When office vacancy becomes a risk

(Cologne, April 12, 2023) The office market has continued to perform well despite major challenges over the past three years. The vacancy rate in Cologne is at a historically low level of 2.9 percent. Office rents are stable at a high level. They have even risen in the past twelve months, particularly for modern or newly built space. The average rent in the cathedral city rose by around 16 percent between the end of 2021 and the end of 2022 to 17.07 euros per square meter; in 2021, the figure was 14.38 euros. The prime rent increased by five percent to around 29 euros per square meter over the same period. Over a five-year period, the maximum rent rose by a record 14.50 euros per square meter to 39 euros per square meter. This is according to the latest Cologne office market report by Larbig & Mortag Immobilien. In other important office locations such as Berlin, Frankfurt am Main, Munich, and Stuttgart, the trend was similarly positive, albeit with widely varying vacancy rates. Most experts assume that the number of office workplaces in Germany will continue to rise in the coming years, although not everyone will have a permanent workplace in an office due to more flexible working arrangements and home offices. This should offset the current significant decline in new construction and prevent an oversupply of space.

The widespread adoption of home offices has led to more companies focusing on the quality of their office space. When employees come to the office, they should find attractive and inspiring spaces (New Work). Floor plans, furniture, air conditioning, and lighting should optimally support them in their upcoming tasks. For example, there are screened-off areas for concentrated work or phone calls. Separate rooms with good technology should be available for meetings and presentations. Greater importance is also being placed on meeting and communication areas. A survey conducted by Larbig & Mortag Immobilien last year, in which 160 decision-makers took part, confirms that different work zones are becoming more important. Around 55 percent said that modern working environments are an important quality feature for them. Air conditioning is important to 42.6 percent of those surveyed, and 48.4 percent are paying more attention to the energy consumption of their spaces. Last but not least, attractive office spaces are important for finding and retaining employees. "The search for skilled workers is a challenge that will continue to accompany many companies in the coming years and will not subside like a pandemic," explains Uwe Mortag, managing director of Larbig & Mortag Immobilien.

However, the stable office market is no reason for owners of outdated office space to breathe a sigh of relief: obsolete office space in locations with little demand will find it even more difficult to attract new tenants in the future. This is not only due to the floor plan and technical requirements of users described above, but increasingly to their sustainability efforts. On the one hand, the EU has been imposing stricter financing regulations for a few years now (EU taxonomy). For example, companies must increasingly comply with ESG criteria, reduce and avoid environmental pollution, meet social criteria, and ensure that materials used in construction or renovation are recycled.

Large property owners such as insurance companies, funds, and family offices are also restructuring their real estate portfolios with the aim of divesting themselves of older buildings in order to achieve their self-imposed decarbonization targets. "The issue has also gained importance on the tenant side. We are observing that many space seekers are also setting their own sustainability requirements and, for example, are only renting space that meets certain energy quality standards in accordance with the German Sustainable Building Council (DGNB) or comprehensive ESG criteria," observes real estate consultant Mortag. Landlords who ignore these developments must expect their space to remain vacant in the long term because it no longer meets user requirements.

Landlords of older properties should upgrade them. This applies in particular to buildings constructed before 2010 that have undergone little or no renovation since then. The reason: since 2009, the first Energy Saving Ordinance has been in force for buildings, imposing energy requirements on developers of new buildings. In the eight most important German office locations, including Cologne, around 85 percent of the office space stock was built before 2010. If these spaces have not yet undergone refurbishment, this should be tackled now.

The good news is that conditions are better than they were a few months ago: because residential construction is stagnating, more construction and trade companies have capacity for other projects, such as office renovations. Many of the material shortages that prevailed six months ago and led to higher prices have now been resolved.

Another factor is becoming increasingly important and plays into the hands of existing buildings that are being refurbished: the_{carbon footprint} of a building is becoming more important to office users. This includes not only emissions during operation, but also the gray energy that was generated during the construction phase and is already bound in the buildings. Older, renovated buildings perform better in this respect, as their emission values have theoretically been reduced through years of use. Compared to renovating existing buildings, demolition and subsequent new construction consume a lot of cement, the production of which consumes a lot of_CO2 and contributes to a poorer balance sheet.

Owners who are unable or unwilling to make these investments, for example due to high interest rates, should consider selling the property and investing the proceeds in equivalent new properties. There are equity-rich investors who have focused on existing properties with value-added potential in terms of ESG and the associated rent increases.