Office Nordic

Rental market recovery after the COVID-19 pandemic will be tested following the softer outlook for the economy, though the starting points are on healthy levels across the Nordics. Sharply rising interest rates and higher production costs for projects, in combination with the revised economic outlook, have tilted the balance on the negative side. However, appetite should recover again, helped by increases in prime yields boosting return potential, and assuming the economy rebounds in 2024.

Rising funding costs impacted subsegments differently across the Nordic office market and JLL expects a continued flight to safety into the core segment and growth capitals, while value add and lower growth regions will likely see yield requirements to compensate for cost increases and higher perceived risks. Substantial capital has been raised within the value add segment, which could fuel risk appetite during the second half of 2023, assuming stabilisation of the economic outlook and funding costs.

Indications continue to show that tenants are willing to spend more on quality premises, while at the same time requiring less space per employee, owing to the hybrid workspace model. All in all, we continue to see solid demand for sustainable space in prime locations, with a premium for flexible leases. CPI-linked lease agreements will act as a supportive factor to rental growth into 2023–2024, although a weaker outlook for the economy will likely increase polarisation between assets, linked to the quality of property, location and tenants.

Thomas Persson Head of Capital Markets, Nordic

-62%

Financial highlights Investment volumes for the office segment in the Nordics in 2022

8.7€bn

Investment volumes for the office segment in the Nordics over the last 12 months (EURbn)

3.69%

Average Nordic prime office yield up 56bp y/y

Office Stockholm

The rental market continued its strong recovery after the COVID-19 pandemic, but with reduced take-up volumes during the second half of 2022. Centrally located properties of high standard remain in focus when tenants are looking for new spaces. On a yearly basis, the vacancies rose in many submarkets, with the most central submarkets seeing a decrease in vacancy levels or a trifling increase, while suburbs further out saw a bigger increase in vacancy levels. A continued strong employment market, together with a high demand for office spaces with high standards, made JLL keep the prime rent estimates flat during the fourth quarter.

Investment market

The first half of 2022 was strong from a historical perspective, with an investment volume of over SEK 21 billion in the office sector, placing office as the second most active sector after residential. However, the investment market plummeted in the second half of the year as inflation worries caused interest rates and total funding costs to rise. Sentiment factors related to ongoing transactions during the second half of 2022 caused yields to be raised in all submarkets by 50–125 basis points, resulting in the yield for Stockholm prime central business district (CBD) reaching 3.50 percent in the fourth quarter of 2022.

Tenant market

The demand for modern, sustainable premises in prime locations continued to grow in 2022 as many companies tried to entice their employees back to the office after the COVID-19 pandemic. A shift in the economic outlook during the summer made companies more reserved when signing new leases, resulting in 74 percent of the total take-up for 2022 happening during the first half of the year. The most central submarkets continued to dominate the rental market and represented 69 percent of the total take-up during 2022, confirming the strength in these rental markets.

Funding status

The softer outlook for the economy, in combination with rising funding costs, is having a negative impact on LTV. Funding costs and LTV from Nordic banks continue to be linked to property owner and tenant type as the banks clearly prioritise existing relationships, favouring domestic investors. However, this could limit the transaction market related to funds and international capital.

Sustainability

Sustainability continues to be an increasingly important aspect, both for tenants and investors. With tenants becoming more cautious about signing new lettings, environmental, social and governance (ESG) practices are becoming an increasingly important factor in their deciding making. This is leading to increased polarisation between sustainable and non-sustainable office buildings.

Outlook for 2023

Despite the threat of a worsening economy, strong office locations in Stockholm remain sought after by investors. However, tenants lease profile and vacancy risk can impact the attractiveness. The polarisation between A- and B/C-properties will most likely continue to grow throughout 2023, making it pivotal for landlords to invest in their older stock to ensure they stay competitive.

Linda Sandstedt Senior Director Capital Markets

Vacancies rose at the end of 2022, correlating with a record-high stock of newly built office spaces that were completed during the year. The new built stock was mostly located in Rest of Inner City and Norra Älvstranden/Lindholmen, slightly shifting the strong focus that has been on CBD over the past few years. The demand for centrally located, environmentally friendly spaces continued to grow, which pushed the rental growth in Gothenburg in 2022 for most submarkets. Continued polarisation in the rental market bodes well for investments in the older stock as landlords seek to avoid risk-increased short-term vacancies in those properties.

Investment market

Rising financing costs, in combination with a weaker economic outlook, is having a negative impact on sentiment. This was reflected in our prime yield estimates for all submarkets, with a 50–100 basis point increase in 2022, resulting in the yield for Gothenburg prime CBD reaching 4.15 percent at the end of 2022.

Tenant market

The first half of 2022 showed an unusually strong tenant market, with record high take-up volumes on a half-year basis. After the summer, the take-up volumes decreased as tenants became more hesitant, mainly due to uncertainties connected with the economic forecast and continued employee support for hybrid work-models. Prime rental levels remained strong; however, supported by mix effects related to new build properties.

