European office investment recovery led by the UK

LONDON — The United Kingdom is leading a recovery in Europe’s long-sluggish office property market, with overall investment in the sector expected to increase further in the second half of the year.

Britain recorded 4.1 billion euros ($4.52 billion) worth of office transactions in the first half of 2024, accounting for almost a third (29%) of total European offices, according to August data from international property firm Savills.

This marks an increase of five percentage points over its five-year average share of deals in the region (24%) and surpasses France’s €1.8bn deals (13%) and €1.7bn deals billion euros of Germany (12%).

The rise comes amid a prolonged downturn in the office sector, which has suffered the twin effects of post-pandemic workplace shifts and the move to higher interest rates. Overall, European office investment transactions in the first half of the year fell 21% year-on-year to €14.1bn, according to Savills data — down 60% on the five-year first-half average.

However, industry analysts now see activity accelerating from September to the end of the year as interest rates fall further and investors look for opportunities to capitalize on displaced prices.

“H1 trading data lags market sentiment, but we are confident that the indicators for the future are positive,” Mike Barnes, associate director in Savills’ European trade research group, told CNBC via email.

The UK property market was the first in Europe to contract significantly after peaking in 2022.

However, the early conclusion of July’s general election – along with the Bank of England’s initial rate cut – brought some clarity to the market and added impetus to the recovery, mainly within the capital, analysts said.

“London is a little bit ahead, partly because it appreciated earlier and faster and more significantly,” Kim Politzer, head of European real estate research at Fidelity International, told CNBC by phone.

Higher yields have partly driven that rise, with average annual office yields in London rising more than 6% of property value this year, according to MSCI data. This compares with around 4.5% in Paris, Stockholm and German cities such as Berlin and Hamburg.

The recovery now appears to be trickling down to other markets as the European Central Bank continues its rate-cutting cycle, reducing the debt load and boosting liquidity.

“One of the biggest things holding back liquidity in the European real estate market has been interest rates and financing,” Markus Meijer, CEO of Mark, told CNBC’s “Squawk Box Europe” on Thursday. “A downtrend in interest rates is going to start to open that up,” he added, pointing to upside over the next 12 to 18 months.

Ireland and the Netherlands, which often closely follow the UK’s trajectory, are now showing momentum, Savills said. Steady economic growth and higher office occupancy rates in Spain, Italy and Portugal also show signs of strength.

“Southern Europe looks particularly strong from an office perspective,” said James Burke, a director in Savills’ global cross-border investment team.

In France and Germany – battling political flux and lackluster growth, respectively – recovery has yet to materialize. Tom Leahy, head of EMEA property research at MSCI, said this was partly due to the continuing “gap in price expectations” between buyers and sellers in these countries.

“It’s as broad as it’s ever been. The markets are very illiquid right now,” Leahy said by phone, noting that further repricing could be expected.

However, office occupancy rates remain a concern for investors. While Europe’s return to the workplace was strong against the US — overall vacancy rates 8% and 22% respectively, according to JLL — overall utilization has a way to go.

The acceptance of European offices as measured by square meters was down 17% in 2023 compared to the pre-pandemic average, according to Savills, suggesting a lack of expansion or indeed contraction by tenants. This appeared to increase this year, with almost two-thirds (61%) of companies reported average office utilization of 41% to 80%, compared to half (48%) of businesses last year, according to CBRE. Almost a third expect attendance levels to increase further.

Meanwhile, a divide has emerged between the haves and the have-nots, as tenants demand more modern and functional buildings to help lure their staff back into the workplace. As such, the central business district, or CBD, properties located in close proximity to public transport and local amenities are in high demand and can attract a wide range of tenants.

“Micro-locations that depend on proximity to transport links, but also proximity to high amenity areas in terms of F&B (food and drink) or leisure, are key,” Savills’ Burke said.

It comes on the back of a wider shift towards greener buildings amid incoming energy efficiency requirements in the UK and EU.

Grade A offices – typically those newly built or refurbished – accounted for more than three-quarters (77%) of London office leasing activity in the second quarter of this year, the highest level on record, according to August report from real estate firm Cushman & Wakefield.

In one June ReportFidelity said the buildings’ green credentials could now become the “single most important feature” in the new investment phase. Landlords whose buildings meet those requirements will be able to charge a “green premium” and command higher rents, Politzer said.

“These Grade A green buildings are in short supply and are generally leased while they are still being developed or renovated,” he said.

That will likely spur investment by “opportunistic players” in green properties, Politzer said, while those that fail to upgrade could come under further pressure. Meanwhile, the lack of new developments is expected to lead to further growth in premium offices in the coming years.

“Looking ahead, the tight growth pipeline suggests a reduction in new office space entering the market. This will lead to a gradual decline in both overall and Grade A vacancy rates over the coming year and an increase in fuel rents, particularly at the higher end of the market,” Andy Tyler, head of the London leasing office at Cushman & Wakefield, said in the report.