Interests in imbalance

After more than a decade of uninterrupted upward movements, the German office real estate market has entered a phase of stagnation. The ECB’s interest rate turnaround, the geopolitical consequences of the Ukraine war and a fragile global economy have led to a significant cooling since 2022. For investors and asset managers, this means that predictability and cash flow security – once reliable constants – are increasingly in question.

From boom to blockade

The years 2010 to 2021 were characterised by almost linear growth: low financing costs, stable macroeconomic conditions and high demand for space supported long lease terms and ensured planning security for owners and users alike. This resulted in rising annual transaction volumes in the office segment and prime rents, which reached new records in Munich, Berlin and Frankfurt.

This model is now reaching its limits. Companies that took expansion for granted during the boom years are confronted with multiple uncertainties: rising tariffs in transatlantic trade, recessionary tendencies in Germany and Europe, weak demand in important export markets. In many cases, strategic corporate planning is reduced to short-term reaction patterns.

This has a direct impact on the space market: current take-up fell by 25-30% compared to the peak values in 2021. At the same time, the vacancy rate in cities such as Frankfurt or Düsseldorf rose to over 8%, which further unsettles market participants.

Differentiated demand profiles

While the headquarters of large DAX companies have so far remained relatively stable – often because representative buildings are part of the brand identity – monolithic large areas are coming under pressure, especially in peripheral locations.

Telecommunications providers, insurance companies and health insurance companies are systematically reducing their space requirements. Partly through efficiency programs, partly because hybrid work models require less physical presence. In addition, there is uncertainty about how the increasing use of artificial intelligence will affect the number of employees.

One example is a large insurer that is gradually reducing its campus by more than 30% in a major city in southern Germany. Instead of entering into long-term rental commitments, he is looking at flexible satellite offices in central locations in order to offer employees presence space while at the same time keeping fixed costs in check.

For owners, this means that the former synchronisation of long-term cash flow security and stable user planning has been broken. Users are looking for flexibility, owners want security – a conflict of goals that is paralyzing the market.

Financing as a bottleneck

In addition to the demand effects, financing conditions are a key negative factor. Office properties that traded at prime yields of less than 3% during the boom phase now face financing costs of 4 to 5%. Many transactions are simply no longer feasible without sellers accepting massive value discounts. This explains why the investment volume in 2024 marked the lowest level in over ten years at around 5 billion euros in the office segment. Compared to 2021, this represents a decrease of approx. 80%.

This creates a dilemma for institutional investors: On the one hand, the segment is traditionally the backbone of the commercial real estate market – over 40% of all commercial transactions are regularly accounted for by offices. On the other hand, rising interest costs require a rethink in the structuring, term structure and risk distribution of leases.

Lessons from Production: Utilization Before Binding

In industry, it has always proven to be a good idea to make the best possible use of production capacities. Transferred to the real estate industry, this would mean that owners must be more willing to adapt to the economic conditions of their users.

Shorter contract terms and flexible models, with a flexibility premium, could make it possible to feed space back into the market more quickly – and at the same time reduce tenants’ balance sheet burdens, as long-term lease obligations act as liabilities due to IFRS.

The owners’ argument that short maturities are associated with higher cash flow risks cannot be dismissed. But this risk can be partially compensated:

Market price adjustments for contract extensions or new lettings have often been underestimated so far. Expansion costs can be brought under control by means of dismantling penalties or standardised expansion solutions. Hybrid models that secure floor areas in the long term but link expansion areas with more flexible models could build a bridge.

Fungibility as an underestimated factor

An aspect that is often overlooked is the fungibility of office properties: in good locations with high location quality, re-lettability remains attractive even with shorter contract terms. The price for a fully let property in a prime location therefore depends not exclusively on the remaining term (WALT), but to a large extent on the quality of the location, third-party usability and management competence.

Professional asset managers deliberately calculate with re-letting scenarios and have the confidence to bring space back onto the market flexibly. A short lease in a prime location can therefore be more attractive from a risk-return perspective than a long lease in a peripheral location with uncertain demand.

Long-term bottleneck remains

Despite all the current dreariness, one thing should not be overlooked: office properties are closely linked to economic output on the demand side. As soon as the economy picks up again, the demand for space will also increase. However, the production side – i.e. the development of new office space – is sluggish, expensive and characterised by approval processes. It often takes five to seven years for a new property to be marketable.

This means that after phases of weakness, significant price increases can occur if supply can no longer meet demand. This cyclical volatility is a constant in the office real estate market – and it is an argument why countercyclical investments can be worthwhile right now.

Between security and adaptation

The current stagnation in the office space market is less an expression of a lack of demand than the result of a structural misfit between owner and user interests. On the one hand, investors who depend on long-term cash flows – whether for financing reasons or regulatory requirements. On the other hand, companies whose planning uncertainty pushes towards flexible, easier balance sheet solutions.

Only if we succeed in bridging this contradiction with new contract models, greater space adaptability and a realistic view of geopolitical and technological risks will the German office real estate market be able to overcome the paralysis of the last three years.

The next cycle will no longer be a sure-fire success – but it could be one that is more resilient than ever before through more flexibility, professional re-letting strategies and a new partnership between users and owners.