PERE Predictions 2019: Zurich expects slower growth in European office sector

While overall European office vacancy rates have dropped significantly in the region, the Swiss insurer anticipates the pace of contraction to moderate next year.

The European office market, currently robust overall, is likely to soften by the end of next year, said Olafur Margeirsson, real estate strategist at Zurich Insurance Company.

“Basically what we see in the European office markets, the trend in 2019 is that this actually might be the last year before the top,” he said.

Vacancy rates in Europe have fallen significantly over the past year, declining by 30 basis points to 6.5 percent during the third quarter – the lowest level since 2002, according to commercial real estate services firm JLL.

Although vacancies will most likely continue to drop in 2019, the pace of that contraction will likely slow down, Margeirsson said. “Then it will depend significantly on the economic picture in 2020 how far that vacancy will drop before it will in fact start rising,” he said. “Because in the end, the real estate market is cyclical by nature and we should expect it to go into a slowdown phase at some point.”

Of course, movements in vacancy rates will vary market to market. For example, Spain and Italy have a stronger outlook for continued compression in vacancy rates. However, in the more so-called core Eurozone economies that have been longer in the expansion phase, further contraction in vacancy rates is anticipated to be less significant, he noted: “The employment levels are much higher, they don’t have as far to drop when it comes to unemployment numbers, so the stock of employed people is actually already quite high already.”

Meanwhile, construction activity in the European office sector, which has picked up in response to the overall fall in vacancy rates, is a potential concern, as new supply may come online at the same as demand in certain markets may be stagnating or contracting because of underlying economic factors.

Margeirsson: Construction activity in the European office sector will be a concern

In cities such as Frankfurt, Berlin and Stuttgart in Germany, and Amsterdam in the Netherlands, “you can see that the current amount of construction pipeline is probably above the long-term sustainable level,” said Margeirsson. While activity is likely to remain strong throughout next year, “once we move towards the end of 2019, it’s going to be questionable whether the amount of construction is simply just too much already. Again, it’s going to be so important to see economic growth being maintained in the Eurozone economies, so that we won’t see the space market cycle develop too quickly towards the slowdown phase.”

The insurer, consequently, will be actively seeking office investment opportunities in both Italy and Spain.  However, “when it comes to the more core Eurozone areas, we are more focusing on markets and properties with a defensive profile and on locking in the rents, extending the leases and basically be more active on the asset management side,” Margeirsson said.

Among the southern European office assets that Zurich acquired in 2018 were the Rua Barata Salgueiro 33 in Lisbon; Piazzale Luigi Sturzo 23 in Rome; and Carrer D’estruc 9 in Barcelona.

Within the European office market, Margeirsson said one notable trend is the growing demand for flexible office space. “It’s a very interesting development, and this will continue most definitely,” he said. “It’s driven by technology and once 5G finally gets online in the European countries, then the trend will probably pick up pace.”

Faster and better connectivity, after all, is critical to office users that may be working remotely and consequently need quick access to data and the ability to do data-intensive work on their laptops. “It’s the increase of mobility that creates more demand for more flex offices, because people would like to have the flexibility,” he added. “Once the technology gets faster and once it gets better, the ease of supplying flex offices will increase.”

While Zurich does not specifically target flexible office properties, it is looking at investments in the space. “The returns can indeed be very attractive. But those assets are more asset management intensive than the traditional office space,” said Margeirsson. “We certainly understand that in order to keep being a relevant office space provider, we need to keep ourselves on our toes and supply onto the market what the demand side is looking for.”