DTZ Research today published its 2014 Annual Outlook highlighting that economic growth has picked up and the global macro-outlook has improved. In Europe, this improvement has emerged more slowly than hoped. However, the gradual recovery of the economy is expected to boost European job growth and increase demand for occupational space.
Average European occupancy costs are forecasted to increase below inflation over the next two years. Combined with limited new supply of space, increased demand will push up both prime and average rents across most European markets. Furthermore, DTZ forecasts that average or secondary rents to increase more rapidly than prime rents to 2016. This reflects a ‘catch-up’ effect as secondary rents recover from their current historically low base.
Europe remains the most expensive region globally. But, within Europe there is a wide range of affordability between markets. To quantify this more precisely, DTZ Research has calculated an affordability ratio. The most affordable market is where there is the lowest cost for a unit of output. Looking forward, corporate occupiers would be expected to focus on the most affordable markets for expansion. Size of the market would also need to be considered.
Magali Marton, CEMEA Head of Research at DTZ and co-author of the report said: “As expected, most of the cities with high productivity, including London, Paris and Frankfurt also have high occupancy costs. In contrast, Moscow is the least affordable market, combining high costs with low productivity. Smaller markets such as Copenhagen, Brussels and Rome are shown to be especially affordable. All three are more affordable than the European average, providing a good alternative for occupiers looking for expansion in key sub-regions within Europe.”
When considering space efficiency and DTZ’s forecasts, many of the most efficient cities are also likely to see the fastest increases in occupational costs over the next two years. Consequently, occupiers can only try to improve space efficiency in order to offset these higher costs. There is limited room to do this across most large European markets but some, including Frankfurt and Munich, do present opportunities. In the rest of Europe, occupiers will need to look for innovation to create operational flexibility, such as more innovative workspace planning.
Investors, on the other hand are currently benefiting from good relative value across the majority of European markets. The DTZ Fair Value Index ('FVI') score stood at 74 in Q3 2013, which is at near record high. The UK and CEE markets are the most attractive with scores of 85 and 81, respectively. Dublin office, Frankfurt retail and Milan office are all categorized as hot for the moment. However, based DTZ’s forecasts, the FVI is expected to decline sharply in 2014 and 2015. This decline will be triggered by a combination of lower expected returns as markets become more fully priced and higher required returns caused by rising bond yields and interest rates.
Richard Yorke, UK Head of Research at DTZ and co-author of the report comments: “Based on its relative attractiveness, investors’ appetite for commercial real estate is very strong. This is further helped by a normalization of the lending markets. But, investors should take advantage of current pricing quickly before interest rates rise. At the same time, prime opportunities have become less attractive. Consequently, investors need to consider secondary assets and locations more closely, which are still attractively priced. Investors need to be bold and move quickly to take advantage of this limited time opportunity.”
With limited time to take advantage of this opportunity, DTZ Research expects annual investment volumes in Europe to increase to EUR150 billion for 2014. Much of this volume will be transacted in the larger and more liquid markets, like London and Paris. But, smaller markets like Prague and Brussels also do well on liquidity and could provide good targets for investors.
Domestic investors will continue to account for the majority of investment, but non-domestic investors are projected to account for an increasing share. London currently also ranks top for cross-border investors globally in terms of liquidity. The increased weight of investment capital will coincide with the expected fall in the FVI. This decline in attractiveness should ultimately result in reduced investor interest and lower volumes. However, the current strong momentum is expected to carry through until at least 2015.
Hans Vrensen, Global Head of Research at DTZ and lead author of the report concludes: “Europe has a significantly improved macro and property market sentiment. But, we do need to remember that it has the highest occupancy costs of any region globally, with little room for improved efficiency in larger markets. Occupiers need to be more focused on operational flexibility to improve global competitiveness. Investment markets are attractively priced and have become more normalized. However, with limited time to take advantage of attractive pricing, as interest rate rises are looming. Investors need to be bold and focus on liquidity, both on acquisition and disposal.”