In the latest Bayfield Training Webinar, David Hourihan and Sonia Martin-Gutierrez present: Flight to Quality – The London, Frankfurt, Dublin and Paris office investment markets.
The Office Investment Markets: Size & structure
The commercial real estate investment market in Germany is the largest of the four countries (France, UK, Ireland, and Germany). As David explains, in all four cities, prime yields have hardly shifted during the pandemic. For example, in Paris and Frankfurt prime yields are holding at 2.75%. Lack of supply of core and core-plus is inhibiting levels of turnover. Moreover, there is a shift away from larger portfolio acquisitions to single smaller investment deals. In Dublin, prime CBD yields are holding at 4%.
However, where there does seem to be divergence is on the vacancy rates. Dublin holds the highest vacancy rate of 9%. The rate of annual take-up in 2020 is down 48% year-on-year. In addition, prime headline rents declined slightly in 2020.
David argues that Dublin is in a bubble of sorts due to an overreliance on demand from the TMT sector. Thus, if TMT companies (such as Facebook and Google) stop seeking space in that market, it will have serious repercussions.
London and Paris have vacancy rates at 6.5 and 6.4%, respectively. In London, prime headline rents for the West End are holding but there is greater downward pressure on rents, with landlord incentives being offered. Similarly, prime headline rents for Paris Centre West are holding; however, rents in secondary locations have fallen. In addition, landlord incentives are also growing. Finally, Frankfurt has the lowest vacancy rate, currently at 4-5%, with landlord incentives also being offered.
Next, David provided a SWOT analysis of the four markets. A common strength of the four markets is a high level of transparency and reliable data: All four markets rank in the top 10 (out of 99 countries) of the global real estate transparency index report. A notable strength of the Frankfurt market is the lack of restrictions on foreign ownership of German property.
There is divergence regarding weaknesses. In Frankfurt, purchasers are subject to a real estate transfer tax of between 3.5-6.5%.
There is a non-standardization of DCF appraisal techniques in London and a reluctance to adopt more sophisticated quantitative modelling applications. David points towards stamp duty tax (7.5%), rent reviews, and an overreliance on technology companies as occupiers in the Dublin market.
In terms of opportunities, Paris and Frankfurt are predicted to benefit from an influx of office occupiers post-Brexit. In addition, Paris will be hosting the Olympics in 2024 and should benefit government infrastructure projects, such as the Grand Paris Express. Regarding threats, all four markets share a degree of pollical uncertainty both home and abroad—for example, post-Brexit uncertainty in the UK.
The first key trend emanating is a ‘flight to quality.’ As Sonia explains, a flight to quality occurs when investors shift their asset allocation away from riskier investments and into more quality assets with less market and construction risk. During uncertain times, especially financial downturns, it is human nature that most investors will look to place their money in less risky investments. For example, David explains that long-term investors are currently more interested in core office investments.
The second key trend is uncertainty in the valuation process. David clarifies that during this period of uncertainty, investors want more detailed advice on market trends. However, an inherent defect of the property market is the lack of transparency of information. According to David, the significance of this defect has increased during lockdown. For example, fewer transactions have meant fewer comparables, which severely affects a valuer’s ability to accurately establish market value.
In addition, adding to the transparency problem are confidentiality clauses in leases or non-disclosure agreements that are becoming more commonplace in the market. Finally, data platforms are becoming more ringfenced, for example, requiring users to subscribe.
Next 12 months
As Sonia explains, the next twelve months will showcase a paradigm shift in office space, with more remote working staff. Consequently, some occupiers are leaving larger suburban spaces in secondary locations and moving to smaller spaces in prime locations.
Furthermore, occupiers will be driven by the need to attract and retain talent in a highly turbulent and competitive marketplace. David explains that the flexibility to work two or three days a week remotely is significant shift for the London and Dublin markets, where people have traditionally had long commutes to work. Working remotely opens new opportunities for a more diverse workforce; for example, people who were once ruled out of job opportunities because they had to be in London can now be considered.
Moreover, occupiers will need office space with a completely different design ethos that creates a more pleasant working environment in what has been dubbed as the ‘hotelification’ of the office space—for example, creating an environment with better amenities, air quality, sound quality, natural light, convenience, and green credentials.