Office markets are defying the economy
The situation in the German office markets remains strained. Current vacancies across the top six markets total 2.9 million sq m of office space, representing a vacancy rate of 3.5%. This is 110,000 sq m, or 10 basis points, lower than at the end of the first quarter. Consequently, the supply reserve (the number of months within which current vacancies would be let) remains marginally below last year’s record level in all markets (Graph 1). Berlin has by far the lowest reserve of 3.5 months. Frankfurt and Düsseldorf at least have reserves in excess of a year, with figures of 16 and 18 months respectively. There is a particularly acute supply shortage in the highly sought-after locations such as city centres and B-locations with good infrastructure. Hence, in retail locations in cities, space on upper floors that has been used by retailers to date is now being converted to office space. This is a logical consequence of two opposing trends. On the one hand, brick-and-mortar retail is having to contend with declining revenues, which makes retail space above the ground floor difficult to exploit. On the other hand, office space is particularly scarce in central locations and rents on such space are witnessing significant growth. However, such conversions can only resolve the supply shortage to a limited degree.
Even the appreciable deterioration in the economy and the threat of a recession on the horizon have not produced a collapse in demand to date. Take-up rose across all markets, with the exception of Munich, and in some cases significantly (Table 1). By the end of the year, take-up in the individual markets should be close to last year's totals, while Berlin and Düsseldorf are even likely to show modest increases. Rental levels increased sharply, with prime rents rising by 1.6% to €32.50 per sq m, and the direction of rental growth is unlikely to change materially over the coming 18 months. While the completion volumes of 1.3 million sq m in 2019 and 2.0 million sq m in 2020 mean that significantly more new office space will come to the market than the 10-year average (0.95 million sq m), the majority of this space is already pre-let. Completion volumes across all markets will exceed the 10-year average during the three years up to and including 2021, with Berlin standing out significantly with completion figures of approximately 800,000 sq m in both 2020 and 2021. Hamburg and Munich will also see significant increases (Graph 3). However, the pre-letting rate across the markets for 2019 to 2021 ranges between 60% (Düsseldorf) and 72% (Frankfurt). Berlin is an exception in this case once again.
The pipeline in the capital until the end of 2021 totals just over 2 million sq m, of which 44% is pre-let. However, the majority of the space remaining available will not be completed until 2021. The pre-letting rates for 2019 and 2020 are significantly higher at 77% and 53% respectively. However, this will not inevitably produce an oversupply since the supply shortage in Berlin is particularly acute with a vacancy rate of 1.4% (= 280,000 sq m). The growth prospects in the German capital are also very positive (Table 2). With GDP growth of 2.1% over the coming twelve months and a projected increase in the number of office employees of more than 14,000, demand for office space will remain strong.
Since demands can be expected to remain consistently strong despite the dip in the economy, there is no relief to the strained market situation in sight for tenants for the time being. For more and more occupiers, therefore, extending their leases on their existing space is a sensible option, provided that this space continues to meet their requirements in terms of size and fit-out. Tenants seeking new space, meanwhile, should allow for a prolonged search. On the other hand, expanding the search to B-locations with good infrastructural connections and local amenities in the immediate vicinity can increase the selection of leasing options. Fundamentally, however, competition among potential tenants will remain strong over the coming 18 months.