Demographics, technology and urbanisation are transforming Europe’s office markets. Mahdi Mokrane and Simon Marx explain
With the recovery in Europe’s main office occupier markets proving to be modest rather than exceptional, investors have had to tread carefully in recent months. True, investment performance has exceeded all expectations, driven by a wall of capital seeking yield in a liquid sector familiar to both domestic and foreign investors. However, that means prime office yields in many established European markets have been pushed close to historic lows, so that investors are now faced with an even more difficult task than in the past in identifying assets that will outperform in the long term. Our research points to three interlinked themes that will help investors navigate these markets. We have labelled these DTU, or demographics, technology and urbanisation.
The connection between occupier demand and demographics is intuitively straightforward; more people generally means more workers and hence more office space. Less obvious, however, are the subtler preferences that different age groups have for ‘consuming’ real estate. A fundamental transition is under way from the baby boomers to the millennials (those born after 1980), with the latter set to dominate decision-making within businesses over the next 30 years. This younger generation has different aspirations and preferences when it comes to making choices about where to live, how they enjoy life, but also their preferred office working location and environment. Their embracing of emerging technologies and flexible working practices knocks down proverbial walls. Understanding how these future business leaders will want to run their offices is critical in anticipating demand for office space over the next economic cycle and beyond.
The impact of positive demographics on a city is reflected in LaSalle’s European regional economic growth index (E-REGI), which identifies those regions across Europe with the best economic prospects. It has been shown to approximate the relative strength of real estate occupier demand in the medium term. Both London and Istanbul, two of the top three cities in this year’s index, boast future population growth as a significant source of strength. London will have to accommodate an additional one million people over the next 10 years, who will choose to live there despite its expensive housing market and overburdened transport system. The demographic component of Istanbul’s total score is among the strongest in Europe. The city benefits from a large, youthful and growing population which will ultimately translate into demand for office space.
The impact of technology on the way that buildings are used and equipped is profound, and should not be dismissed as a second, short-lived dotcom boom based simply on the likes of Facebook and Twitter. Nor should undeniable trends in technology such as e-commerce be defined simply as detrimental to retail and beneficial to logistics. For office buildings, advances in telecommunications, building security, heating/cooling, and the efficient use of energy are just a few examples of ongoing changes.
Technology is a growth driver that relies on a well-educated and highly-trained workforce. Firms in this industry cite proximity to relevant pools of labour and higher education facilities as key factors in location decisions. The proliferation of tech companies in cities such as London, Dublin, Berlin, and Hamburg is clear in the office take-up volumes. In a change from previous behaviour, new-era tech giants are taking large offices in near-CBD locations. Inevitably, a host of satellite companies are following suit. The emergence of tech hubs is changing the landscape of certain office submarkets, such as ‘Silicon Roundabout’ in London’s Shoreditch, or Dublin’s ‘Silicon Docks’ as dubbed by the local media, or Berlin’s self-styled pseudonym Silicon Allee. There is also a strong correlation between technology hubs and the broader R&D hubs. Ranked second in E-REGI is Paris, benefitting from the largest expenditure in R&D of all European cities. This encompasses healthcare, cosmetics, aeronautics and automotive – and not just high-tech.
Urbanisation arose with the development of the first cities. It is intensifying in many markets and is almost overwhelming the capabilities of some governments to provide adequate services. E-REGI’s top ranking city is London, for which population growth and urbanisation are forecast to be defining features of the next generation. London is reacting with modern infrastructure projects; most notably high-speed transportation systems like Crossrail, which could fundamentally change where people live and work. Fringe office markets like Farringdon will be transformed from alternative to mainstream, and eventually subsumed into established submarkets, commanding much higher rents.
For those countries where the population outlook is a concern, urbanisation will be crucial to the future of its office markets. Germany is a good example of this; in 2012, Germany was the second-most attractive country in the OECD for immigration, just behind the US. Berlin has a young, thriving population, attracted by the city’s vibrancy and regeneration. The subsequent boost to its occupier and investment markets has been clear, with much of it focused on technology and new media.
Aligned with urbanisation is densification, which occurs where land-use policies allow higher buildings and a greater mix of uses. This is truer of cities like London and Frankfurt which embrace towers and change of use in their city centres, as opposed to historical, low-rise cities such as Paris or Munich. Even adjusting for cyclical volatility, a dearth of modern office space is predicted over the longer term in these and other growing cities. Urbanisation helps us understand how offices can remain an attractive prospect for investors in a low-growth environment.
