European office investment rebounds, led by UK

LONDON – The UK is leading the recovery in Europe's long-sluggish office property market, with overall investment in the sector expected to rise further in the second half of the year.

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

This represents a five percentage point increase over the five-year average (24%) of its share of transactions across the region, and outpaces France’s €1.8 billion (13%) and Germany’s €1.7 billion (12%).

The rise comes amid a prolonged slowdown in the office sector, which has suffered from the dual impact of post-pandemic workplace shifts and the move to higher interest rates. Savills data showed European office investment transactions in the first half of the year fell 21% year-on-year to €14.1bn – down 60% from the five-year first-half average.

But industry analysts now see activity gaining momentum from September through the end of the year, as interest rates fall further and investors look for opportunities to profit from volatile prices.

“The first-half transaction data is lagging market sentiment, but we are confident that the forward-looking indicators are positive,” Mike Barnes, associate director in Savills’ European commercial research team, told CNBC via email.

The UK property market was the first in Europe to see a significant contraction after its peak in 2022.

However, the early conclusion of the general election in July – coupled with the Bank of England’s initial interest rate cut – brought some clarity to the market and added momentum to the recovery, particularly within the capital, analysts said.

“London is leading the way to some extent, partly because it has repriced earlier, faster and more significantly,” Kim Pollitzer, head of European real estate research at Fidelity International, told CNBC by phone.

Rising yields have been one reason for the surge, with average annual office yields in London rising to more than 6% of property value this year, according to MSCI data. That compares with about 4.5% in Paris, Stockholm and German cities such as Berlin and Hamburg.

It is now noticeable that the recovery has spread to other markets as the European Central Bank continues its rate-cutting cycle, reducing debt burdens and boosting liquidity.

“Interest rates and financing have been the biggest factors that have been holding back liquidity in the European real estate market,” Markus Meyer, CEO of Mark, told CNBC’s “Squawk Box Europe” on Thursday. “The downward trajectory of interest rates will start to open up that space,” he added, pointing to positivity over the next 12 to 18 months.

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

“Southern Europe looks particularly strong in terms of office occupancy,” said James Burke, director of Savills’ global cross-border investment team.

In France and Germany — which are struggling with political volatility and weak growth, respectively — the recovery has yet to take hold. Tom Leahy, head of real estate research for Europe, the Middle East and Africa at MSI, says this is partly due to a “persistent gap in price expectations” between buyers and sellers in these countries.

“It's as broad as it's ever been. The markets are illiquid right now,” Leahy said by phone, noting that more repricing is expected.

Office occupancy rates remain a concern for investors, however. While Europe’s return to the workplace has been strong compared to the U.S. — with overall vacancy rates at 8% and 22%, respectively, according to JLL — overall utilization still has some way to go.

According to Savills, European office occupancy by floor space is down 17% in 2023 compared to the pre-pandemic average, suggesting no expansion or even downsizing by tenants. This year has been an uptick, with nearly two-thirds (61%) of firms reporting average office utilization of between 41% and 80%, compared to half (48%) last year, according to CBRE. Nearly a third of firms expect attendance levels to increase further.

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

“Smaller locations rely on proximity to transport links, but also proximity to high-end areas in terms of food and beverage or entertainment, which is key,” said Burke of Savills.

This follows a wider shift towards greener buildings amid energy efficiency requirements coming in across the UK and EU.

Grade A offices – typically those that have been recently built or refurbished – made up more than three-quarters (77%) of office leasing activity in London in the second quarter of this year, an all-time high, according to an August report by property firm Cushman & Wakefield.

In a report in June, Fidelity said that green building standards could now become the “most important feature” in the new investment phase. Owners of buildings that meet these requirements will be able to charge a “green premium” and command higher rents, Pulitzer said.

“Green buildings of the highest quality are available in small quantities and are usually leased while they are being developed or renovated,” she said.

This is likely to spur investment from “opportunistic players” in green real estate, while those who fail to modernise could face further pressure, Pulitzer said. Meanwhile, the dearth of new development is expected to drive further growth in high-quality offices over the coming years.

“Looking ahead, the constrained development pipeline suggests a reduction in new office space entering the market,” Andy Tyler, head of London office leasing at Cushman & Wakefield, said in the report. “This should lead to a gradual decline in overall and Grade A vacancy rates over the next year, fuelling rental growth, particularly at the higher end of the market.”