, creativity, mutual inspiration and information transfer,” affirms Boucher. He agrees that there is a tendency among banks, insurers and other major companies to cut back on office space, but the reduction in individual work­stations has been partly offset by the creation of larger meeting rooms and communal spaces. From his research, he is convinced that “the office will continue to play a key role for companies and their workforces alike, typically as a combination of one or two days spent working from home and the rest together on site.” 

Despite the increasing economic, financial and geopolitical uncertainty, the rental markets continue to flourish.

The fact that working from home has gained in importance is revealed by a survey of employees carried out by JLL. It showed that European office workers are currently spending an average of three working days a week in the office space provided by their company, whereas the pre-pandemic figure was 4.4 days. This does not mean, however, that employees are spending the rest of their time working from home. Instead, “third places”, such as co-working spaces, are also gaining in significance. Real estate consultancy Savills predicts that what have become known as flexible workspaces could make up 20 percent of all office space in Europe in future. According to Savills, in the first six months of 2022, some 5 percent of European office space use was accounted for by this form of office workspace, which can be used on flexible terms and comes fully equipped with office infrastructure.

Rent differentials for location and ESG standard are increasing

This is not the only change in evidence in the office world. Significant shifts are also emerging in terms of favoured locations. “We’re still seeing interest in high-end office space, especially in city centre locations,” says Marcus Lemli, Head of Investment Europe at Savills. This is confirmed by Laurent Boucher of BNP Paribas Real Estate. Companies are looking for compact, modern, flexible offices that come with numerous services, are well situated and have good public transport links. Sven Lintl, Head of Asset Management Germany at Union Investment, shares this assessment: “A lot of tenants are looking to snap up these high-end, easily accessible office spaces, or in some cases to expand them,” he says. “The hybrid world of work is here to stay, forcing companies to offer their staff a compelling alternative to working from home.” 

Figures from BNP Paribas Real Estate under­line this trend, revealing that in 2022, rents for prime office space increased by 6 percent in London and 3 percent in Paris. At the same time, most central business districts are reporting very low vacancy rates: 1.2 percent in Munich, 2.5 percent in Paris and 4.2 percent in Milan, for example.

Conversely, office spaces in peripheral locations without bus and rail links are increasingly struggling. This applies in particular to ageing office buildings that no longer meet today’s high sustainability standards. There is no getting away from ESG, stresses Alexander Fieback, Team Leader Office at German analyst bulwiengesa – not just in the investment market, but also increasingly when it comes to office lettings. Occupiers are prepared to dig deeper for well-situated, sustainable offices with a high-spec fit-out, confirms Hela Hinrichs, Senior Director EMEA Research & Strategy at JLL: “Sustainability and energy efficiency are now playing a dom­inant role in the selection of office space.” 

Emergence of “green premium” and “brown discount”

Hinrichs thus expects further rent increases in this segment in the current year, ­whereas in peripheral areas the trend is likely to be one of rising vacancy rates and falling rents. Laurent Boucher puts it pithily when he speaks of a “more pronounced segmentation of the markets into winners and losers”. This spread is also relevant for investors. According to the Real Estate ESG Snapshot released by consultancy firm EY, 93 percent of the real estate ­market players surveyed expect a “green premium” to emerge for taxonomy-­compliant properties. Conversely, 89 percent of them anticipate a “brown ­discount”, meaning a lower price for ­properties with poor sustainability ­credentials. bulwiengesa expert Fieback draws a clear conclusion: “The yield spread between core and non-core will widen.”

This trend is being amplified by the fact that developers are significantly scaling back their new build activities due to ris­ing interest rates and higher construction costs. “The looming reduction in con­struction could further exacerbate scarcity in the prime segment,” says Savills investment boss Marcus Lemli. This will likely have the effect of further pushing up rents and, consequently, also returns for investors who bought high-end prop­erties at sensible prices.

Von Christian Hunziker