Source: Jones Lang LaSalle IP, October 2010.
Patricia Lannoije, Head of Research BELUX at Jones Lang LaSalle, said: “The research also shows that demand for office space decreased slightly over the quarter, but stands 36% higher than a year ago with net absorption remaining positive. Further yield compression pushed capital values higher; the capital value index increased 4.7% over the quarter. Yield compression was witnessed in 13 out of 24 markets with Paris and Moscow both experiencing compression of 50 basis points.”
European office occupational markets
The majority of Europe’s economies continue to recover - albeit with substantial differentials. This is reflected in the Q3 2010 rental clock. This quarter, 14 of the 34 ‘clock markets’ are now at or beyond 6 o’clock with the majority moving further through the ‘bottoming out’ quadrant. Prime rents across the region increased modestly, with the Q3 Office Index, based on the weighted performance of 24 markets, increasing by 0.7% over the quarter. This continued the growth seen since the beginning of the year, albeit at a slower pace. The increase was driven by Moscow (+6.3%), Stockholm (+5.4%) and London (+2.9%). Rents were unchanged for the rest of the Index markets including Brussels and Luxembourg with the exception of Spanish Cities with rents in Madrid decreasing by -2.7% and by -2.5% in Barcelona. Hefty incentives remained a feature of many markets and net effective rents were on average 17% below prime face rents, with the largest spread reported in the UK, Ireland and some Dutch markets. There also remained a clear differential between prime and secondary space with rents for secondary space remaining under downward pressure.
As economic growth returns, occupiers are increasingly committing to deals, although much activity remains driven by consolidation and churn. With 2.5 million m² transacted in Q3 2010, office take-up decreased by 8% over the quarter. This is not unusual given the summer season and, compared to this time last year, take-up was 36% higher and only 5% below the five year average. And comparing the first nine months of 2010 with the same period last year, take-up was already 39% higher. In Brussels, take-up in Q3 reached 77,000 m², 30% down compared to the second quarter but still 15% higher year-on-year. Total take-up during Q1-3 2010 reached 344,000 m² which is 80% above last year’s level and back on the five year average. In Luxembourg, with a volume of 23,700 m² registered during Q3 10, the take-up has reached 72,400 m² so far in 2010. Even though it remains below the five year average, this is up 23% in comparison to same period last year.
The European Commission’s economic sentiment indicator illustrated further improvement in September to reach its highest level since March 2008. However, the public deficit across Europe is likely to drive cost cutting and austerity measures which could reduce occupier confidence to deal and lead to negative net absorption from the Public Sector. Take-up is expected to be broadly in line with long term averages although it should be noted that an “average” outcome to 2010 would be much better than expected at the start of this year.
The average European vacancy rate remained double-digit but was stable over the quarter at 10.3%. It has remained at between 10.2% and 10.3% since the end of 2009. Whereas vacancy continued to decrease in CEE, mainly driven by further reductions in the Moscow and Prague markets, levels in Western Europe increased slightly - by 20bps to 10.0%. The vacancy rate remained furthest away from the five year average in Barcelona, Madrid, Moscow and Luxembourg which moved from 7.1 to 7.6% over the quarter due to second hand space coming onto the market. Conversely, rates in Berlin and Frankfurt were within a few percentage points of their five-year average levels. Rates of over 15% could still be found in Amsterdam, Dublin and Budapest and there was a significant spread across Europe with the lowest rate at 6.4% in London West End. Although vacancy only decreased in 8 of the 24 Index markets, we believe most markets have reached, or passed, their peaks. In Brussels, vacancy rate slightly down from 11.5% to 11.4% over the quarter due to low level of speculative completions.
On the supply side, completions are declining. Around 1.2 million m² completed in the third quarter across Europe. This reflected a fall of 16% in comparison to Q2 and 15% compared to the five year average. A lack of prime space will be an increasing trend across many markets as a meaningful return to speculative development is unlikely in the medium term. With most investors remaining risk averse and speculative development finance still largely absent, the repositioning of Grade B space to Grade A via refurbishment remains a lower cost and lower risk option. As supply is absorbed we should see successive declines in the vacancy rate from its current level. That said, releases of second hand space by occupiers following recent deals may keep overall supply relatively high - while Grade A space erodes more quickly.
Patricia continued: “Future supply for 2010 for Brussels totals 255,000m², down a quarter on 2009. For Q4 2010, some 60,000m² is expected to be delivered onto the market of which 15,000m² speculatively In Brussels, the pipeline for 2011 and 2012 is currently estimated at 125,000 m² (half of the level completed in 2010) and 60,000m² respectively, which are historically low levels which should relieve the pressure on vacancy. Concentrated during H1 2010, the whole year completions in Luxembourg amount to 70,000 m², 40% down the 2009 level. Projects initially foreseen for Q4 2010 have been postponed to 2011. If the total 2011 pipeline (80,000 m²) is slightly up on the 2010 level, only half is speculative.”
European office capital values
The economic recovery continued to be reflected in office investment markets. While overall transaction volumes decreased slightly by 12% in Euro terms to €21 billion during the quieter summer months, activity is expected to increase again towards the end of the year fuelled by low interest rates and increasing lending activity. Yields for prime assets compressed further in 13 of the 24 Index markets led by Paris and Moscow who both saw yields compressing by 50bps over the quarter as well as compressions of 25bps in London West End, Stockholm, Madrid, The Hague and Budapest. Prime yields (6/9 yr leases) in Brussels hardened by 20 bp from 6.20 to 6.00% and remained stable in Luxembourg at 6.00%. Across the region, capital values grew by 4.9% over the quarter on a weighted average and now stand 17.3% higher than a year ago. With rental levels comparably stable over the quarter, capital value growth in Q3 was largely driven by yield compression and this continued to result in positive growth in markets where occupational performance remained relatively weak - in Madrid for instance capital values increased by 0.4% despite further falls in rents. In Moscow, Stockholm and London capital values were driven by both rental growth and yield compression. Elsewhere growth was entirely based on yield compression. It should also be noted that capital values for secondary assets remain under pressure given the lack of both rental growth and yield compression.
Patricia concluded: “Yields in many markets are now expected to trend more stable meaning rental growth will be the main driver of performance in the short to medium term. Capital values remain well below the record levels of mid-2007 and are 70% lower in Dublin, 62% lower in Moscow and still 53% and 49% lower in Madrid and Barcelona respectively. In the Luxembourg market, given the lower volatility overall, capital values remain only 3% lower than at the last peak – another example of the wide range in performance which characterize the European market.”
Source: Jones Lang LaSalle