Location, location, location — while address remains a key factor when choosing an office space, the “sustainable, next-generation office” also considers the site’s immediate surroundings, energy efficiency, branding and tenant health, says German asset manager DWS.
Tenants are queuing around the block for such top-tier spaces in Europe, claims Matthias Naumann, DWS’s chief investment officer of real estate in Europe, the Middle East and Africa (EMEA) and Asia-Pacific (APAC). “Companies are looking for the highest energy ratings; wellness plays an increasingly big role, given that they want to attract particular kinds of employees. Vacancy rates for these top spaces are nearly zero in most European markets,” says Naumann, whose firm had some EUR841 billion ($1.22 trillion) in assets under management as of March 31.
He adds that big blue-chip companies have announced net-zero goals and are now reducing their reducing their emissions from operations. For example, power use from their offices falls under Scope 2 emissions.
In a bid to decarbonise, some companies have enacted strict rules on their office tenancies, says Naumann. These extend beyond the typical clauses on energy efficiency and green building certification. He adds that some prospective tenants have policies in place to exclude newly-built properties from consideration, citing the high levels of embedded carbon.
“This is how we came up with this ‘next-generation office’ concept, where we acquire Grade B [or] Grade C buildings in great locations, then fully reposition them into next-generation office spaces,” Naumann tells The Edge Singapore.
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He adds that typical refurbishment works include rewiring and knocking down walls in favour of an open concept floor plan. “In some cases, you keep just the skeleton of the building… You want a floor layout that allows for breakout spaces, [and] ideally outdoor spaces. It is to pull people back to the office.”
The capex required for such a transformation is sometimes on par with the purchase price — “almost like 50% of the value of the building goes into additional measures”, says Naumann. That said, he adds that DWS turns such properties around within two years, compared to the three-and-a-half years it takes on average to construct a new office building.
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DWS has found easy pickings across Europe, except in the busiest cities, by focusing on second-tier properties that need sprucing up. “At the moment, nothing is being built in those spaces because of financing availability, general nervousness of the developers [and more],” says Naumann, without referring directly to the war between Russia and Ukraine, hurting European business and investment sentiment. “So, if you get into this space over the next six to 12 months, you will find yourself in a very good position to see strong growth going forward.”
Naumann adds that sellers have been more resistant in “strong markets” like Germany and Paris. “Next-generation offices are not available [there, and] if they are available, they don’t offer the returns you want… London has been a bit more volatile, a bit more seller willingness to engage.”
He says that may change later this year as the market environment shifts. “I think landlords just want to sit out as long as they can… Some landlords probably know there’s a lot of risk to their assets, and they may be unable to reposition themselves. So, they could put it on the market, and you’ll get the discount you want.”
The divergence between Grade A and secondary assets in Europe is widening in terms of capital values, rental growth and vacancy rates, says DWS in a March report. In the future, DWS expects the diverging trend in the office market to strengthen, with green premiums widening for the best-in-class offices while aged assets in peripheral locations could see large falls in capital values.
“A trend already becoming visible is a shift in tenant demand from Grade B towards Grade A stock,” says DWS’s real estate research team. “While almost 60% of office take-up between 2010-2019 was attributable to Grade B office space, this ratio changed during the pandemic. Between 2020 and 1H2022, take-up of Grade A stock amounted to almost 66%, while inferior stock lost ground.”
DWS’s analysts name seven sub-markets most attractive for an office refurbishment strategy: London’s West End and city, central Paris, Munich, Berlin, Amsterdam, Stockholm and Madrid. They also list seven “tactical target” cities which could become viable “given an adequate correction in pricing”: Milan, Dublin, Frankfurt, Hamburg, Barcelona, Edinburgh and Copenhagen.
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Opportunities in Warsaw
DWS’s other real estate focus in Europe is in living spaces — “not so much on the buildto-rent (BTR) but more into co-living”, says Naumann. Examples include micro-apartments, student housing and senior living.
“It’s much easier to form joint ventures with operators who did not necessarily need us 15 to 18 months ago because of all the cheap financing available from banks,” he adds. “That has changed now.”
According to Naumann, cities with the most potential include the “usual suspects” — London, Berlin and Amsterdam — but also Warsaw, which he describes as a market “under-appreciated in many terms”.
While Poland has been, for some time, the fastest-growing economy in Europe, the Russia-Ukraine war has precipitated an exodus of some 3.5 million refugees to the country, and they are congregating in the capital, says Naumann.
Located within 200km from the Ukrainian border, Warsaw’s job market is receiving another boost from the “well-educated” refugee population, says Naumann. “At the same time, they also strongly impact the residential market.”
Rent for Warsaw’s smallest apartments shot up by over 33% y-o-y in March, according to a report by Polish real estate portal Otodom. Across all apartment categories, rent in Warsaw swelled 20% over the same period.
In May, a report by the television network Euronews indicated that renting a two-person flat in Warsaw costs around 3,300 zlotych ($1,067.05), just shy of the 3,490 zlotych minimum wage.
“Warsaw is one of Europe’s most sought-after [residential markets],” says Naumann. “When you look on real estate websites for an apartment, you’ll probably find only 100 to 150 advertisements, which is super low.”
Traditionally, the residential sector tends to offer the lowest margins, while low yields on the traditional private rented sector (also known as BTR) have historically created difficulties in achieving sufficient interest cover ratios, note DWS’s analysts in a May report.
Student housing, senior living and co-living tend to offer a higher income return and a lending premium than traditional multi-family residential, reflecting the operational risk and market immaturity.
“Given the strength of the long-term demand drivers for these segments, as well as today’s low levels of vacancy and rising rents, we consider them a particularly attractive option,” say DWS’s analysts. “An ageing population in Europe supports the story around senior housing while growing numbers of international students and a limited stock of existing supply also support a positive outlook for student housing.”
Photo and infographics: DWS
