The recovery of European office investment is led by the UK

LONDON – Britain is targeting a recovery in Europe’s long-simmering office real estate market, with overall investment in the sector expected to pick up in the second half of the year.

Britain recorded office transactions of 4.1 billion euros ($4.52 billion) in the first six months of 2024, accounting for almost one-third (29%) of total European office transactions, according to August data from international real estate company Savills.

That marks an increase of five percentage points in the five-year average (24%) shows transactions in the region, and exceeds 1.8 billion euros (13%) in France and 1.7 billion euros (12%) in Germany.

The surge comes amid a prolonged downturn in the office sector, which has been hit twice by post-pandemic workplace changes and a move to higher interest rates. Overall, European office investment transactions in the first half of the year fell 21% year-on-year to 14.1 billion euros, Savills data showed – a 60% drop on the five-year H1 average.

But industry analysts now see activity gathering from September to the end of the year, as interest rates fall further and investors seek opportunities to capitalize on price dislocations.

“H1 transaction data lags market sentiment, but we are confident that the indicators for the future are positive,” Mike Barnes, associate director in the European commercial research team of Savills, told CNBC by email.

The UK real estate market is the first in Europe to experience a significant contraction after its peak in 2022.

However, the early conclusion of the general election in July – along with the initial rate cut by the Bank of England – has brought some clarity to the market and added steam to the recovery, especially in the capital, analysts said.

“London is slightly ahead, partly because it’s priced earlier and faster and more important,” Kim Politzer, head of European real estate research at Fidelity International, told CNBC by phone.

Higher returns have partly driven the rise, with average annual office yields in London rising more than 6% of property values ​​this year, according to MSCI data. That compares to around 4.5% in Paris, Stockholm and German cities, such as Berlin and Hamburg.

The rebound now appears to be filtering through to other markets as the European Central Bank continues its cycle of rate cuts, easing debt burdens and increasing liquidity.

“One of the biggest things holding back liquidity in the European real estate market is interest rates and financing,” Marcus Meijer, Mark’s CEO, told CNBC’s “Squawk Box Europe” Thursday. “The downward trend in interest rates is about to start,” he said, pointing to a positive outlook for the next 12 to 18 months.

Ireland and the Netherlands, which have often followed the UK’s trajectory, are now showing momentum, Savills said. Solid economic growth and higher office occupancy rates in Spain, Italy and Portugal are also showing signs of strength.

“Southern Europe looks very strong from an office perspective,” said James Burke, a director in Savills’ global cross-border investment team.

In France and Germany – which have been battling political flux and lackluster growth, respectively – recovery has not fleshed out. Tom Leahy, head of EMEA real estate research at MSCI, said that was partly due to a “price expectations gulf” between buyers and sellers in the country.

“It is as wide as it has ever been. The market is very illiquid at the moment,” Leahy said by phone, noting that further repricing can be expected.

Office occupancy rates remain a concern for investors. While Europe’s return to the workplace has been strong against the US – with vacancy rates of 8% and 22% respectively, according to JLL – overall utilization has some way to go.

European office take-up measured by square meters fell by 17% in 2023 compared to the pre-pandemic average, according to Savills, indicating a lack of expansion or indeed a reduction in tenants. That appears to have increased this year, with nearly two-thirds (61%) of companies reporting an average office utilization of 41% to 80%, compared to half (48%) of companies last year, according to CBRE. Almost a third expect attendance levels to increase.

Meanwhile, there is a divide between the haves and the have-nots, as tenants demand more modern and functional buildings to help workers return to work. As such, central business district, or CBD, properties close to public transport and local amenities are in high demand and can attract a wide range of tenants.

“Micro-location depends on the distance to transport connections, but also the distance to highly amenitized areas of F&B (food and beverages) or leisure point of view, which is key,” Savills’ Burke.

It is the back of a wider shift towards greener buildings amid energy efficiency requirements coming in across the UK and the EU.

Class A offices – typically those recently built or renovated – accounted for more than three-quarters (77%) of London office leasing activity in the second quarter of this year, the highest level on record, according to an August report from real estate firm Cushman & Wakefield.

In a June report, Fidelity said a building’s green credentials could now be the “most important attribute” in the new phase of investment. Landlords whose buildings meet those requirements will be able to charge a “green premium” and offer higher rents, Politzer said.

“These Grade A green buildings are lacking and most of them are rented while they are still being developed or renovated,” he said.

This will drive investment from “opportunistic players” into green properties, Politzer said, while those who fail to upgrade could come under more pressure. Meanwhile, the lack of new developments is expected to increase growth in quality offices in the coming years.

“Looking ahead, the limited development pipeline suggests a tapering of new office space entering the market. This should lead to a gradual decline in the overall vacancy rate and class A over the coming year, and fuel rental growth, especially at the upper end of the market,” Andy Tyler, head of London office leasing at Cushman & Wakefield, said in the report.