European office space delivery delayed as construction costs spike

Office developers across Europe are incurring significant increases in construction costs as labour shortages, supply chain issues and the war in Ukraine push up prices.

Managing this uncertainty is proving increasingly difficult, and as margins are squeezed, some developers who haven’t broken ground on office schemes are now adopting a wait-and-see approach.

JLL data for the top 23 European office markets shows that over the three months to June, almost 1 million sqm of office space was delayed or even cancelled. And as uncertainty around prolonged inflation lingers, future supply forecasts are likely to contract further.

However, the squeeze in development is not a straight line across Europe. Data indicates that smaller markets such as Amsterdam, Stockholm and Brussels have seen a much more notable decrease in the volume of their medium-term development pipeline compared to larger markets such as London and Paris. In London, a healthy 125,000 sqm (1.36 million sqft) of speculative office development kicked off in Q2, showing that even in these uncertain times, large projects which are well into their journey to realization are being pushed ahead. Some larger office developers will continue to press ahead as they’re more able to place construction contracts competitively and leverage existing relationships.

At one point, 2022 to 2023 was expected to be the peak of Europe’s current development cycle. Fueled by strong demand for Grade A, ESG accredited and well-located space, around 13 million sqm of office space was expected to be delivered across Europe, almost double the 10-year average.

But this forecast was already under pressure before recent tensions emerged. As of the start of 2022, just 58% of the pipeline through to 2024 had actually broken ground. Since then, construction costs have soared by 11% across the Eurozone and by almost 20% in the UK (see Chart 1). If new starts aren’t completely curtailed and a few projects kick off before the end of the year, we may still see annual completions reach between 3.5 to 4 million sqm, in line with the 10-year average of 3.8 million (note this included a significant period of development drought following the 2008 global financial crisis).

The squeeze on premium, Grade A space has been particularly acute. In Amsterdam, fielding a requirement for more than 5,000 sqm would yield a short list of just three or four existing buildings. A 0.3% vacancy rate for new space in the central business district of Paris is pushing occupiers out to La Défense and other districts. In London, we see companies coming to market two years earlier than normal as the pre-letting market for best-in-class space tightens up.

The hollowing-out of the development pipeline will further accelerate Europe’s already polarized office market and fuel rental growth. In Q2 alone, we saw the European prime rental index move up by 1.3%, the highest growth rate since the second quarter of 2019. In extremely supply-starved markets such as Dusseldorf, we saw 8.1% growth between April and June this year, while rents in Berlin and Zurich rose by 4% and 3.8% respectively.

Inflation is forecast to peak this quarter then begin a slow fall back to normal levels by the end of next year. However, risks are to upside, and even if inflation falls it doesn’t mean the level of prices for construction materials will come down and therefore continue to hamper new development. The future supply pipeline will remain under pressure, and we can expect continued rental growth in the prime segment.