Funding status

The softer outlook for the economy, in combination with rising funding costs, is having a negative impact on LTV. Funding costs and LTV from Nordic banks will be linked to property owner and tenant type as the banks clearly prioritise existing relationships, which could limit the transaction market.

Sustainability

Sustainability, as a requirement for investors, has grown in importance in recent years and is now becoming one of the most important aspects, as companies work hard to reduce their CO2 footprint and become more environmentally friendly. This makes the return outlook for sustainability improvement investments favourable.

Outlook for 2023

JLL expects rental levels to remain stable in 2023, owing to newly built projects being finalised that will attract tenants to sign new leases at continued high levels. This will further increase the polarisation between grade A properties and B/C properties as these will struggle with rising vacancies and have a more difficult time attracting tenants without high investment volumes.

Sara Vesterlund Senior Director Capital Markets

Office Malmö/Lund

The office market in Malmö/Lund turned out to be very strong during 2022. Record-level take-up volumes, on a yearly basis, reduced vacancy rates on an aggregated level. Stable rental growth also showed that Malmö/Lund is still attractive and bodes well for the market going into 2023. However, uncertainties connected with the ongoing economic situation did affect the market during the second half of 2022 and will most likely have a continued effect during 2023.

Investment market

Rising financing costs, in combination with a weaker economic outlook, had a negative impact on sentiment. This has been reflected in our prime yield estimates for all submarkets, with a 60–85 basis point increase in 2022, resulting in the yield for Malmö prime CBD reaching 4.60 percent at the end of 2022. A thin investment market, in combination with an already higher yield requirement, has had a stabilising effect on Malmö compared with Gothenburg and Stockholm.

Tenant market

The tenant market in Malmö was strong in 2022 and was more stable compared to both Stockholm and Gothenburg. The total take-up was up 43 percent in 2022, compared with 2021. It’s important to remember that 2021 had a lower volume than previous years, partially due to the COVID-19 pandemic, but it shows that the market had a strong recovery throughout 2022. Vacancies were down in all submarkets in the fourth quarter, compared to the third quarter, which is also an indication that the tenant market is stable.

Funding status

The softer outlook for the economy, in combination with rising funding costs, is having a negative impact on LTV. Funding costs and LTV from Nordic banks will be linked to property owner and tenant type as the banks clearly prioritise existing relationships, which could limit the transaction market related to funds and international capital.

Sustainability

There is a strong focus among investors on property certification and investments to reduce CO 2 footprints. The return outlook for investments in still favourable as it reduces operating costs. Certifications also add a quality angle to the properties, which can support increased rental levels, which might prove to become even more important as yields increase.

Outlook for 2023

A big stock of newly produced office space is expected to be completed during 2023, which might put pressure on the market and reduce rental growth. Fortunately, 82 percent of the stock is pre-let, which will reduce the downside. The high share of pre-let also shows that the demand for high-standard office spaces continues to be high. We expect rents to remain stable during the first half of 2023, with a key focus on new build in good locations.

Office Helsinki

The second half of 2022 finally started showing further signs of recovery, with increasing demand and overall tenant activity in the office market. We had expected this to commence sooner but recovery was delayed due to further financial, economic and geopolitical uncertainties. Active companies have proceeded with clarity in their office requirements and strategy for the mid to long term. The stagnation and confusion of the past few years has diminished, resulting in a healthier and more active market. This is expected to improve further in 2023.

Investment Market

Higher financing costs put significant upwards pressure on yields, especially on core office products where yields have been historically low. Transaction volume in 2022 amounted to €0.9 billion, less than half of the 2021 office volume.

Tenant market

The office market has performed well, despite the uncertain macro conditions and other external influences. The level of activity and number of transactions has almost been comparable to the prepandemic era. Greater demand and market activity helped to offset pressure on real returns caused by the rising cost of construction, inflation and energy costs. Signs earlier in the year suggested that companies might downsize significantly in response to new hybrid working policies, but this seems to have materialised to a much lesser extent. In any case, this impact was reflected in occupancy rates later in the year, especially in secondary assets and locations not accessible by public transport.

Funding status

Financing is available from bank lenders for assets in core locations with a quality anchor tenant or diversified tenant mix. Low yields and higher interest rates are driving LTVs below 50 percent levels. Lenders have also started to focus on potential recession impacts on new leasing. Non-core locations, short weighted average unexpired lease terms (WAULT) and some vacancies/value-add cases are having to look for financing from alternative sources with higher margins.

Sustainability

The current political and environmental climate is increasingly favourable for the promotion of ESG. Clear benefactors are the environmental initiatives and energy-saving measures, which are becoming more profitable through soaring energy costs and fears of supply shortages. In addition, reliance and affiliations with governments, companies and individuals considered non grata are now under tighter scrutiny, and companies must re-evaluate their ESG strategies.

Outlook for 2023

We expect the occupier market to continue the positive trend of 2022, even in the absence of any meaningful improvements to the economic environment. Demand will be driven further from the inevitable release of the bottleneck caused by the pandemic. Relocations, long overdue, will keep commencing and creating more activity and demand for good quality assets near amenities and transport links. In addition, historically high indexations on current leases may also cause movement between sub-markets, creating more opportunities.

