Europe’s office opportunity moves south

Investment volumes for German offices are down as investors and their lenders increasingly look to Spain.

Spanish offices are in vogue for investors, and lenders are following suit.

According to Savills, the volume of investment in Spain’s office market during Q1 of 2019 exceeded €800 million. This was more than double the amount recorded during the first quarter of 2018 and 80 percent higher than the average recorded during any first quarter since 2008.

Meanwhile, CBRE’s data show that in the much bigger German market there was a 22 percent drop in office transaction volumes during the first quarter of 2019 to just below €5.5 billion. Market participants have blamed this on a shortage of supply, and say demand for the country’s prime office space remains high.

Yet despite their continued interest in Germany, investors and lenders alike are now asking whether the bullish trend in the country’s office market is coming to an end. Some of them, one lender said, are already looking to allocate part of their capital away from Germany to countries such as Spain, which started its recovery later than other markets and is at an earlier stage of the property cycle.

Opportunities in Spanish offices have been found in recent years within the prime central business districts of Madrid and Barcelona. Today, however, a scarcity of supply in prime zones is pushing core investors to focus their attention on other well-established locations. Savills says that while prime yields for Madrid offices can be as low as 3.25 percent, core-plus and value-add offices in peripheral locations offer between 4.5 percent and 6.5 percent.

Lenders are backing investors whose attention has been diverted towards business areas outside the most prime office locations, as long as tenant demand has been demonstrated. In February, for instance, Germany’s pbb Deutsche Pfandbriefbank provided a €170 million loan in a club deal with Caixabank to refinance Tristan Capital Partners’ portfolio of six assets in office sub-markets of Madrid. Although Tristan bought the portfolio from Spanish SOCIMI Colonial in an all-cash deal, Real Estate Capital understands that the London-based private equity firm refinanced the assets while implementing a business plan for rental growth.

According to BNP Paribas Real Estate, strong letting dynamics and low vacancy levels in Madrid drove prime rental levels up to €420 per square metre per year in 2018 – a 13 percent rise on the previous year. Renovation of office stock also fuelled prime rental growth in Barcelona, which was up 11 percent to €312 per square metre per year.

Given the expectations for further rental growth and for office refurbishment projects as a result of the low levels of availability, it is not surprising that lending competition has increased in Spain. Many German banks – such as Deustche Hypo, which left the market after the global financial crisis – have now returned.

Consequently, senior loan margins for prime offices have fallen to between 120 and 150 basis points, from 150 to 170 bps a year earlier, according to sources. Yet despite this, CBRE’s latest European Debt Map shows that the Spanish office market still offers a risk premium for senior loans of 25 bps when compared with Germany.

With real estate investors expected to invest heavily and aggressively in Spanish offices, lenders will continue to capitalise on the financing opportunities. Europe’s larger markets, such as Germany, will remain crucial to office investors. But for those unwilling to wait for Germany to become more affordable, and who are keen to operate in less-saturated markets, Spain represents a stronger growth opportunity.

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