Uncertainty hampers business activities; no one-size-fits-all solution for remote working
Nine-month lettings take-up below 2 million sqm in the Big 7
FRANKFURT, 6th October 2020 – It takes a real crisis for offices, working environments and the role of real estate to become socially acceptable topics of conversation. Scarcely a day goes by without some discussion or other about the home office, remote working or future working concepts. And the possible consequences for companies, culture, infrastructure, cities, employee satisfaction and mobility are not only being discussed in the personnel and finance departments of large corporates. Economists are also developing various scenarios to illustrate the effects this change could have on the economy and employment market. Much of this is very speculative, and many things are still far from clear. New cases are rising again, and the resulting short-term, ad hoc crisis management can again quickly displace such long-term trends and considerations.
“Nonetheless, economic forecasters, personnel departments and employment research specialists seem to agree on one thing: flexible working is here to stay and will become an integral part of corporate culture,” said Helge Scheunemann, Head of Research at JLL Germany. Scheunemann added: “The emphasis here must be on ‘flexible’ rather than equating it with the home office, especially in the sense of working zero days per week in the office. Working from home may be an aspect of flexibility, but it also includes other workplaces such as co-working environments, converted hotel lobbies or the café around the corner. Longer term, such a multi-location scenario could also include space rented by companies on the outskirts of cities. From this, two other essential aspects become very clear: 1. There will be no one-size-fits-all solution for all companies, and 2. remote working does not necessarily correlate with lower demand for office space.
For now, most companies are focusing on manoeuvring their businesses safely through the economic crisis. When it comes to demand for commercially used property, it is crucial how the existing and required workforce presents itself. If we believe the recent economic data and the ifo business climate index, the economic slump could be somewhat milder than was feared at the beginning of the pandemic. In the September survey carried out by the ifo institute, the participating companies were again more positive about their current situation than in the previous month. In addition, they also expect to see a further recovery in their businesses. “In short, the German economy seems to be stabilising despite the increasing number of infections,” said Scheunemann. This is also evident on the employment market. According to the Institute for Employment Research (IAB), based on the large number of companies affected by the lockdown, only a few, namely around 12%, indicated they had laid off employees. What’s more, not all of these layoffs were necessarily a consequence of Covid-19 but occurred for other reasons. Accordingly, the unemployment rate at 6.2% is higher than in the previous year, but the number of unemployed in September was lower than in the previous month.
For 2021, the IAB is forecasting an increase in employment by 130,000 people and a decrease in unemployment by a further 100,000 people.
Demand in the Big 7 falls noticeably by 37%
“A decline in the willingness of companies to hire had already been indicated at the end of last year, regardless of Covid-19. This economic setback is now having a delayed effect on office markets, and is further worsened by the current recession. The effect on the nine-month figures is clearly evident,” said Scheunemann. He added: “Following the weakest first quarter of the last six years, the third quarter slightly outperformed the April-June period. However, the aggregate take-up volume for the Big 7 markets reached only 1.9 million sqm in the period from January to end-September and is more than 37% below the previous year’s level. Even if you factor in last year’s very high take-up figure in a long-term comparison, the decline is still quite significant.”
Take-up decreased in all seven property strongholds, ranging from minus 24% in Munich to minus 61% in Stuttgart. In Berlin, take-up fell by more than 30% to 498,000 sqm, which is unusual for the generally popular German capital. “The reasons for this acute weakness in demand are obvious: uncertainty about the future course of the pandemic and the business environment. Spending is being slashed in many companies, and for now planned relocations or expansions are not on the agenda,” said Scheunemann.
Last but not least, how to achieve the right balance between the required office space and flexible working by employees remains a tough question to answer. Here, it is incumbent on every company to find a model that works for itself. An office still conveys a corporate identity and provides a place to meet and exchange ideas, while the use of remote working and the home office will increase where it is appropriate and possible. The search for adequate solutions will take some time and must certainly cover a complex field. At any rate, more home working does not equal lower demand for office space.
So, what will happen next? The take-up volume could increase in the fourth quarter and the annual result could still exceed 2.5 million sqm. However, the market will still shrink significantly. In percentage terms, take-up could fall by more than a third compared to the record year of 2019 or by a quarter compared to the boom years between 2010 – 2019. The decline in demand in 2020 would then be even more pronounced than during the financial crisis. And then? In addition to the strong economic recovery that is currently forecast by economists for 2021, we must also factor in the effect of leases that are due to expire. “The expiry of five-year leases alone will produce a re-letting potential of 2 million to 2.4 million sqm for 2021. In our view, this more than compensates for possible ongoing uncertainties at corporate level as well as for workplace concepts and models that could potentially reduce office space requirements. This leads to the expectation of an increase in lettings take-up of 10-15%,” said Scheunemann.
