Office lettings market continues to tick over

FRANKFURT, 2nd October 2019 – A crisis is looming, not only in geopolitical terms but also now more noticeably in Germany at the most fundamental level. As an export-oriented economy, Germany is particularly hard hit by global trade restrictions - a consequence of the destructive trade war between China and the United States on one hand, and of politically motivated sanctions imposed by Donald Trump on the other. As expected, the economy in Germany shrank in the second quarter, and got off to a disappointing start in the third quarter. Indeed, where should the impetus for growth come from at present? Companies are scaling back investments, and short-time work and staff reductions are on the table for discussion in industry. This is all now having an increasingly adverse effect on Germany’s previously buoyant domestic economy, although private consumption will remain a pillar of strength this year with growth forecast at 1.6%. Overall, Consensus Economics predicts that the German economy will grow by only 0.6% in 2019, rising to 1.2% next year. “But in view of the risk factors that show no sign of weakening, as well as other political conflicts such as the unrest in Hong Kong, a big question mark hangs over any forecasts at present. It is to be specially noted that we are still not receiving any good signals from industry, and the car industry is suffering from shrinking demand from China and the only limited progress that is still being made with electric mobility development,” said Timo Tschammler, CEO of JLL Germany.

What remains? The jobs market is still in robust form, although a turning point could also be reached here and it would not be surprising if the unemployment rate increases in the coming months. Employment in particular, and the ifo employment barometer as a proxy for this, has proven to be a very reliable indicator for the German office lettings market in the past.

Helge Scheunemann, Head of Research at JLL Germany, said: “From a purely statistical point of view, the following correlation applies: If the index loses 5%, space take-up decreases by 10%. And, indeed, the ifo employment barometer fell by around 5% in the first half of the year — the strongest decline since 2009. However, the office lettings markets have not yet been affected by the increasing reluctance of companies to recruit new staff. This is also related to the fact that the office lettings market tends to react after a delay of about nine months.” Timo Tschammler added: “For 2020, we therefore expect to see a somewhat more pronounced decline in demand for office space. The recessionary trends would then also filter through to the service sector, which includes the industries that account for about 85% of total office space take-up on average in the Big 7.”

Further increase in take-up volume – Berlin and Stuttgart record strongest growth

The office lettings markets in the seven strongholds registered further take-up growth in the current year. Overall, 3.05 million sqm was either leased by tenants or bought by owner-occupiers in the first three quarters. Compared to the corresponding period of the previous year, this represents an increase of 5%. While this initially appears to be at odds with the economic downturn, it can be explained on one hand by the delayed reaction described above. On the other hand, owing to the significant supply shortage in the current cycle some relocations could not be realised because there was no available space. Strong variations exist between the individual markets, however. Stuttgart (+58% to 257,000 sqm) and Berlin (+26% to 759,000 sqm) recorded the strongest growth, while Frankfurt (-15% to 389,000 sqm) and Munich (-12% to 605,000 sqm) fell somewhat short of the previous year’s figures.

“With a strong third quarter behind us, we expect the take-up volume for 2019 as a whole to be in line with the previous year at close to 4 million sqm. The figure for 2019 would then still be around 5% above the five-year average. Nonetheless, the outlook for 2020 is likely to be somewhat bleaker should the poor economic situation become more entrenched,” said Timo Tschammler.

At present, there are several overlapping effects/trends on the office property market with varying influences on space take-up. First, the strong economic development of recent years still means that many businesses are expanding and taking up more office space (growth in space take-up). Second, as the economy slows down, the impact of this will spread from industry to the service sector (slowdown in growth and weakening demand). And third, the prevailing space shortage particularly in prime locations reduces the potential for space take-up despite demand.

One topic that is currently widely debated is the development of flexible office space concepts. Flexible office space operators have grown exponentially in the last three years, and this level of growth is continuing in the Big 7. In the first three quarters of this year, new lease contracts were signed for around 190,000 sqm, of which 70,000 sqm alone in Berlin. As a result, take-up in the German capital already almost matches the entire volume of the previous year. Around 30,000 sqm was registered in each of Frankfurt, Düsseldorf and Munich. The largest contract in the third quarter was signed by WeWork for 20,000 sqm in Düsseldorf, with JLL acting as broker for the lease. For 2019 as a whole, up to 250,000 sqm is expected in total.

Vacancies continue to fall

The short-term supply of office space is still in decline. Overall, only 3 million sqm is available to companies seeking space in the Big 7. The figure was 1 million sqm higher only five quarters ago. However, the rate of decline is not as strong as in the prior quarters. While vacancies in the past four quarters fell by an average of 250,000 sqm per quarter, the figure dropped to only 25,000 sqm in the period from July to end-September. Düsseldorf and Hamburg registered the

sharpest quarterly declines in vacancies, with each falling by 0.3 percentage points to 550,000 sqm and 472,000 sqm respectively. If the assessed period is extended to a year, all seven markets show a decline in vacancies of between 6% (Stuttgart to 189,000 sqm) and 31% (Cologne to 185,000 sqm). In Berlin, the vacancy rate again fell below 2% at the end of the third quarter (1.9% to 396,000 sqm). The highest vacancy rates can still be found in Düsseldorf and Frankfurt (696,000 sqm), each with 6%. “In view of the extreme shortages in other strongholds, these quotas are no longer regarded as a handicap because they indicate the availability of a certain amount of space for users,” said Helge Scheunemann.

The aggregate vacancy rate for the Big 7 stood at almost 3.2% by end-September and was 0.7 percentage points below the figure for the same quarter of the previous year. By the end of the year, vacancy rates will fall slightly again to an average of 3.1%. Despite the increase in new construction activity, a trend reversal is again not in sight for 2020, according to Scheunemann.

The construction volume remains above the 4-million-sqm threshold

Something is (finally) happening on the development front: In the first three quarters of 2019, total completions in the Big 7 amounted to 800,000 sqm. This is 50% more than in the corresponding period of last year. By the end of the year, a further 440,000 sqm is expected to be completed, although 85% of this is already let or sold to an owner-occupier. Even though the total completions volume of 1.24 million sqm is the highest since 2009, the market could certainly absorb even more at present.

In the coming year, office completions in the Big 7 are expected to exceed 1.9 million sqm. Of this volume, around a third is still available, although in Stuttgart and Hamburg the level of availability falls to 15% and 17% respectively. Development activity has been particularly strong in Munich (370,000 sqm) and Berlin (260,000 sqm), but the proportion of newly developed space that is still available in these sought-after cities lies between 11% in the German capital and 14% in the Bavarian metropolis. At 4.3 million sqm, total office space that is currently under construction is at a high level. This applies in particular to Berlin (1.5 million sqm under construction) and Munich (865,000 sqm under construction). “Both are markets with very low vacancies, so we are not anticipating any oversupply,” said Helge Scheunemann. Scheunemann added: “Vacancies are likely to increase again particularly from 2021/2022, thus offering users more choice. Thus from their perspective, this would be regarded as a positive development.”

Rental prices continue to rise  – Cologne experiences significant growth

Rental prices are still going in only one direction: upwards. Compared to the previous year, prime rents increased in all Big 7 markets (from 1.8% in Düsseldorf to 13% in Cologne). The JLL prime rental price index increased by 6.8% year-on-year and currently stands at 216 points — the highest value since 1992. A further increase is expected by the end of year, up 6.6% compared to the end of 2018. “We also expect rental prices to continue rising in 2020, although the average growth across the seven strongholds should weaken considerably to around 2%. However,

outside the prime locations, significantly higher growth rates will be achieved in some instances in the last quarter and next year,” said Timo Tschammler.