European and U.S. office markets – a tale of two continents

The U.S. office market has long been seen as a leader in property cycles.

Lately, the hybrid way of working, ESG targets, and a flight to quality have ushered in structural change for office markets across the globe, leading many occupiers to re-assess their real estate needs and the type of buildings they want to occupy.

With office vacancy rising and an increase of obsolete buildings in the U.S., is Europe set to follow? 

U.S. return-to-office lags the rest of the world

As companies continue to crystallise return-to-office policies, re-entry rates have varied across the world. Three years after the pandemic, the average return to the office in the U.S. stands at just 50% in comparison to levels seen before the pandemic. Longer commutes, public transport safety and the comfort of bigger homes in sprawling U.S. suburbs may provide some explanation why many Americans prefer to work from home. However, several large employers have announced re-entry guidelines which seek to increase office attendance. But with unemployment at an historic low, dipping to just 3.5% in March 2023, employees continue to have the upper hand in a tight labour market.

In European office markets, the average re-entry level currently exceeds 70%. In major cities such as Paris, Madrid and Amsterdam, office attendance is close to 90% compared to pre-pandemic levels. European transport is seen as more reliable and safer, while work culture tends to favour office presence where employees often enjoy a more generous amount of office space per person. London fares a little worse with re-entry at just over 50% – partly attributed to lengthy and expensive commutes – though Transport for London data shows that the number of journeys has been steadily increasing since the beginning of this year.

Europe & U.S. vacancy gap is widening

New working patterns are undoubtedly having an impact on office vacancy rates across the world and the gap between European and U.S. office vacancy continues to widen.

Average U.S. office vacancy rates have continued to climb to a record 20.2% in Q1 2023, with vacancy in Houston, Dallas, San Francisco, and New Jersey at over 25%. This is partly driven by space released from the tech sector, with a particular excess of supply of office stock that is older than 10 years.

Meanwhile, Europe’s office vacancy rate has also increased steadily in the past few years, from 5.2% in Q1 2020 to an average of 7.6% this year. This remains in line with the long-term average as office supply, especially Grade A, continues to be severely constrained in most of Europe’s central business districts. Tenant-controlled space is also seeing an uptick in vacancy across major European cities, but higher quality product is typically absorbed quickly due tighter supply dynamics.

Net absorption remains positive in Europe

Rather than expanding footprint, occupiers across the world are increasingly looking for less but leading office product, underpinned by progressive ESG credentials, proximity to amenities, and strong transport network connections. 

With leasing volumes continuing to fall, driven in the U.S. primarily by corrections among key growth industries alongside delays in large-scale activity and significant subleasing, net absorption has remained largely negative since the pandemic. European office demand rebounded to its pre-pandemic level and net absorption has stayed positive despite recent market volatility and an increase in subletting.

European cities are not immune to the challenges seen in the U.S. and the region will of course also see an increased rate of obsolesce. That said, the top of Europe’s office market is likely to continue to fare better due to stronger fundamentals and may even support outperformance from late 2023 onwards.