Is the European office market set to overtake the US?

Office real estate developers and investors have been living in tough times, battered by a hike in interest rates and soaring vacancies provoked by the work-from-home revolution and the tech downturn. But there are signs that the worst is over, and, perhaps surprisingly given Europe’s lacklustre growth, it could be the Old Continent rather than the New Continent that leads the way. 

Analysis by CoStar, a commercial real estate analytics provider, shows that vacancy rates in comparable key city markets in the US are consistently higher than the UK. For example, New York had a vacancy rate of 14.1% at the end of May 2024 compared to its global city rival across the pond, London, with a 9.7% vacancy rate.  Some major US markets such as San Francisco, Los Angeles, Washington and Chicago are particularly struggling with vacancy rates above 15%. Europe’s major business district vacancy rates are, for example: 10.6% for Paris, 9.7% for Frankfurt, and  9.8% for Madrid, according to a recent report by BNP Paribas. Not great, but rates are beginning to stabilise, and better than the US.

So, what’s going on? Some markets, such as San Francisco, have been particularly impacted by the downturn and job losses in the tech sector. But another factor is the higher proportion of office workers choosing to work from home in the US compared with most European countries. US workers typically work 1.4 days a week from home, compared to 1.0 day per week in Germany, 0.7 days per week in Italy, and 0.6 days per week in France, according to an article looking at the post-pandemic return of workers to the office article, published in Bloomberg last September. The UK at 1.5 days per week was the highest in Europe. This pattern could be attributed to the typically longer commutes US workers endure, often by car, compared with their European counterparts, who have better access to cheaper and more reliable public transport. Similar reasoning could also explain why the UK is an outlier, with London such a dominant city in the national economy and its commuters suffering the longest and most expensive commutes in Europe.  Another possible factor could be US office workers having larger homes more suited to home offices.  

This month the ECB cut interest rates for the first time in five years to 3.75%, while in the US the Fed base rate remains at 5.5% and the UK’s base rate is slightly lower at 5.25%. Due to higher growth in the US and stickier inflation, international markets expect rates to remain higher for longer than initially thought at the beginning of this year, and the spread between ECB and Fed interest rates is forecast to widen as the year progresses.

With many office investors and developers nervous at the thought of refinancing at interest rates considerably higher than the last time they borrowed in the times of quantitative easing and central bank stimuli, could Europe’s office market with lower borrowing costs and vacancies be a better bet? But will sluggish European growth strangle this advantage? Then there is the instability of elections both in the US and Europe.

Whatever happens, the next six months will be interesting times for commercial property investors and developers.