Autumn 2018: Office property market in the Big 7 marked by space shortages and rising rents

Autumn 2018: Office property market in the Big 7 marked by space shortages and rising rents

October 05, 2018

FRANKFURT, 4th October 2018 - Is the glass half full or half empty? In typical German manner one would tend towards the negative statement. However, the assessment of the economic situation at the end of the third quarter is anything but clear. At times, business sentiment improves or “has not deteriorated as much as expected”, then uncertainty again takes hold and has a negative impact on future expectations. On the other hand, the situation on the labour market and economic growth rates are sending out more positive signals.
“Challenging developments such as the escalating trade dispute between the US and China on the one hand and a very robust domestic economy on the other have created a mixed situation that is likely to continue into the fourth quarter of the year,” said Timo Tschammler, CEO of JLL Germany. He added: “All in all, the economy is still sound, and aside from the political turmoil and disputes, it is the companies that are operational in Germany which currently provide a shining example of the country’s much-vaunted stability. The lights are on green for further growth, especially in the service, trade and construction sectors.”
The economy is forecast to grow by 1.9% this year and then by 1.7% in 2019, according to Consensus Economics. As for employment, the boom continues, with the service sector in particular still on an expansion drive. In 2018 alone, around 350,000 jobs should be created, followed by a further 300,000 new positions in 2019. Yet as companies demand additional labour, recruiting problems intensify and appointment processes lengthen. “The consequence of this for the office property markets is that companies seeking new premises face two challenges: first, relocation plans cannot or can only be partially realised due to the prevailing shortage of available office space and, second, business expansions may not be realised due to the lack of skilled workers, with the result that planned relocations are shelved for the time being,” said Timo Tschammler.

Situation on the office property market
"The consistently high demand for space by companies cannot be met due to the shortage of space. In central locations, there is a glaring lack of space. Accordingly, rents are rising across the board. The low volume of completions in recent years has hardly helped improve the supply situation. This could change in the next few years owing to the rising level of construction activity. However, whether all planned project developments start on time remains questionable due to the high utilisation of the construction industry. It is unlikely that rental prices will remain unchanged or even be lowered,” said Timo Tschammler, summing up the current situation on the office market in the German real estate strongholds.

Take-up volume remains high – but not every user finds suitable premises 
The continuing positive economic development accompanied by falling unemployment and growing levels of office-based employment are reflected by the robust demand for space. Office space take-up in the seven office property strongholds was at a high level in the first nine months of the year, even though it did not quite reach the previous year’s result. In total, 2.84 million sqm was either rented or occupied by owners in the first three quarters of the current year. This equates to an annual decline of almost 6%. However, a longer term view reveals the true extent of demand, with take-up 11% higher in a five-year comparison and 21% above the 10-year average. 
Lower take-up in four of the seven markets played a decisive role in the overall decline, with losses ranging from -10% in Hamburg through to -21% in each of Berlin and Cologne and -25% in Stuttgart. Munich again boasts the largest take-up volume of 686,000 sqm, and also recorded the highest year-on-year growth of 14%. Berlin is ranked in second place with a take-up volume of 575,000 sqm, but suffered a 21% decline. Frankfurt remained a growth market. 
“Companies are showing a continuing tendency to expand. Despite the general trend towards improving space efficiency, they often rent larger spaces than before due to workforce expansions and larger floor layouts for communal areas. Net absorption in the current year is correspondingly high at 653,000 sqm,” said Matthias BarthauerResearch, JLL Germany.
With regard to the forecast, Timo Tschammler added: “We should continue to register strong demand for space on the Big 7 office property market until the end of the year. However, this will be limited by the steadily decreasing supply of space. Not every company seeking new premises will be able to find an appropriate space. We therefore assume that the result from 2017 (more than 4 million sqm) will not be achieved. Take-up on the office market in 2018 could be up to 10% below the record volume of the previous year — although this would still be 7% above the five-year average.”