Vacancies continue to rise slightly – sub-lettings are again a topic of interest
“Positive signals are still emanating from the supply side. Even if the decline in vacancies has finally halted and the turning point has been reached, the increase is still rather moderate,” said Scheunemann. In the Big 7 combined, by the end of the third quarter the volume of space available at short notice was almost 7% higher at around 3.2 million sqm compared with the previous year. The average vacancy rate therefore stood at 3.4%. “By the end of the year, we expect to see a further slight increase to what would then be 3.7%. With this level of vacancies, we are still a long way from seeing a glut in supply. Nor do we expect to see double-digit vacancy rates in the medium term, as was the case in 2010,” said JLL’s chief researcher.
One issue that always arises in times of crisis is the sub-letting of space that is no longer needed. “We are currently seeing more movement here, but the full extent of current discussions is not yet possible to read from the figures. This is understandable, because the decision to part with space is not one that can be made overnight. Nevertheless, the near 30% increase in space offered for subletting in the third quarter may be a first indication. Such space currently accounts for around 10% of all vacancies. However, this is not yet having a noticeably negative effect on rents,” said Scheunemann.
Developers increasingly postpone new construction plans
In the first three quarters of 2020, office space completions amounted to a total of around 832,000 sqm. This was almost 9% more than in the previous year. Of this volume, however, only 156,000 sqm was still available at the end of the third quarter. To give this a more positive spin, 81% of the volume had already been let or assigned to owner-occupiers at the time of completion. Over the next couple of years until 2022, a further 5.1 million sqm is either under construction or in the planning phase. At the same time, project developers have already reacted or will have to react to the market situation: numerous plans have been postponed for the time being.
“Here, too, there is a degree of uncertainty about the future viability of office space; a change in user requirements and user behaviour will consequently also trigger a reaction on the part of developers,” said Scheunemann. In this respect, a postponement is not a bad sign per se. Such a measure could at least prevent a significant volume of vacant space coming onto the markets. Furthermore, only 50% of the planned 5 million sqm is still available, meaning that lease contracts have already been signed for this new space. “Should we see further confirmation of the economic expectations towards the end of the year, and if it is foreseeable that demand will also stabilise again, we assume that plans that have currently been put on hold or postponed will be reactivated relatively quickly. This will also depend on how the financing banks assess this sector and its future viability,” Scheunemann said.
Prime rents prove to be stable
Despite the significant decline in lettings in the property strongholds, rents are proving to be very stable and robust. Not a single city has so far registered a drop in rents despite the increase in vacancies. The JLL prime rent index remained stable at 220.5 points by the end of the third quarter, and was also 2.2% higher compared to the same period of last year. With regard to the Big 7, Stuttgart and Hamburg registered the strongest increases in a 12-month comparison, with rises of 4.1% and 3.5% respectively.
At the same time it should be noted that this stability relates to nominal rents. “Effective rents, that is, once incentives granted by owners have been deducted, are already declining. Landlords are more willing to offer generous incentives in terms of rent-free periods or fit-out contributions,” said Scheunemann. On average, the incentives would be around 5-10% of the nominal rent for a 10-year lease. In future, however, tenants could apply more pressure in rental negotiations, although this mostly applies to older spaces. On the other hand, there is a tendency towards offering a flexibility surcharge on rents if tenants want shorter contract periods (two to three years). The JLL chief researcher added: “In view of the only moderate expansion in supply by the end of the year, we do not expect any other market situation in the last quarter of 2020. Centrally located and well-equipped office space in particular will always be of interest to clients that want this kind of space and are prepared to pay top rents.” A possible scenario where companies relocate from city centres to the outskirts of cities will not change that.
“Ultimately, despite all the controversial views about working environments and locations, there remains a consensus: offices in the next few years will be of a higher quality and will adapt more closely to the wishes of users and their employees for an improved quality of stay, health and well-being and flexible concepts. It follows that there will be scope for renewed rental price growth, regardless of the respective location,” concluded Scheunemann.
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 nearly 93,000 as of June 30, 2020. JLL is the brand name, and a registered trademark, of Jones Lang LaSalle Incorporated. For further information, visit jll.com.