The commercial real estate industry is a dynamic and complex sector, with its own unique set of challenges and opportunities. With globalization and international investment becoming increasingly prevalent, it is more important than ever to stay informed on the trends and developments in different regions of the world.
In this blog post, we are thrilled to feature an interview with Andrew Smith, SIOR Europe President, to discuss the current state of the real estate landscape in Europe. Andrew Smith is a highly respected industry expert with over 30 years of experience in commercial real estate. He is a Fellow of the Royal Institution of Chartered Surveyors (FRICS) and a Member of the Society of Industrial and Office Realtors (SIOR). In this exclusive interview, Andrew will share his insights on the challenges and opportunities facing the European commercial real estate market, as well as his perspectives on the future of the industry in the region. So, whether you are an investor, developer, or simply curious about the latest developments in the industry, this interview is not to be missed.
What do you think are the most significant impacts of the COVID-19 pandemic on the commercial real estate market in Europe?
The COVID-19 pandemic has had significant impacts on the commercial real estate market in Europe, including a permanent change in shopping habits, with a shift towards e-commerce that has positively affected the industrial sector (distribution and warehousing), but negatively affected retail assets.
Urban centres have undergone changes with the closure of many retailers due to the pandemic. As a result, cities have had to transition from being solely retail-focused to becoming more dynamic places for work and leisure, resulting in a more diverse tenant mix with an emphasis on leisure and social tenants.
Food & beverage tenants initially suffered during the pandemic, but they have since rebounded due to the return of offices and tourism.
Work-from-home mandates have changed the way offices are utilized, creating winners and losers in office real estate assets. Landlords have had to quickly adapt to mitigate losses, such as offering more flexible arrangements and spaces.
Which types of properties have been the most affected by the pandemic, and which ones have remained relatively stable?
The retail sector has been significantly impacted by the pandemic, resulting in the closure of many retailers and large voids in retail locations. Out-of-town retail locations, particularly for essential food stores and discount retailers, have fared relatively better. Shopping centres and city centres were forced to close, leading to permanent closures of many retailers. The sector continues to suffer, intensified by a fall in real incomes and subsequent declining retail sales across Europe.
The office market has also been affected by the increase in hybrid working and declining office-based employment, constraining growth. Meanwhile, the industrial sector has seen positive impacts, with capital values skyrocketing as 3PL businesses experienced growth in profitability and demand for storage space. Although capital values have fluctuated, they remain higher than pre-pandemic levels, with values in Europe reported to be 0.5% higher than March 2019 as of Q4 2022. Total return has also increased for warehouse/distribution and manufacturing/production assets in Europe.
Investment activity in healthcare has increased, driven by strong occupier demand and long lease terms, while the life sciences sector has boomed and continues to expand, pushed into the limelight by the pandemic.
Do you think the trend towards remote work will continue to affect this market in the future?
During the pandemic, vacancy rates rose, and leasing activity fell. However, post-COVID, business confidence has increased, and we are witnessing a recovery in leasing activity. Demand has been uneven, with a preference for 'grade A' spaces that are amenity-rich and located in desirable areas. Occupiers are prioritizing employee well-being, collaboration, and ESG credentials, particularly energy efficiency due to increasing regulations. This has led to tight vacancy rates and upward pressure on rental values in central business districts (CBDs) where supply is limited, and demand is high.
Prime office spaces under construction or undergoing refurbishment are being pre-let quickly. Most of the increase in vacancy rates is observed in secondary office stock or non-CBD locations as there is a shift towards high-quality spaces. These spaces remain important for affordability, but the performance gap is widening.
Behavioural changes have also altered the way offices are used, and landlords have been responding by increasing their flexible offerings in various ways, such as incorporating collaborative spaces or establishing flexible workspace partnerships.
While remote work will continue, it does not render the role of the office redundant.
In which European cities or regions do you see the most significant growth potential in the commercial real estate market, and why?
Life sciences and data centers are expected to continue attracting capital, including in locations such as the Golden Triangle in the UK, and innovation hubs like the Netherlands, Berlin, and Munich in Germany.
Germany: Capital growth in office markets over the last 3 years (MSCI) has been 36% in Berlin and 22% in Munich, indicating strong performance. Demand for office space remains robust.