Flexible office space operators continue to be active on the market

When planning a relocation, companies place great value on the office environment, facilities, attractive communal areas and a general feel-good factor for employees. These features are also highlighted by flexible office space operators when marketing their products. In the current year, coworking space providers signed new lease contracts for about 170,000 sqm of office space in the Big 7. This corresponds to about 6% of total take-up. Frankfurt and Cologne are the market leaders here with shares of 11% each. “We see very high demand from operators for central and easily accessible office spaces. If it were possible to satisfy this demand, the share of take-up would currently be in the double-digit percentage range,” said Matthias Barthauer.
The current shortage of space is both a curse and a blessing for these operators: a curse, because they themselves face considerable difficulty in implementing their expansion plans, and a blessing because “normal” office users who are also experiencing space shortages make use of flexible office space as a short-term solution. The stock of flexible office space sites is currently on the rise: more than 450 of such locations have opened up with around 650,000 sqm of space. In the last three months of the current year, a further 25 locations with almost 100,000 sqm of space will be opened. 

Vacancies fall further – but the bottom will soon be reached
The shortage of space is currently the central market parameter. It limits space take-up and forces up rental prices. Office vacancies in the Big 7 have fallen by 900,000 sqm this year, and stood at 3.65 million sqm at the end of September 2018. This equates to a cumulated vacancy rate of 3.9%, which is 40 basis points lower on a quarterly basis and 100 basis points below the year-ago level. “Space shortages are particularly acute in central locations. For many users, this means they are either forced to renew their existing leases or, if they are under pressure to relocate, to explore spaces in secondary locations and even in surrounding areas depending on the size. Flexibility combined with the ability to compromise is therefore a necessity for users. However, good transport links and an attractive environment are key factors for a location in order to be able to score points with the workforce,” said Timo Tschammler
The vacancy rate has already fallen well below the 7% mark in Frankfurt for the first time since 2002, and stands at 6.6%. Now, after nine months of the year have passed, only one market in the Big 7 still has a vacancy rate above 7%: Düsseldorf with 7.1%. Yet even here the rate is expected to fall below this level by the end of the year. Stuttgart still incurs the lowest vacancy rate (2.3%), followed by Berlin (2.7%). “Following an expected slight decline to 3.8% for the Big 7 as a whole, the bottom is likely to be reached in the current cycle since completion volumes are set to rise due to increased construction activity in the forthcoming quarters,” said Matthias Barthauer.

New building volume rises
In total, 556,000 sqm of office space was realised in the current year (+10% compared to the same period in the previous year). Only 14% of this was available at the time of completion. Berlin, Munich and Hamburg each accounted for a completion volume of more than 100,000 sqm. In the final three months of the year, more than 400,000 sqm of completions are expected in the Big 7 (of which 82% is already pre-let). Munich will account for the highest volume of about 170,000 sqm. 
According to latest forecasts, 1.77 million sqm will come on to the market in 2019, followed by more than 2 million sqm in the following year. Construction activity has thus continued to increase: at present, 3.93 million sqm of office space is under construction or undergoing extensive refurbishment. Compared to the previous quarter, this represents an increase of around 250,000 sqm. From today’s perspective, 44% of the total space under construction is still available. “This should somewhat alleviate the supply bottleneck. However, it should also be noted that the time of completion often shifts, primarily because of the high capacity utilisation of the construction companies and craftsmen,” said Timo Tschammler.

Further rental price growth due to supply shortage 
“The rental price as a result of supply and demand reacts to the current market situation and is currently going in only one direction: upwards. In the current cycle, the JLL prime rental price index has been increasing since 2010,” said Timo Tschammler. The current value stands at 201.85 points, an increase of 5.6% over the last twelve months. Compared to the previous quarter, prime rents rose in six of the seven markets (except Stuttgart), whereby Berlin and Cologne recorded the highest absolute increases of €1.00/sqm/month. For Cologne, this is the first increase in the office prime rent since mid-2012. Compared to the previous year, growth ranged from around 3.8% in Dusseldorf and Hamburg to 12.1% in Berlin.
The significant increase in rents applies not only to prime sites but also to secondary locations. Vacancies are also diminishing here because demand is spilling over from central locations, and an increase in rental prices is inevitable. In Berlin, for example, prime rents rose in 14 out of 15 sub-markets over the course of the year — with the strongest rise of 40% evident in the Mitte sub-market. A similar picture has emerged in the Munich city area, where rising prime rents were registered for 11 out of 12 submarkets in the first nine months, particularly in the Ost (east) sub-market. Here, the rents grew by 19%.
Between the fourth quarter of 2018 and the end of 2019, a further increase in prime rents is expected in six of the Big 7 markets. Only Düsseldorf is not expected to see any change. Our forecasts range between +1.3% (Frankfurt) and +3.9% (Munich).