Europe’s prime office market vacancy rate is expected to fall back to its 2009 level by the end of 2016 and then to continue declining over the rest of the decade, according to CBRE. In Europe’s major cities, office development is not keeping pace with growing demand driven by improving employment trends and almost all key office markets are expected to show falling vacancy rates and accelerated rental growth over the next five years.
Neil Blake, Head of EMEA Research, CBRE, commented: “Recent events surrounding Greek debt re-negotiations have obscured what has become a sustained, if uneven, recovery in European economies and this is starting to feed through to Europe’s big office occupier markets. In many cities, office development is not keeping pace with growing demand and almost all major office markets are expected to show falling vacancy rates and rental growth over the next five years, driven by employment growth. ‘Recovering’ cities dominate the employment growth tables for the next five years as corporate confidence grows and expansion plans are executed. As a result a period of sustained rental growth is expected in most markets.”
Office-based employment in major cities is increasing at approximately double the growth rate of total employment across Europe. The cities forecast to experience the fastest growth in office-based employment over the next five years are Istanbul, Warsaw, Madrid, Barcelona, London, Lisbon and Bucharest. Istanbul remains at the top of the employment growth league despite potential short-term economic and political instability due to the longer-term growth forecasts for Turkey’s economy.
While almost all major office markets are forecast to report rental growth, in cities such as Warsaw, Istanbul and Prague, recent development activity and new stock coming on stream will soften rental growth prospects considerably. London and Dublin, which are currently experiencing the fastest rental growth, are also major markets that are responding to demand with increased development. This may lead to rental growth moderating and possibly even easing back towards the end of 2020.
The aggregate vacancy rate for major cities has already fallen from a peak of 9.6 percent at the end of 2010 to 8.9 percent now. By mid-2016, CBRE expects this to reduce to 8.4 percent (equivalent to June 2009 levels) with a further fall to 8.1 percent forecast by the end of 2020, a 10-year low. Falling vacancy will be accompanied by a pick-up in leasing activity. Taking 2015 and 2016 together, leasing volumes are forecast to expand by almost 12 percent in Europe’s major cities with an increase of 20 percent in Madrid, Barcelona, Munich, Vienna, Brussels and Warsaw.
High vacancy rates will persist in cities such as Amsterdam, Budapest, Dublin, Madrid, Prague and Warsaw. However, rental growth is still expected in these markets as empty stock becomes economically redundant due to outdated design or location issues. Vacancy rates in London will actually be higher in five years’ time than they are now as new buildings come on stream.
If geopolitical relationships stabilize, Moscow is set to be the best performing prime market by the end of 2020. Moscow’s anticipated rebound follows sharp falls seen in 2014 and is predicated on at least a partial easing of economic sanctions and recovery in oil prices to more than $80 a barrel by 2020.
Moscow’s office market also has challenges from rents being set in US dollars, while tenant earnings are largely in (now devalued) roubles. There is evidence (CBRE Landlord Survey) that landlords are willing to mitigate the problem by allowing “rental holidays” although they remain resistant to setting future rents in roubles rather than dollars.
Rental growth is forecast to be strongest in Madrid, Barcelona and Moscow (with caveats) with an expected increase of over 4 percent p.a over the five years to end Q3 2020. Prime office rents in Madrid are currently €306 psm, up 4.1 percent from their low point a year ago. They are expected to reach €321.3 psm by March 2016 and €441.8 psm by the end of 2020.
Neil Blake added: “The positive economic backdrop and employment picture means that nearly all European office markets are forecast to report improved returns for investors in office properties. The extent of optimism around the recovery can be seen in the fact that we expect London, one of the lowest yielding markets, to see a further 50bps drop in yields over the next year. However, over the next five years we expect greatest returns to occur in markets such as Budapest, Rome, Madrid and Milan as well as Moscow.
“Political risk is the greatest issue for market outlook over the next few years. From Russia/Ukraine to Greece, and the outcome of the Spanish elections, ongoing growth could be jeopardised on a number of fronts. However longer term volatility in equity and bond markets is unlikely and we see no reason for sustained impact on property markets in the rest of Europe.”
Valentin Gavrilov, Director of Research, СBRE in Russia, said: “Improvement in forecasts of key indicators for European office markets is the result of expected medium term acceleration of economic growth in Eurozone. In majority of European business cities new delivery of office space was constrained by unstable economic situation. In addition, business districts there, are already well established and have quite limited space for new development. It means that Europe is close to a new cycle of investors’ interest to the commercial real estate. Nonetheless, the risks of cancellation of this scenario are still noticeable and related to economic problems of the weakest countries and geopolitical issues.
In Russia 30-40 percent decline in rental rates occurred in just 1.5 years due to the more than 2 times decrease of oil prices and consequences of geopolitical issues. Elimination of any of these factors is in position to start rather fast process of rental rates recovery to the pre-crisis levels. As a result, potential for rental rates growth in Russia seems to be one of the strongest in Europe. However, timing of realization of this potential remains fairly uncertain due to the negative trend in oil prices and lack of positive progress in resolution of geopolitical issues.”