Office construction decline to fuel prime rental growth

Office construction is suffering the worst decline since the pandemic. Faced with rising construction and finance costs, labour shortages and low investor confidence, many developers are delaying decisions to start new office schemes, especially speculative new-build projects. 

The current economic headwinds are also slowing development delivery times, which is widening the supply shortfall for prime offices. According to JLL research, 1.7 million sqm of European completions were postponed in 2022 and a further 1.2 million sqm so far in 2023, an equivalent of almost a quarter of expected completions. European office completions slowed in H1 2023, reaching 2 million sqm, the lowest volume since the first half of 2020.

The estimated level of completions for 2024 to 2025 has increased considerably, with an additional 2 million sqm now pushed out to 2025. However, as many as half of those future completions are yet to begin construction, with multiple barriers to development such as a lack of pre-let, securing of planning permission, funding, rights to natural light and pressure from alternative uses. The current completion dates (see below) are the earliest each scheme can be delivered - and will continue to move out each quarter until construction starts.

Following a strong 2022, Europe’s occupational markets weakened in the first half of 2023 due to market uncertainty, tenant caution and transactional delays. In Q2 2023, take-up was down by 28% on Q2 2022 and was the lowest quarter since Q3 2020 during the pandemic.

Despite subdued demand and reluctance by corporates to make decisions on space requirements, appetite for high quality office product is accelerating, with a particular focus on strong ESG credentials, proximity to amenities and strong transport network connections. With increasing corporate commitments around net zero, tenants are being more selective when deciding what space to occupy. Our research shows that demand for Grade A offices currently accounts for more than 60% of all the office demand across Europe, a trend that shows no signs of slowing.

Meanwhile, there is a wave of Grade B lease expirations coming across Europe, with currently over 10 million sqm of lease expirations due in 2024-25 in London, Paris and Germany’s big five cities. Upgrading of space at the end of leases will fuel office take-up in the next few years.

Current construction levels are not keeping up with the demand; our research further shows that demand for net zero carbon buildings outstrips supply by a factor of three to one. A potential supply gap is likely to be more pronounced from 2024 due to a limited number of new starts having taken place in the past 12 months and the volume of ongoing delays.

With supply of green buildings dwindling as office construction faces the worst decline in recent years, and demand for best-in-class intensifies, the market faces an unprecedented supply shortage in the coming years. Occupiers will struggle to secure the right office space to meet their environmental targets when they reach the end of their leases. The ones who do, may be willing to pay the price.