The lockdown begins to leave its mark on the office lettings market
Office space take-up in the Big 7 falls 30% year-on-year
FRANKFURT, 6th April 2020 – Germany is on high alert, not only in terms of people’s health but also with regard to the economy. An unprecedented lockdown has forced the domestic economy to grind to a halt, and the outcome is still uncertain.
In German, the word ‘luv’ refers to the windward side of a ship. The degree to which the economy is knocked off course by the current pandemic will determine whether its recovery takes an “L”, “U” or “V” form. “We will only find out which formation we are heading for in the next weeks or months, when the full extent of the recession becomes known and government rescue packages are in place. Right now, acute crisis management, or the capacity of companies to act, is paramount,” said Helge Scheunemann, Head of Research at JLL Germany.
JLL Germany’s chief researcher is therefore not surprised to see that companies from almost all sectors (trade, services and construction) have stopped recruiting new staff or have put recruitment plans on hold. It is no coincidence that the Ifo employment barometer fell by 4.6 to 93.4 points in March, the biggest drop since this key economic indicator came into being. Economic institutes are now largely anticipating a significant decline in economic output to varying degrees, at least in the next two quarters.
Hurriedly launched government rescue programmes are designed to alleviate more acute setbacks. In particular, the multi-billion-euro “economic stabilisation fund” is intended to strengthen companies by providing capital and guarantees. If necessary, the state should be able to invest in companies, as was the case during the financial crisis more than ten years ago. There are also emergency loans for businesses and a support package for the self-employed and small businesses. In addition, the short-time working model that was used quite successfully in the financial crisis has been implemented again.
At the beginning of March, we were still talking about falling unemployment and a high number of vacancies, while short-term work was practically non-existent. Since then, there has been a complete turnaround. The last two weeks in March marked a historic turning point. More than 470,000 companies submitted applications for short-time work by 27 March alone — and the trend is rising. “This increase could of course be quickly slowed down or reversed if the economic lockdown is eased, but since infection rates are still rising rapidly then the economy is likely to remain in emergency operation mode at least during April. For comparison: during the financial crisis, short-time worker applications peaked in July 2009 at just over 61,000. The difference in the figures illustrates the dramatic macroeconomic recession we are currently dealing with,” said Scheunemann.
Demand for office space falls significantly compared to the previous year
As Scheunemann points out, “this cannot fail to have consequences for the commercial office lettings markets. Here too, the second half of March clearly illustrates how the office market has changed after the spread of the coronavirus. It would be pure speculation and therefore pointless to say how this might look in future. Looking at the cold figures for the first quarter of 2020, it can at least be said that the lettings markets would have declined even without the coronavirus, since first signs of a somewhat subdued market were already evident at the end of last year.”
Total take-up for the Big 7 (Berlin, Cologne, Düsseldorf, Frankfurt, Hamburg, Munich, Stuttgart) amounted to 701,000 sqm in the first quarter of 2020, corresponding to a 30% decline on a 12-month basis. This represents the weakest three-month period in terms of take-up since Q3 2014. The figure is also 15% below the 10-year average for first quarters.
None of the seven property strongholds emerged unscathed from the general downturn, which is unusual given that the trend has generally been upwards in the past 10 years. Munich was again the market leader with take-up of 184,000 sqm and a moderate reduction of 6%. Cologne and Stuttgart experienced the sharpest declines of 60% and 61% respectively. Even Berlin, which has become accustomed to success, registered a drop of around a quarter to 172,000 sqm.
What will happen next?
More than 50% of companies surveyed for the new JLL-Thermometer that was developed at the end of March fear that the health crisis will have a major and lasting impact on their core business. The possible effects for office markets could be that space requirements are mostly reduced.
“The coronavirus crisis is already having an impact on current deliberations about new lease contracts or lease extensions. More than half of the companies surveyed confirmed that decisions were being postponed. Put in positive terms, a postponement does not mean that a relocation or rental plan will fall through. As the crisis progresses, space optimisation measures are likely to become increasingly important, also in view of the fact that home working could become a permanent option for more and more employees,” said Scheunemann. He added: “This could influence adjustments of existing space, for example through sublease contracts, as well as price renegotiations of current tenancy agreements. In the current economic situation it should be constantly emphasised that it is deemed appropriate for both sides – owners and users — to come up with sensible and sustainable solutions.”
Vacancies stabilise at a low level
After dropping significantly from quarter to quarter in recent years, vacancies now seem to have reached a low point: at the end of the first quarter of 2020, a total of 2.85 million sqm was available to companies seeking office space in the Big 7. This represents a reduction of more than 11% compared to the previous year. The vacancy rate averaged across all strongholds remains at 3%. “Until now, before the spread of COVID-19, the volume of new office space was the only factor that was expected to influence vacancy levels this year. A drop-off in demand was not part of the plan. This is now likely to change. It can be assumed that vacancy rates will increase in the coming months owing to the diminishing rate of demand. The topic of sub-letting could also be back on the agenda for office users,” said Scheunemann.
Completions volume set to fall
In the first quarter of 2020, office space completions amounted to a total of almost 220,000 sqm. This still represents only a very moderate new-building volume. The high proportion of pre-let space only serves to highlight the need for modern and well-equipped space. Or to put it another way: only 6% of the 220,000 sqm was still available at the time of completion. “This demonstrates that the rental market is still on the move and that new contracts are also being signed. It remains to be seen to what extent the positive trend of pre-letting in office developments will continue. Last but not least, it also depends on whether planned office developments or those under construction are postponed or even put on hold. A ban on personal contact, confinement measures and restrictions on office work are already having a massive impact on construction processes,” said Scheunemann.
For the next three quarters, a total of around 1.55 million sqm is still in the pipeline in all seven strongholds, and is already under construction. The majority of this space is already pre-let, although most contracts were signed well before March 2020. Only around 386,000 sqm or a quarter of the total volume is still available to companies seeking new office space.
“The pipeline is currently still full for the next few years. However, we assume that not all new construction projects will be realised. In the event of an overall decrease in demand, pre-letting rates will also fall, and this can also cause projects to be halted if financing is based on such quotas being reached,” said Scheunemann.
Prime rents remain stable in the Big 7
At the end of the first quarter, there was sufficient evidence that prime rents in all seven strongholds could be left at the same level as in the last quarter of 2019. The JLL prime rental index remained at 218.1 points on a quarterly basis, which still represents the highest level since 1992, although year-on-year growth was 4.6%. Assuming that the cycle has reached its peak, it is worth comparing it to the last cycle peak and the subsequent global financial crisis. The current index value is as much as 32% above the previous high point in the fourth quarter of 2008. It could be assumed that there is high potential for this to fall. “However, it should not be forgotten that during the boom phase up to the financial crisis at the end of 2008, the average vacancy rate in the Big 7 dropped to 8.6%. This time, however, the shortage of space is much more extreme and thus props up rental prices,” said Scheunemann.
After the financial crisis, the rental price index declined over seven quarters before the recovery started. The total decrease was only 5% at that time, with the most pronounced declines occurring in 2008-2010 in Berlin (-10%, from €22 to €20) and in Frankfurt (-9%, €37 to €33).
“The next few weeks will bring more precise information about the willingness of office tenants to sign deals, concessions made by landlords in terms of deferrals and the granting of incentives with corresponding consequences for actual rents. Many predominantly smaller companies have already started renegotiating with their landlords. We currently do not see any such activities at large corporates. Relocation issues and the importance of office space are part of a long-term strategy that is not quickly abandoned,” said Scheunemann.
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