Concessions and inducements hold sway
Strong demand for top-quality spaces continues to underpin prime office markets around the world. Rising fit-out costs coupled with softening rents in Asia have offset modest rental growth in the prime office markets of Europe and parts of the US. As a result, global average net effective costs to occupiers were flat (0%) in the first quarter of 2024.
Landlords are having to work harder to attract and retain tenants, and our new analysis shows how concessions and incentives have grown in use since 2019.
Quarterly highlights
Almost half of the 35 markets we monitor reported a decrease in net effective costs to occupiers this quarter, contributing to the relative stagnation in costs in the first three months of the year. This is largely due to a slight decrease in annual gross rents of approximately -0.2%, offset by an increase in the costs of fitting out space for office usage which rose by 1.5% in Q1.
In Asia Pacific, net effective costs decreased the most of any region at -0.7% in the first quarter; however, they remain 0.6% above on a year-on-year basis. The regional picture is varied, though. In India, gross rents have seen some decreases this quarter (averaging -5.3%), but fit-out costs combined with limited concessions in a landlord-favourable market have driven net effective costs up by 0.3%. Chinese prime office markets remain sluggish, with Shenzhen in particular seeing a -3.5% decline in net effective costs this quarter. Due to broader economic circumstances, many occupiers in China are focusing on reducing operational costs, including rent, which has put downward pressure on prime market prices.
EMEA markets continue to outpace other locations, recording quarterly net effective cost growth of 0.6% and annual growth of 4.8%. This is buoyed by growth in annual gross rents of 2.1%, and an increase in fit-out costs this quarter of 1.3%. Over the past year, fit-out costs in the region have increased by some 14.7%, in part due to a continued drive in the region toward sustainability and a willingness from occupiers to pay higher prices for premium spaces. Dubai stands out with a 3.1% increase in total costs this quarter. The city remains a highly desirable business hub, where both international and domestic occupiers seek best-in-class space.
North American prime office markets continue to show resilience despite the negative sentiment around the office sector as a whole in this region. Top-tier prime buildings, as measured here, saw a slight cost increase of 0.3% in net effective costs on average this quarter. Occupiers continue to put a premium on quality space to enhance employee retention and company image. This has led some areas, such as New York’s Midtown, to see a 2.4% gross asking rent increase in their prime market in Q1.
Market Insights: Concessions and incentives
In recent years, concessions and incentives have become increasingly important to attract and retain tenants in a competitive office market. Work-from-home and pandemic-era trends have made a lasting impact on the leasing environment.
Demand for fully fitted turn-key space in prime office locations has grown. This type of space is desirable to tenants for its ‘plug-and-play’ benefits, allowing quick move-in and set up times for new tenants. Occupiers increasingly demand high-quality, fully built-out space without needing to invest time and money into planning and executing the design themselves, and astute landlords can also charge a premium for rent on these spaces.
General landlord contributions to fit-out costs (excluding turn-key space) are increasing in North America and Europe – it is not common practice in Asia Pacific. Since the first quarter of 2019, the average landlord contribution to fit-out has increased by approximately 37.5% in the amount contributed to the cost, across the 35 markets we monitor. However, this increase in contribution does not match the rise in fit-out costs more broadly, which results in landlord contributions as a percentage of the total fit-out costs decreasing to 23.4% in this quarter from 26.8% at the beginning of 2019.
Increasing fit-out costs are a growing issue and are the source of this disparity in costs, compared to the share of total fit-out globally. These prices are rising due to a variety of factors, including a general increase in labour and material costs, as well as inflationary pressure. This is a challenge for both landlords and tenants; for landlords, it means that it will likely be harder to market undeveloped space and more expensive to commit to turn-key developments. Tenants, on the other hand, may be forced to account for these prices in their office footprint decision process.
Rent-free periods are another increasingly popular and common means of incentivising leasing activity in a building, especially in light of higher fit-out costs. Over the past five years, the global average duration of these periods has increased from approximately seven months to ten over the typical lease term. This increase is particularly acute in markets facing higher vacancy, such as North America, where the average length of these periods grew by four months over the same five-year period. Contrast this with landlord-favoured markets such as Seoul – where tight prime and general office markets has resulted in a five-month average decrease from 2019.
In some markets, landlords are going above and beyond the standard amenity provision. In addition to gyms and conference centres, ESG credential upgrades to buildings and further sports facilities such as basketball courts have become popular additions. Hong Kong is an example of this, if the market space is at a premium and buildings can’t typically accommodate more amenities, landlords are getting creative by providing tenant-exclusive apps that offer discounts to local shopping and food.
Outlook for the year ahead
Looking forward to the rest of 2024, a continued flight to quality will push tenants to prime offices, but increased fit-out costs and macroeconomic uncertainty have begun to weigh on net effective costs globally. Landlord concessions are likely to remain in favour of tenants, but competition for space in best-in-class buildings, such as those covered in this report, remains robust. Gross rental rates are starting to ease from historic highs in some markets, but demand remains strong for the top-end prime office product, and this will underpin prime rents going forward.
METHODOLOGY
The Savills Prime Office Cost (SPOC) Index presents a quarterly snapshot of occupancy costs for prime office space throughout the world, as provided by our expert, local tenant representation professionals and researchers.
The adjusted annual all-in occupancy cost represents real-time transaction terms for 20,000 sq ft (2,000 sq m) of usable space based on a basket of the top five most expensive properties to calculate ultra-prime average. The North American markets use a sample of very high rent threshold buildings (leasing occurring at the highest end of market).
All costs are reported in an annual, standardised format of USD per sq ft of usable space to account for variations in currency, reflect local payment protocols, and adjust for measurement practices across the globe. We have also factored in the credit value to the tenant generated from abated rent and the cost associated with fitting out the premises in order to provide an ’all in‘ total occupancy cost in USD per usable square foot.
The fit-out costs were gathered from local Savills teams assuming the leasing scenario described above, plus the following:
i) 30% cellularisation with the remainder of space open plan,
ii) construction and cabling only (no furniture or professional fees).