Poland: According to Bloomberg, Ukrainians accounted for 45% of all new foreign companies that set up operations in Poland last year, which may boost the real estate market. Warsaw has seen a 21% growth in industrial capital values over the last 3 years (MSCI), remaining flat over the past year.
Sweden: Copenhagen has seen a 13% growth in industrial capital values over the last year (MSCI), which is notable considering that many countries have experienced value declines. This suggests strong fundamentals and a potential ability to weather the economic downturn better than others
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Growth may be correlated with GDP growth (source: IMF data mapper).
What trends do you see in the commercial real estate market in Europe in the coming years, and how do you expect the market to evolve?
Cost pressures: In the short- to medium-term, we can expect economic challenges to persist and continue to impact the real estate market. The negative pressures on European real estate have shown signs of easing, although slower than expected.
Inflation appears to have peaked, but remains high. Although economic challenges are widespread with the impact of the war in Ukraine affecting global markets, there has been wide variation in Europe. Compared to the Euro area inflation average of 8.5% at the beginning of the year, we've seen lows of 3.4% in Switzerland, 6.1% in Spain, and 6.2% in France, for instance, and highs of 25.4% in Hungary and double digits across much of Eastern Europe (i.e., 17.5% in the Czech Republic and 16.4% in Bulgaria). The European Central Bank (ECB), however, continues to raise interest rates in an effort to address high inflation, with officials saying they may need to raise rates to hit 4%. They predict a rapid easing in price pressures from the summer.
These macroeconomic pressures will continue to impact market sentiment across Europe. Rising costs of financing and construction materials have had a knock-on effect on development. Development pipelines have reduced in many countries, with the ability to meet demand (industrial and grade A office) likely to be hampered over the next few years as a result. Rising costs of debt will also be problematic. Repricing of real estate is underway after huge falls in global investment volumes. Prices are likely to stabilize later this year, which should stimulate more investment activity.
Quality/ESG: Grade A office space will continue to be the most sought after. Landlords will have to make decisions about secondary and tertiary stock, particularly as green regulations come into play across Europe and occupiers invest in employee wellbeing. Do they repurpose them or retrofit? For example, in the UK, commercial buildings must achieve a minimum EPC rating of E by April 2023, upgrading to B by 2030. In the Netherlands, as of January 2023, all office buildings need to satisfy a minimum EPC rating of C, with plans to set the minimum to A in 2030. Wider EU commitments will also come into play, for example, the European Green Deal is a key initiative to drive energy efficiency in both public and private buildings. The EU published 'A Renovation Wave for Europe' in 2020 to boost renovation and decarbonize real estate. Both investors and occupiers will pay large premiums for properties with green credentials.
Labour: Low levels of employment across Europe have created a tight labor market. This is a challenge for occupiers of real estate, but also in the construction of real estate. It may hold back development. Increasing labor costs are also becoming a challenge for businesses. Signs of softening in the labor market and increased business insolvencies are emerging.
Tech advancements: This is being seen across all asset types and will have a huge impact in the medium- to long-term. Industrial: increase in automation and robotics. Office: use of Artificial Intelligence for repetitive tasks (i.e., Chatbots in customer service, data processing, reviewing contracts) may mean offices look different, with high-tech and knowledge-intensive roles net positive and administrative roles at risk. Management and collaboration will be key. 'Smart buildings' - AI will also be used more in workplace management, for example, by analyzing daily occupancy it can make suggestions on maximizing the use of space; using data to optimize energy use.
Subsequently, there will be an increased demand for power. Landlords will be forced to address this – how do they get sufficient power to sites? Will we see an upsurge in on-site renewables?
In summary, the future of the European commercial real estate market is influenced by various factors such as cost pressures, ESG considerations, labor market dynamics, and technological advancements. Exploring renewable energy options to address the increased demand for power may be necessary. Staying informed and proactive in navigating these trends will be key for success in this evolving market.
We would like to extend our appreciation to Andrew Smith for providing valuable insights on the trends and challenges in the European commercial real estate market. As highlighted in this blogpost, the market is poised to face various challenges and opportunities in the coming years, from cost pressures and ESG considerations to labor constraints and technological advancements. Staying informed and adapting to these evolving trends will be crucial for real estate stakeholders to thrive in this dynamic environment. We hope that the information shared in this post has been valuable in shedding light on the future of the commercial real estate market in Europe.