Office market faces reality of hard lockdown at end-2020, with some glimmers of hope
Office lettings take-up more than a third below year-ago level in the Big 7 German cities
FRANKFURT, 8th January 2021 – The coronavirus pandemic was and is an unforeseen and unpredictable event, perhaps even a “black swan” event. But how long is it likely to last, and how deeply will its effects continue to be felt?
There is no reliable answer to this question, which is why all areas of society, the economy, politics and, of course, property markets remain in a state of uncertainty. The lockdown, which has been in force since December, has now been extended until the end of January. Despite the (sluggish) vaccination process, the status of the disease remains precarious; even economic researchers have welcomed the introduction of tougher, albeit temporary, measures. The economists seem to agree that Germany will again enter into a technical recession. Economic growth is likely to have turned negative both in the last quarter of 2020 and the first quarter of 2021.
All this appears to confirm that the path to economic recovery will be more difficult than initially expected. During 2020, GDP growth forecasts for 2021 were downgraded from over 5% to only 3.8% at present. “Government support measures have helped to overcome some of the biggest upheavals, but there is no denying that we are currently experiencing an economic crisis that has affected all industries and segments,” said Dr Konstantin Kortmann, Head of Leasing & Agency at JLL Germany. The various climate indices provide a clear and immediate response to the different news events: reports about the vaccine caused share prices to jump in November, but the second lockdown had the opposite effect with a deterioration in buying mood and poor consumer sentiment. The GfK consumer climate index fell to minus 6.7 points for December from minus 3.2 points in November. Then again, a national event such as the outcome of the Senate election in the US state of Georgia is driving up stock prices once more.
“At any rate, industrial companies are currently proving supportive to the economy. This is illustrated by short-time working measures, among other aspects. In industry, short-time working fell across all sectors towards the end of the year, but it increased in the two sectors that have been particularly affected by the second lockdown: retail and hospitality. For example, the number of employees on short-time work rose to over 6% of those subject to social insurance contributions in retail and to 39% in the hospitality industry — with significant repercussions for the economy as a whole, as well as for the property industry,” said Kortmann.
Overall, the coronavirus crisis in 2020 abruptly ended the rising trend on the German labour market that has lasted more than a decade. On average, around 44.8 million people were gainfully employed in Germany during 2020. According to preliminary calculations by the Federal Statistical Office, this figure was 477,000 or 1.1% lower than in 2019. The sharpest decline in the number of people in employment last year was among service providers, with a fall of 281,000. A total of around 33.5 million people were still active in the service sector. The biggest job losses were seen in the retail, transport, hospitality and corporate service sectors. Conversely, there were employment gains in the public service, education and health sectors.
Significant decline in demand for office space, especially for large office units
“Against this macroeconomic background, the general economic conditions were anything but positive. So it is hardly surprising that a significant weakness in demand has become increasingly evident on the German office markets. Office space take-up in the Big 7 cities fell by more than 33% to a total volume of 2.67 million sqm. In the current recession, budgets are more likely to be cut, with office relocation projects put on hold and actions to renew leases for existing spaces. As a result, there is a particular dearth of large-scale lease contracts for 10,000 sqm and above. The weak demand and a reluctance among users to sign deals are particularly noticeable here. Compared to 2019, the number of deals for office space in this category fell by 43% to 32 across the Big 7 during 2020, accounting for total take-up of 656,000 sqm,” said Kortmann.
Take-up has decreased in all seven real estate strongholds, ranging from -25% in Munich to -55% in Stuttgart. Even Berlin, which has become accustomed to success, registered a 25% decline. Nevertheless, the German capital remained in first place thanks to a take-up volume of 745,000 sqm. “Perhaps the most visible sign of the crisis is the quarterly result in Munich, where take-up didn’t even reach 100,000 sqm. A smaller lettings volume has not been seen in the Bavarian capital since at least 1998,” said Helge Scheunemann, Head of Research at JLL Germany.
Kortmann added: “Without a doubt we have reached a turning point in the cycle. How serious this will be is not yet clear. Due to the delayed occurrence of the economic effects relating to the reluctance of companies to hire more staff, we expect to see an increase in lettings from mid-2021. Rental contracts signed in recent years and now due to expire account for a volume of around 3.2 million sqm, which should help prop up the figures. Even searches for large spaces, some of which have already been announced for the first quarter, could account for total take-up of around 2.9 million sqm in 2021, which would be an increase of 11%.
“However, as can be seen in the wider economy, the market stands and falls with the further development of the pandemic, the progress of vaccination programmes and political decisions. You don’t need to be a clairvoyant to predict that the longer the lockdown, the fewer lettings there will be,” said Scheunemann.
