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July 23, 2018

Strong rental growth in Europe’s office markets is bringing “second-best” submarkets into consideration for investors.

With investment yields at historic lows in the region’s established office districts, investors’ search for reliable rental income has intensified.

Tightening office supply is bringing some submarkets into consideration for investors.

Across Europe, the root cause of tight market conditions remains the same. Local governments’ reticence in handing out planning permission following the 2008 global financial crisis, competition for land from other asset classes and a lack of development finance from real estate lenders.

Submarkets in Amsterdam, Stuttgart, Prague, Munich and Stockholm – all markets with a lack of new supply – are tipped to outperform over the next two years as a severe lack of choice and rising occupancy costs in core locations push occupiers to consider options beyond the main business district.

Each city is forecast to experience above-average rental growth in the next two years, according to JLL’s European Office Rental Growth Hotspots 2018 report.

“Second-best submarkets are benefitting from the limited choice for occupiers in the main office districts,” says Alex Colpaert, JLL Head of EMEA Offices Research. “It’s a widespread phenomenon across Europe.

Closer inspection

When following office occupiers’ moves, a degree of caution is required, says Colpaert.

“While both in both Stockholm and Amsterdam some of the centrally located submarkets offer great potential for rental growth, it does not necessarily mean that if you go 10 km outside the centre you automatically find real value,” he says. “It’s about identifying structural improvements rather than just rental growth.

“Solna in Stockholm, Sloterdijk Telepoort in Amsterdam and Munich East are likely to experience rental growth in the years ahead.”

A key factor in the success of an office submarket is connectivity, with reliable transport networks playing a part in the relocation decision for occupiers who are in greater tune with the demands of their staff.

“Yes – some submarkets can provide occupiers with as much as a 50 percent rental discount. But cost savings are far from the only incentive,” says Colpaert. “Employee fulfilment has become a crucial factor for corporate moves and therefore moving to a low-cost business park with little to no amenities and sense of community will often prove counterproductive.

“Talent is now a major factor and changes in the way people move and work will often determine the winners and losers in terms of submarkets.”

Areas with potential

Identifying submarkets able to stand the test of time requires detailed analysis, with areas regarded as vibrant today not necessarily automatically destined for longer term growth.

“Finding submarkets where this is little more than a rental blip is the holy grail,” says Colpaert. “Submarkets offer many qualities, but will they stay that way?”

In Prague, Prague 1 (CBD) vacancy is now 700 basis points below its five-year average. With just two buildings with a combined floor space of 14,300 delivered in 2017, scarcity of space will increasingly result in a rental premium.

In Stuttgart, which ranked second in JLL’s study, vacancy levels in the city centre and the Vaihingen-Möhringen submarket, where Daimler is building a 90,000-square meter office campus, are just 70 basis points apart. As well as offering a rental discount to the city centre, the submarket’s accessibility via the S-Bahn and proximity to Stuttgart Airport create an attractive offering for occupiers.

“Stuttgart’s city centre offers very few options for occupiers in need of floorplates bigger than 1,000 square meters and development is limited,” says Colpaert. “Once again, that’s forcing occupiers to some of the best in class submarkets.

“The gap between selected submarkets and established office districts is narrowing, as it is in other European cities.

As prime and selected second-best submarkets continue to converge, investors looking to put capital to work in Europe’s office sector could have more to choose from.

Click to find out why UK cities are looking for more office investment.

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Alex Colpaert

Head of EMEA Offices Research, JLL

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