Office Market Overview

Q2 2023

The German office rental market is also now beginning to cool

July 20, 2023
The German office rental market is also now beginning to cool

The continuing rise in interest rates by central banks is having a noticeable effect in the market, whereby the fall in inflation is being accompanied by weakening demand for space. While the decline in inflation is a good sign, the effects of an economic slowdown are now becoming more pronounced - and all the more so because some of the interest rate rises have not yet fully impacted on the economic cycle.

As a consequence, market sentiment in the office letting market has weakened in the second quarter with a total half-year take-up volume of 1.16 million sqm recorded in Germany’s seven real estate strongholds, down 40 percent on the result from the same period last year.

One of the current main risk factors is stress in the banking sector. This is increasingly spilling over into the real economy and tighter lending conditions are likely to impact on economic activity over a longer period of time. It is also causing a further spreading of the market: while competition for quality is high, demand in second-tier locations is weakening. At the same time, companies are looking for less space than before and are no longer willing to conclude leases at just any price.

Gloomy mood in the overall economy affects office demand

This leaves a risky trade-off between fighting inflation and a weakening economy, a situation which is reflected in the further deterioration in business sentiment in June. The ifo Index fell again, adding to the gloomy picture following the decline in May, and the Expectations sub-index slumped significantly for the second successive month. Overall, there will be little growth in the German economy this year. Uncertainty about future economic trends and the development of interest rates, which have a significant impact on corporate financing, is also having an effect on the real estate markets, causing users of office properties to behave more cautiously.

Conversely, the labour market remains extremely robust. For the central banks, however, the strength of the labour markets is a cause for concern because it can develop into a wage-price spiral with lasting effects. For Germany, several rounds of collective bargaining with strong wage increases have already been agreed, and further decisions are pending. These pay deals mean significantly higher labour costs for companies and this raises the question of whether they can and will pass these costs on to customers. Because profit margins remain relatively high, the European Central Bank expects that companies will not pass on price rises at the expense of profits. This will determine discussions about further interest rate rises.

Significant fall in office space take-up while the focus on quality remains

Demand weakened in each of the seven office strongholds, ranging from 15 percent in Frankfurt to 70 percent in Stuttgart. The decision-making processes for a potential move still take a long time, particularly when they involve space in the medium to large size categories. Companies are exploring the market and possible options carefully, and the trend towards renting higher-quality space remains. ‘Better but less’ is the current motto. This is because, while the requirement for quality has increased, the size of office space required is smaller. Energy efficiency, sustainability and a feel-good factor for employees are the main drivers of demand. These aspects must be satisfied at a new location. Staffing requirements are not reducing. A well-appointed office, as the communicative hub of the corporate culture, is essential for attracting new talent. There are currently around 820,000 office job vacancies in Germany, creating demand for up to 20 million sqm of additional space. A theoretical figure, to be sure, because redensification is taking place, not all jobs are being created one-to-one in the physical office and existing vacancies are being filled. Nevertheless, the calculation shows that a significant volume of required space will remain. There is some pressure building up among companies, which is another reason why we remain quite optimistic for the year as a whole and still expect a take-up volume of around 2.8 million sqm, which would be 20 percent below the 2022 result.

Volume of vacancies and space available to sublet remain stable - supply pipeline of new space is narrowing

Despite declining take-up volumes, vacancy rates in the seven office strongholds have not risen further. Currently, around 5.17 million sqm of space is available to companies looking for a short-term space solution, corresponding to a year-on-year increase of almost 15 percent and a vacancy rate of 5.3 percent. The volume of space available to sublet, an indicator of crisis, is also unchanged at 834,000 sqm at the end of the second quarter. This is equivalent to 16 percent of the overall vacancy rate.

The apparent differentiation of the market in terms of demand is also reflected in vacant space. Significantly more than half of the volume of vacancies is accounted for by offices that are no longer able to satisfy current requirements or are only of an average fit-out specification. Therefore, and in view of the current low volume of completions, we expect to see bottlenecks and shortages in some areas. New space in the form of entirely new buildings, but even more so upgraded space in the existing stock, are still essential.

But there has been a considerable deterioration of the mood in the construction industry in particular. In addition to the continuing high, albeit somewhat easing cost levels, the issues of challenging project financing and a declining order situation are increasingly acute. And although building costs seem to have peaked, they remain at an extremely high level with projects being suspended as a result. This situation is also affecting the commercial sector with the project pipeline currently being revised downwards every quarter. A total of just under 660,000 sqm of office space was completed in the first six months of 2023, a decline of 31 percent compared to the same period in 2022.

1.5 million sqm of office space is scheduled for completion this year

We currently expect a completion volume of 825,000 sqm in the second half of 2023, bringing the total completion volume for the year as a whole to just under 1.5 million sqm. This is around 300,000 sqm below the 2022 level. It should rise significantly in 2024: almost two million sqm of space is already under construction and scheduled for completion over the coming year. Some of this space was scheduled for release this year but has been delayed. This year-on-year increase must be put into perspective because Berlin alone accounts for over 40 percent with more than 800,000 sqm. Moreover, more than half of this space is already let or earmarked for owner-occupiers.

If the demand trend for top-quality space continues in conjunction with rising rents, which we assume will be the case, pre-letting rates for projected space will increase. Conversely, construction of projects that were originally planned on a speculative basis will only commence if pre-letting takes place.

Prime rents continue to rise - rental incentives increase slightly

The stabilising or only slightly rising vacancy rate is not exerting any pressure on rents on the supply side. Quite the reverse: the current decline in completions is causing prime rents to continue to rise, in some cases significantly. The JLL Prime Rental Index showed a value of 268.9 at the end of the second quarter, almost 14 percent above the previous year's value.

We are observing year-on-year rental growth in all cities, ranging from 5 percent in Berlin to almost 27 percent in Düsseldorf. In the last few months, too, several “exceptional deals” in excess of the reported prime rent have been concluded. The €50.00/sqm p.m. mark has been exceeded in Berlin, Frankfurt and Munich. Nevertheless, it is important to also consider the rental subsidies agreed by landlords as JLL expects these to increase slightly over the coming year. In the case of a 5-year fixed-term lease, JLL expects the rental incentives - converted into rent-free periods - to settle at between 5 and 15 percent.

Contact us

Our Office Market contacts:

Office Leasing:
Stephan Leimbach, Head of Office Leasing Germany

Office Investment:
Jan Eckert, Head of Capital Markets DACH & Office Investment Germany

Helge Scheunemann, Head of Research Germany


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