The transaction market is going through a period of considerable uncertainty and low liquidity due to higher financing costs and sustained uncertainty surrounding future interest rates. The 2022 office transaction volume amounted to NOK 32.6 billion, 54 percent lower than the record-high volume in 2021. On a positive note, the leasing market had a very strong year with rental growth of 14 percent in Oslo.

Investment Market

In the second half of 2022, the Norwegian Central Bank began hiking the key policy rate more rapidly. Although we are nearing the end of a significant interest rate hike from the central bank, the transaction market in the second half of 2022 revealed growing discrepancies between the buyers’ and sellers’ price expectations, and it has taken time to find a new price equilibrium. Office assets were the most traded asset in 2022, accounting for 37 percent of the market. Noticeable transactions during 2022 included Reitan Eiendom’s 50 percent purchase of Furuholmen Eiendom’s properties in Majorstuen (Oslo), and NIAM’s acquisition of Gullhaug Torg 3 from City Finansiering. During the last quarter of the year, Entra ASA sold the prominent KPMG-building localised in Sørkedalsveien 6 to CapMan.

Tenant market

Throughout 2022 we saw a surprisingly high demand for office space in the office leasing market in Oslo. Limited supply and high demand resulted in a fall in office vacancies throughout the year. Combined with an increase in activity levels, this sparked an extraordinary rental growth of 14 percent in Oslo CBD, while most other areas followed close behind. Fourth quarter vacancy levels were recorded at 4.6 percent in Oslo CBD, while the overall vacancy for Oslo was 5.5 percent.

Prime rent for Oslo CBD is NOK 5,700 per square metre, compared to NOK 5,000 one year ago. Weaker economic activity and a higher unemployment rate will influence the tenant market. On the other hand, the constrained supply side will, to some extent, act as a counterweight.

Funding status

During the second half of 2022, the hawkish approach of the Norwegian Central Bank (nw: Norges Bank), exemplified by its introduction of higher policy rates to fight inflation, contributed to a significant drop in liquidity. The bond market dried up during 2022 and became almost unavailable to property companies. Increased uncertainty, related to company earnings, tightened bank lending conditions. We expect that bank financing will be more accessible to property companies in 2023 and that the lending margins will be normalised.

Sustainability

Among investors and property owners, sustainability is slowly becoming a differentiating factor. At a time when energy costs have increased significantly in Norway, having an energy-efficient building in a portfolio has become more attractive than before. In addition to this, the vast majority of investors state that they are willing to pay a premium for environmentally friendly buildings. This is motivated by being able to meet the future requirements of the taxonomy and to adjust to tenant expectations and, at some point, requirements.

Outlook for 2023

Going forward, we expect that reduced uncertainty around developments in the real economy, inflation and interest rates will lead to a further improvement in the credit markets, both in Europe and in the Nordics. This will therefore improve liquidity in the transaction market during 2023. We forecast a year-end transaction volume of NOK 100 billion. In the leasing market, we still expect good activity, despite weaker economic outlooks.

Financial highlights

5,700NOK

Prime rent Oslo CBD is up by NOK 700 per sq.m since the beginning of 2022

3.75%

Estimated prime yield, given the sharp rise in interest rates during 2022

Office Copenhagen

Employment is at record-high levels, which has increased demand for office space, but this is expected to decline slightly during 2023. We anticipate continued positive tenant activity over the next six months, despite the challenging market conditions.

Investment Market

Modern, sustainable prime assets are still in high demand, but both investors and tenants place a high value on properties with prime locations in the CBD. Because Danish pension funds are heavily active in the sector, prime office assets seem to be less vulnerable to changes in interest rates. Nonetheless, prime yield has increased in recent quarters and is now at 3.50 percent, up 25 basis points from six months ago.

Tenant Market

The tenant market is robust, particularly in the established and emerging central business districts. Flexibility is a top priority for tenants as they demand shorter lease terms and are hesitant to commit to long-term agreements. Demand is driven by record-high employment figures, but this is expected to decline in 2023. Despite this, the outlook for the tenant market remains good, as the supply increase has been restrained.

Funding Status

Prime offices with long-weighted average remaining lease periods and reliable tenants are in high demand, and financing remains affordable. However, there are some concerns, due to the extremely low valuation yields on some of these assets. Additionally, bank financing is still quite restrictive, making it difficult for non-prime offices to find affordable financing.

Sustainability

ESG is becoming increasingly important in the office properties market. For institutional investors, certifying new office properties as sustainable is now a must, whereas a few years ago it was only seen in niche, sustainability-focused properties. The growing public focus on ESG responsibility is driving this trend and affecting both tenants and investors. The main focus is on reducing the CO2 footprint and energy consumption of the building stock, which is a key area in creating a more sustainable future. Additionally, regulations are expected to increase momentum towards sustainability in the short to medium term.

Outlook for 2023

The current flight to safety is intensifying the division between core and non-core assets. Under these circumstances, prime assets in prime locations will have the greatest chance of success.