Having identified these crucial drivers, it is equally important to translate them into actionable real estate strategies in the current market. Here are four intrinsically-related opportunities for office investment where LaSalle is actively deploying strategies.
• Putting the T in DTU: Look at office space that is close to a technology giant’s hub. In the last few years, industry leaders such as Amazon, Google and Facebook have all occupied or developed large, modern office space in major cities. These companies are flexing their e-muscles, demonstrating that they are major corporate players with a reach that extends beyond software. With these tech giants comes a swarm of smaller, related companies hoping to benefit from proximity. Their office requirements are more modest, as they are often willing to occupy older space that is once again fit-for-purpose thanks to huge improvements in broadband and Wi-Fi. These offices are cheaper than those in financial districts and their trendy locations appeal to their workers. The employees are mobile, well-educated and feed off the vibrancy of the city and the industry. Excellent examples are London and Berlin where the verve is palpable.
• Putting the U in DTU: Don’t think CBD, think near-CBD. Given the low occupancy cost and proximity to the city centre, the technology firms mentioned in (1) often relocate to an edge-of-CBD submarket. However, these locations are supported by even more fundamental drivers. As workers eschew rural areas or smaller cities in favour of larger ones, cities expand in size. As many CBDs cannot expand upwards due to planning restrictions, they will often expand outwards. The fringe locations of today will become mainstream submarkets of tomorrow; London’s Southbank and Farringdon will become as established as Paddington and Victoria are today. Munich’s Arnulfpark, Parkstadt and Ostbahnhof are edge-of-CBD office submarkets growing in significance, as are Rive Gauche and St-Denis in Paris, and the Grand Canal Docks in Dublin. This expansion is largely reliant on private sector development, which ebbs and flows with the financial cycles. However, over the longer term there is an inevitability regarding the growth of gateway or capital cities.
• Equal parts T and U: Transport makes the world go round. The transformation of edge-of-CBD office submarkets led by the private sector mentioned in (2) can be accelerated immeasurably by the public or semi-public sector. Transportation is key to the success of any real estate scheme or market. Once-in-a-generation investment in city-wide projects, such as Crossrail (London), Grand Paris (Paris), City Life or Porta Nova (Milan) – and, to a lesser extent, Berlin-Brandenburg airport (Berlin), Metrolink (Manchester), Oresund bridge (Malmö-Copenhagen) – cannot be provided solely by the private sector. With the exception of a handful of projects in La Défense and certain peripheral markets, office development in Paris for the next few years is firmly focused on the extension of the automated Metro line 14.
Further out from city centres, other mega-industries are also creating sustainable hubs. Biotech hubs (such as Cambridge in the UK, Martinsried in Munich, Villejuif/Every/Saclay in Paris, and Öresund in Copenhagen/Malmö) are only expected to grow in size over the long term. There are automotive and aeronautic hubs too (Toulouse, Munich, Stuttgart) which continue to expand, although these industries are more easily cannibalised by low-cost emerging countries, and so present more inherent risk.
• Applying D, T and U: Accommodate the directors of tomorrow, today. The link between (1), (2) and (3) is the office worker. The layout of the typical office is changing, with millennials sacrificing banks of fixed desks for each employee, for flexible, open spaces with fewer desks than employees. The desire to work in a trendy part of the city is matched by a desire to live in a trendy part of the city – and if those two can be combined then the employer has found the magic formula. For the new generation of workers, walking/cycling to work from a long-term rented apartment in the city fringe is preferable to the previous generation’s long commute by train/car from a mortgaged home in the suburbs. A 27-year-old renting in a flat-share in Whitechapel and cycling to work at an online media company in Shoreditch is an apposite example of this.
The best office investment strategies over the medium to long term will be those that harness the potential of two or more DTU themes, and combine this with attractive pricing and opportune timing. Even those opportunities which appear fully-priced in the current frenetic market could expect a reasonable degree of outperformance in the long term, as the true benefits of DTU come to fruition. Investors that ignore these themes risk paying over the odds for average properties, could miss out on true alpha performance in the long term, and could find themselves left behind by those with real expertise in this area.
Mahdi Mokrane is head of European research and strategy, and Simon Marx is director of European research and strategy at LaSalle IM