Vacancies increase strongly in some areas
As already forecast during 2020, vacancies have increased in most cities. The office vacancy rate averaged 3.7% at the end of the year (2019: 3.0%), although this is still well below the long-term average. In contrast to take-up, there is still little consistency between the markets in terms of changes in the level of vacancies. While total vacancies in the Big 7 increased by 23% year-on-year, Stuttgart recorded a further decline and vacancies in Hamburg also remained stable. On the other hand, vacancies in Berlin and Munich rose by an above average rate of over 50% each, although vacancy rates are still low here at 2.8% and 3.5% respectively.
“Vacancies are set to increase further to an average rate of 4.5% by the end of 2021. However, the office market is still a long way from a supply glut. In the medium term, we will not see double-digit vacancy rates like in 2010,” explained Scheunemann. With regard to sublet space, he added: “This type of space is always an issue in a crisis. This time too, savings can be generated if a letting is successful.” In the Big 7, almost 12% (approx. 420,000 sqm) of total vacancies is currently offered for subletting. In comparison to previous crisis years, the volume was only 370,000 in 2009, although in 2002 it was almost 1.1 million sqm.
“Interestingly, almost a third of the sublet space is offered in the top locations of the Big 7. It is possible that rental opportunities for such sublet space are greater here and higher rents can also be achieved, which in turn leads to greater savings on rental costs. For 2021 we expect to see a further slight increase to around 560,000 sqm, corresponding to a share of around 13%”, said Scheunemann.
Completions are growing, but not as much as expected – developers are postponing plans for new developments and increasingly investing in renovations
Office completions increased significantly in 2020, but not quite as strongly as expected. Almost 1.5 million sqm had been completed by the end of the year, corresponding to an increase of 29% compared to the previous year. The pace of construction was particularly fast in Berlin, where almost 490,000 sqm came onto the market and the volume more than doubled compared to 2019. As before, new market space in all cities benefits from the years of strong rental activity, as illustrated by pre-letting rates. At the time of completion, only 232,000 sqm was still available across the Big 7. In other words, 84% had already been allocated.
However, project developers were already reacting or were being forced to react to the market situation last year: numerous projects have been postponed. At the mid-point of 2020, projections for completions in the full year were still around 400,000 sqm higher than the eventual figure.
For 2021 and 2022, a total of 4.5 million sqm is under construction or in the planning stage in the Big 7. And space is still being let in advance of completion. For 2021, more than half of the space under construction and in the planning stage is already allocated. “The supply shortage that existed for many years in the more coveted locations will not be completely eliminated even by the turn of the cycle,” predicted Scheunemann. He added: “However, new buildings are increasingly viewed as non-sustainable and, given the already large building stock, developers are increasingly focusing on existing buildings and their sustainable renovation. The ratio of total refurbishments to completions in the years 2020-2023 is expected to be around 30% of the volume, which would be double the rate for the 2009-2019 period.”
Potential for further (nominal) rental price growth
The JLL prime rental index stood at 222.4 points at the end of the year, an increase of 2% compared to the same period of the previous year. In terms of the Big 7, Stuttgart and Hamburg recorded the strongest increases in a 12-month comparison, with 4.1% and 6.9% respectively. Even in Berlin, where both vacancies and completions have increased, the prime rent rose by 2.7%. “This clearly shows that despite the framework conditions and falling demand, rental growth is possible and, due to the extremely low supply in previous years, there is a kind of buffer that at least cushions immediate rental price reactions to increases in vacancies and keeps nominal rents on course. In effective terms, however, after deducting the incentives granted by the owners, a slight downward movement can already be observed,” explained Kortmann. Many landlords were willing to offer more generous incentives than before, such as rent-free periods or contributions to office developments.
In 2021, the rental price index for all Big 7 markets is likely to increase slightly by 1.5%. “We are not expecting to see rental declines in any city. In the medium term, we also see potential for higher rents, at least in offices where more quality fittings and furnishings are required in connection with remote working. This increase in quality could drive up construction and investment costs by up to 5%, an aspect that would also influence rents,” concluded Kortmann.
JLL (NYSE: JLL) is a leading professional services firm that specializes in real estate and investment management. JLL shapes the future of real estate for a better world by using the most advanced technology to create rewarding opportunities, amazing spaces and sustainable real estate solutions for our clients, our people and our communities. JLL is a Fortune 500 company with annual revenue of $18.0 billion in 2019, operations in over 80 countries and a global workforce of over 92,000 as of September 30, 2020. JLL is the brand name, and a registered trademark, of Jones Lang LaSalle Incorporated. For further information, visit jll.com.