Savills : London offices underpriced amid recovery for Europe’s investment and occupier market

The international real estate advisor reports that the UK capital could experience yield compression in the future given its higher rental growth prospects and a current yield discount against the five-year average.

Savills compared London's prospects against other office markets in Europe, and found that mainland Europe's ultra-core cities had edged into "fully priced" territory, as rising capital allocations have continued to compress yields amid rising risk-free rates. Savills anticipates the prime office/government bond yield spreads will recover to pre-pandemic levels once interest rate expectations normalise in the medium-to-longer term, with Capital Economics anticipating no Eurozone rate rise before 2025.

A further 12 office markets, including Helsinki, Stockholm and Brussels, appear "fairly priced" in the third quarter of 2021.

Savills Research paper, Emerging European Office Themes, released today, also shows that average workplace occupancy in the region has crept to 4% below pre-pandemic levels, according to Google's mobility data.

Occupancy figures in Amsterdam (-3%) Île-de-France (-12%), Madrid (-9%), Berlin (+2%), Dublin (+0%), Stockholm (+0%), Milan (-12%) and Warsaw (+4%) look favourable considering that office occupancy in a number of cites was 80% as Covid restrictions lifted.

This rising mobility has boosted office demand, said Savills, as in the third quarter of the year preliminary data for the European office markets shows take-up had increased 15% year-on-year by the end of Q3 2021 (although still down 17% on the five year average).

Among improving take-up, there has been a surge in occupational demand from the advanced manufacturing and pharmaceutical sectors in 2021, reaching 13% of total take up (4% in 2020), following growth in venture capital funding into the life science sector.

However, office demand is being primarily driven by professional and business services (21%) and banking, insurance & finance (18%), which remained the most dominant occupier sectors across the European markets in H1 2021.

In Central London, a large number of pre-lets from legal firms drove leasing demand from the professional & business services sector to 24% of total take-up since the pandemic began, compared with the five-year average of 15%.

Savills office take-up data for the City of London also shows that 45% of occupiers, which have acquired 15,000sq ft or more since the start of 2020, and were increasing their office footprint, came from the professional and business services sector.

Jeremy Bates, head of occupational markets, EMEA, Savills, said: "The increase in demand can be partially attributed to such firms coming to the end of long 10, 15 and 20 year leases, in which a large scale move to new, premium office space is required with regards to attracting and retaining employees, as well as companies pushing to increase sustainability reform."

Savills data shows that more than 70% of the office properties that achieved the top 10% of rents in Central London in 2018 and 2019 had a BREEAM rating of 'Very Good' or better.

In addition, the strong preference for "Very Good" and higher BREEAM accredited space accounted for 60% of total take-up in the UK capital from 2019 to present. In 2021, 64% of take-up in the City of London was rated BREEAM "Very Good" or higher.

While in Amsterdam, the proportion of BREEAM leases achieving very good or higher reached between 20-25% in recent years.

Mike Barnes, Associate - European Research, Savills, said: "The demand for sustainable offices will increase in the coming years, partly because of increasingly stringent government sustainability criteria. Landlords will have to act now by asset managing their schemes in order to meet sustainability criteria across Europe and ensure their offices do not become obsolescent."