Weakening eurozone economic environment: outlook for office rents and yields

The deteriorating economic picture across the eurozone has its origins in a mix of temporary factors, such as weakness in the German car manufacturing industry and the ‘gilet jaune’ protests in France, but also in declines in the PMIs and the EC Economic Sentiment Indicator indicating s broader slowdown in global trade. However, domestic economies still have good momentum supporting local real estate markets.

UBS-AM Real Estate & Private Markets says the slowdown in eurozone economic growth may be starting to have an impact on occupier demand. For example, aggregate eurozone office market take-up in 2H18 fell by -8.5% year-on-year, compared with 2H17.

Gunnar Herm, head of real estate research and strategy for Europe at UBS-AM Real Estate & Private Markets, explains:

“On a market level, one of the most significant slowdowns in demand was recorded in Paris, where take-up dropped by 21% in 2H17, perhaps reflecting some of the social tensions towards the end of the year. Some of the key German markets also recorded a rare slowdown with Frankfurt (-36%), Munich (-21%) and Stuttgart (-49%) all seeing notably lower activity than the same period in 2017.

“But in all these cases this is more reflective of the exceptionally strong level of demand in 2017, and a lack of available space in central locations, than a significant drop off in occupier demand in the city. On a more positive note were markets in Southern Europe including Barcelona (+78%), which is benefitting from a rebound in activity after the independence issue in late 2017, and Milan where despite challenges to the Italian economy take-up levels rose by 50% on the 2H17 level. In terms of the sectors, the most significant trend of 2018 was the continued rise of serviced office providers across continental Europe.”

Despite the easing in office take-up, the aggregate vacancy rate for the eurozone offices declined in 2H18. All the main eurozone office markets saw vacancy rates come in during the period with the exception of Milan and Utrecht, where they moved up very marginally. Following several years of strong demand and limited new development vacancy rates in nearly all markets having dropped to single digits – with the only exceptions being Madrid (10.4%), Milan (12.9%) and Rotterdam (11.8%).

Hamish Smith, senior property economist at Capital Economics, explains:

“Near zero low risk-free rates will support Western European office and industrial pricing, despite a softer rental growth outlook.

“The effect of the deterioration in the eurozone economic environment isn’t unequivocally negative for property pricing. Weaker economic growth will dampen occupier demand, putting the brakes on rental growth. But with inflation expected to remain insipid, we don’t see the European Central Bank (ECB) raising interest rates over the next couple of years. As a result, very low government bond yields will persist, which we think will support investor demand and the pricing of prime office assets.”

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