Growth in technology, media and telecoms industries has boosted office markets. Mark Callender explores Europe’s burgeoning ‘tech clusters’
While it would be wrong to write off European financial services as a sunset industry, it seems unlikely the sector will soon see a repeat of the strong growth it enjoyed between the mid-1980s and 2007. Many European banks are still saddled with non-performing loans as a result of poor lending around 2005, and the increase in capital reserves required by the forthcoming Basle III regulations is likely to permanently reduce their profitability. Investment banking has been hit particularly hard and the Centre for Economics and Business Research estimates financial services employment in London is now back to 1993 levels.
So if financial services are no longer the force they were, which industry will lead European economic growth over the next decade? One possible candidate is the technology, media and telecoms sector (TMT), which includes a wide range of mainly digital activities, such as computer programming, data storage, film, games, music, IT consultancy, publishing, telecoms, television and website design. Oxford Economics forecasts this sector will grow on average by 2.6% per year during the four years to the end of 2016 – faster than any other industry and double the pace of total GDP (1.3% per year).
Part of this superior growth will be due to completely new services such as data analytics. However, it is worth noting that a key feature of the TMT sector is that it is continually reinventing itself and that, for every new product enjoying growth, there is often an older product in decline. Thus, the rapid growth of apps that run on tablets and smart phones, and the simultaneous switch to cloud computing, is in part at the expense of software that runs PCs and corporate servers. IHS iSuppli estimates that global sales of PCs and laptops fell in 2012 after a decade of continuous growth. Similarly, while telecoms companies are gaining from the growth in mobile computing, services like Skype, which they do not control, are undermining revenues.
Another feature of the TMT sector is that it tends to cluster in certain cities. TMT companies rely on specialist skills. Once a local pool of expertise reaches critical mass, it attracts young graduates and rival companies from other cities. The flipside of this tendency towards agglomeration is that it can be very difficult for regeneration agencies in low-tech cities to create new tech clusters(1).
While no two tech clusters in Europe are exactly the same, we can identify four main types. Clusters of small technology and media start-up companies in fringe office locations in big cities – for example, Silicon Allee in Berlin and Silicon Roundabout in London. What might be called conventional tech hubs, either in university cities, or locations that historically have been centres for defence or medical research and consist of a mix of start-ups and larger, more established TMT companies. Examples include Aachen, Bonn, Cambridge, Eindhoven, Karlsruhe and Reading. A lot of the TMT companies based in these hubs are accommodated in out-of-town science parks, because of tight planning controls in city centres.
The third type of cluster is in big city centres where there is already a core of large advertising and media companies and this, in turn, has attracted international technology and telecom firms that increasingly need staff with the same skills. While these clusters of large TMT companies may be relatively small within their city, they are important in absolute terms. Around 20% of all people working in Europe’s TMT sector can be found in Dusseldorf, London, Madrid, Milan, Munich and Paris, according to Eurostat.
The fourth type of tech cluster is in medium-sized European cities such as Dublin, Lyon, Helsinki and Stockholm, which have diverse economies, but with a particular bias towards the TMT sector. This fourth set is effectively a hybrid between the second and third types.
Given the forecast growth in the TMT sector, should property investors target offices in TMT clusters? Undoubtedly, the growth of the TMT sector has been an important driver behind the fall in vacancy and recovery in office rents in cities such as Cambridge, Karlsruhe, London’s West End and Munich since 2010. TMT companies accounted for a third of gross take-up in London’s West End and Mid-Town market in 2012 and for 60% of known requirements at the year-end, according to Jones Lang LaSalle.
However, while the TMT sector in Europe as a whole is growing, the process of creative destruction means that some companies are contracting. This can be a significant problem in smaller and medium-sized tech clusters if the office market is dominated by one or two companies and one of them suddenly loses its edge (for example, Nokia in Helsinki).
In addition, investors cannot afford to ignore the supply side. Thus, although there has been a decline in empty office space in Reading over the past two years, the vacancy rate is still very high at around 20% of total floor space, according to PMA, following a surge in development during the internet boom of the late 1990s. Similarly, although less extreme, the decision by Vodafone in Dusseldorf to move to a new purpose-built campus and leave its existing offices has meant that the city’s office vacancy rate – 11% at the end of 2012, according to JLL – has stayed above equilibrium and will probably increase in the short term.
If an office market is oversupplied, or high levels of new building pose a risk in the future, then it might be better to invest in the city’s residential, or retail property. Research from the US(2) shows that it is not just TMT workers in tech clusters who are gaining from the industry’s growth. The increase in spending power also benefits local builders, hairdressers, retailers, and so on. While there may be other factors at work, Aachen, Bonn, Dusseldorf and Karlsruhe were among the best performing retail markets in Germany over the five years to 2012, according to JLL and Schroders.
Furthermore, even if a tech cluster has a favourable balance between demand and supply, it may still not be a suitable location for some investors. For example, investors that wish to buy good quality office buildings let on long leases to strong tenants are unlikely to find them in bohemian locations like Silicon Allee. Instead, the real attraction of fringe office locations is that, while rental growth may be negligible, investors who have good property management skills and can keep their buildings fully occupied are likely to achieve yields which are 100-300bps higher than in the adjacent CBD.
Likewise, investors that need liquidity should probably avoid investing in fringe office locations or conventional tech hubs, such as Aachen and Cambridge, because their investment markets will inevitably be less liquid than CBD office markets in major cities like Munich and London. Alternatively, investors with a strong emphasis on sustainability may feel uncomfortable investing in science parks on the edge of tech hubs that rely heavily upon car transport. It will be interesting to see if science parks can avoid the fate of many 1980s office parks, which are now suffering from significant obsolescence.
We expect the growth of the TMT sector to create attractive opportunities for office investors over the next few years. However, investors will need to be selective and should tread carefully before buying in smaller cities that depend on only one, or two large companies, or where liquidity is limited. In some tech clusters, particularly those with a large amount of vacant office space, investors might find that investing in local residential or retail property might be a better way of capturing the growth in the TMT sector.
1. A Tale of Tech City: The Future of Inner East London’s Digital Economy. Centre for London. 2012
2. The New Geography of Jobs. Enrico Moretti. 2012
Mark Callender is head of property research at Schroders