Copenhagen office rents were stagnant in 2010-2016 in particular. In the CBD, rents increased by only 5.7% in this period, relative to 40%, 26% and 32.7%, respectively, in the other Nordic capitals (Helsinki, Oslo and Stockholm), where rent levels even continued to climb throughout 2017-2018. The trend seen in Copenhagen is largely due to the ample supply of development areas, both in CBD and non-CBD locations, making it possible to keep up with mounting office demand by constructing new offices. As a result, Copenhagen has in the past been able to retain stable and relatively low office rent levels.
Strong demand and historically low vacancy
Today’s Copenhagen office letting market is the strongest market since the financial crisis in the late 2000s: Office occupational demand remains strong, as economic growth momentum has spurred production and, by extension, employment levels. Since Q4 2017, the number of full-time equivalent employees (FTEs) has increased by some 11,300, equivalent to 3% growth. Virtually all business sectors have prospered, with ‘Trade and transport, etc.’, ‘Information and communications’, ‘Business services’ and ‘Public administration, education and health’ (categories used by Statistics Denmark) being the main growth drivers, together accounting for 80% of FTE growth in the past 12 months.
As a result, the Copenhagen office vacancy rate was as low as 6.3% at the start of Q2 2019, marking a ten-year low, although still substantially above the pre-crisis level: For instance, it plummeted to 3.1% at end-Q4 2017. In line with our commentary in the previous edition of PULSE, it is still worth bearing in mind that the actual supply of available office premises is believed to be lower than indicated as about half of current office vacancies are in old, typically functionally obsolete properties built before the millennium, whereas new or relatively new buildings, which better meet today’s tenant demands, are generally less prone to prolonged vacancy periods.
Short supply is driving up rents in the short term
Confidence in sustained growth momentum and increasing consumption levels is currently making many businesses hire staff to be able to keep up with the stronger demand for goods and services both in the short and long term. In addition, multiple businesses are in the market for better and more space-efficient premises. In both scenarios, businesses typically have very specific demands of the new premises in terms of flexibility, quality and location, which may often be met only by new and contemporary offices tailored to individual user requirements.
On the other hand, more dated office premises are not even considered when the business is looking to relocate, unless a central location is a very weighty parameter. Despite today’s clearly favourable market conditions, it continues to be the case that most investors and developers demand a substantial pre-let ratio before starting office new construction. And although the current pipeline of office completions is relatively substantial, both in CBD and non-CBD locations, many users will still find it difficult to find premises that match their location requirements as supply is slow to adjust to demand.
The mismatch between exceptionally low supply and expectations of sustained strong demand for new and contemporary office premises has started to drive up rent levels. Both CBD and non-CBD office rents are therefore predicted to climb in the years ahead. Unlike recent years, when rent hikes were driven mainly by employment growth and therefore stronger demand, the coming years are expected to see rent hikes driven mainly by stagnant supply.
Prospects of structural changes and long-term rent hikes in the CBD
Once Kalvebod Brygge along the Copenhagen waterfront is fully developed, the Copenhagen CBD will have more or less run out of likely office development areas. As a result, the rent hikes currently witnessed for up-to-date CBD office space are believed not to be a passing but rather a structural phenomenon as demand is expected to remain strong longer term as well, whereas supply is expected to level off in terms of offices actually in demand. Consequently, the sustained supply and demand imbalance is believed to intensify the competition for the office premises most aligned with user requirements, which, all other things being equal, will be one of the factors keeping the rent at a higher level than today.
In non-CBD locations, for instance Ørestad, Nordhavn and Valby, development areas are still available, to a large extent making it possible to build offices that are perfectly aligned with today’s office user demands in terms of flexibility and quality. Nevertheless, a number of businesses still consider a central location a weightier parameter, although comparable premises in the CBD (that is, if they exist) come at a far more expensive rent.
On the other hand, some businesses choose to take advantage of the opportunities that emerge in non-CBD locations, which serves to ease the demand pressure on the CBD, putting a dampener on the anticipated structurally determined rent hikes. We do not foresee corresponding structural changes in office rental prices in non-CBD locations as we believe that the substantial added supply of development opportunities in these areas will restore the supply and demand balance. Longer term, this will serve to stabilise the rent at a lower level than today. As a result, the gap between CBD and non-CBD office rents is set to widen.
Overall, we therefore expect to see a structural increase in CBD office rent levels, although slowed by take-up in non-CBD locations. On the face of it, it is difficult to provide an estimate of the level at which the rent is going to stabilise. Our guess is that we will see rents hike by as much as 20% in certain CBD office locations in the span of the next five years, unless we face a downright global downturn, which is deemed unlikely. At the same time, we believe that rent hikes in non-CBD locations will be a short-lived phenomenon as the unexploited development potential in these areas is expected to replenish office supply. Rents are therefore expected to stabilise at a lower level longer term.
Similarities with other European office markets
Like Copenhagen, a selection of other major European cities saw a decline in office rental prices during and after the financial crisis. Another phenomenon shared by the same office markets was a period of stunted rental growth followed by a sharp increase in rents.
Moreover, the other European cities experienced the same structural changes that are currently reshaping the office market landscape in central Copenhagen, i.e. surging office rents due to a shortage of suitable office leases, caused by a shortage of development opportunities and thereby stagnant supply. As shown in figure 3, it varies a lot from city to city at what point the supply of new office development opportunities came to an end and the structurally determined rent hikes started. The prolonged stagnation period witnessed in Copenhagen as compared with the remaining cities may be explained by the fact that, in relative terms, Copenhagen has had a wider selection of available development opportunities earmarked for offices. As a result, the structural changes have happened at a later point. However, they are now expected to seriously take off.
In short, trends in the office markets of other European cities help to underpin the notion that we may see similar developments, including dramatic rent hikes, in the Copenhagen CBD office market.