City Survey

Q4 2023

Chapter 2Macroeconomic environment

2.1The German economy has hit a rough patch

After a year as the “taillight of growth” among the major industrial nations, the recovery process of the German economy in 2024 will depend above all on the dynamics with which inflation rates ease and the domestic economy recovers. At the company level and among financial market participants, the economic outlook is still cautiously pessimistic and does not suggest that the situation will improve before the second half of 2024. Due to China’s weak growth and its importance for the global economy, the outlook for the export-oriented industry is also cautious. The IMF expects global growth of 2.9 percent in 2024, driven primarily by emerging economies. In Germany, a slight increase in exports is likely, but foreign trade will weigh on GDP due to the same increase in imports. The service sector, which has been resilient for a long time, is showing a slowdown at the turn of the year, while the ifo forecast for 2024 predicts slight growth in all service sectors overall. Consensus Economics expects moderate GDP growth of 0.3 percent for Germany in 2024 (Eurozone 0.5 percent), with private consumption expected to make a significant contribution to the recovery.

The negative economic development will therefore slow down the demand for space on the commercial markets in the coming months. On the positive side, the labour market remains very stable. The unemployment rate is expected to rise only marginally in 2024. With falling inflation rates, the current wage settlements are leading to a positive development in real wages, which will support private consumption and also have positive effects on the housing market.

Economic growth and inflation (in percent y-o-y)

Sources: Oxford Economics (December 2023), Colliers
Forecast from Q4 2023

While the ECB has reacted to economic weaknesses with interest rate cuts in the past, it has been showing a contrarian interest rate hike strategy to fight inflation for some time. In a negative scenario, this could exacerbate the recessionary phase. The consensus for inflation forecasts for 2024 is 2.5 percent for Germany (Jan. 24), while inflation in the eurozone is expected to be 2.2 percent.  If the labour market develops positively, a decline in inflation will lead to gains in purchasing power and increases in real wages. In response, after the fastest and strongest rate hike cycle in euro history, we expect the ECB to herald the end of restrictive monetary policy in 2024 and begin to gradually lower key interest rates. Consensus expects key interest rates to reach below 4 percent by the end of 2024.

Interest rate trend (in percent)

Sources: Oxford Economics (December 2023), Colliers
Forecast from Q4 2023

As interest rate cuts by the ECB are currently not expected before Q2 2024, the swap rates that determine financing costs should anticipate this development. The fourth quarter of 2023 already saw a significant decline in SWAP rates, which should continue in 2024, albeit at a slower pace. The negative spread between 5-year and 10-year swap rates over the course of the year has recently closed and will reverse in the course of 2024. In this case, the interest rates for longer-term financing are again more expensive than for shorter-term financing, so investors have more opportunities to optimize their financing costs over the financing terms. Despite the expected easing of tensions, we do not expect a return to the low and partly negative levels of swap rates from 2020 and 2021 in the near future.

Upward pressure on initial yields persists in this environment. At the end of Q4 2023, the risk premium for prime office properties in the top 7 (unweighted gross prime yield of just under 4.85 percent) was around 280 basis points. As a result, real estate investments currently appear more attractive than a quarter ago (spread: 206 basis points) and in the previous year (spread: 166 basis points). A further slight adjustment in initial yields with increases towards 5.00 to 5.25 percent seems likely in the current environment until Q3 2024.

Bond and real estate yields (in percent)

Sources: Oxford Economics (December 2023), Colliers
Forecast from Q4 2023

2.2ESG – EU Taxonomy’s Standards are completed, defining the real estate sector’s “circular economy”

The European Union already adopted the EU Taxonomy in 2020, together with the Technical Screening Criteria (TSC) for the first two environmental objectives “Climate adaptation” and “Climate mitigation”.

Now, on 21.11.2023, the Technical Standards of the remaining four objectives, “Sustainable use and protection of water and marine resources”, “Transition to a circular economy”, “Pollution” and “Protection and restoration of biodiversity and ecosystems”, have been adopted. These standards will apply to all EU member states on the 1st of January 2024.

While the first two objectives affect all industries equally, the remaining four are not equally relevant for all industries. For the construction of new buildings and the renovation of existing buildings, the primary objective “transition to a circular economy” has been defined. Nevertheless, the other environmental objectives must also be considered within the framework of “Do-No-Significant-Harm” (DNSH).

As a primary objective, the environmental objective “Transition to a Circular Economy” includes the following six TSC:

  1. At least 90 % (new construction) / 70 % (renovations) of the non-hazardous construction and demolition waste generated on the construction site shall be prepared for reuse or recycling, except for backfilling.
  2. The life-cycle global warming potential of the building (new construction & renovation) has been calculated for each phase of the life cycle and will be disclosed to investors and customers upon request.
  3. Construction designs and techniques support circularity by integrating design concepts for adaptability and dismantling.
  4. In the case of renovations, at least 50% of the original building must be preserved.
  5. The use of primary raw materials is minimized by the use of secondary raw materials. The following maximum quantities of the primary raw material used must be complied with:
    • Concrete, natural stone or agglomerate stone: < 70 % (new construction) / < 85 % (renovation)
    • Bricks, tiles, and ceramics: < 70% (new construction) / < 85% (renovation)
    • bio-based plastics: < 80 % (new construction) / < 90 % (renovation)
    • Mineral wool glass and insulation materials: < 70 % (new construction) / < 85 % (renovation)
    • non-bio-based plastic: < 50 % (new construction) / < 75 % (renovation)
    • Metal: < 30% (new construction) / < 65% (renovation)
    • Plaster: < 65% (new construction) / < 83% (renovation) 

      If no information is available on the recycled content of a construction product, it can be assumed that it consists of 100% primary raw materials. 
  6. The operator of the activity shall use electronic tools to describe the characteristics of the building in its constructed form, including the materials and components used, for the purposes of future maintenance, recovery, and reuse. The information is stored in digital form and made available to investors and customers upon request.

This environmental objective also focuses on information transparency, which is why any findings must be written down and published on request.

The DNSH criteria for the primary objective “Transition to a circular economy” are similar to the existing criteria for the first two objectives and will therefore not be discussed further here.

These high requirements can have a deterrent effect on investors and owners, which is why the primary target may be “climate change” or “adaptation to climate change”. However, even then, the DNSH criteria must be considered, which includes the obligation to prepare at least 70% of the general construction and demolition waste for reuse, recycling, or other recovery.

With this new appreciation of building materials, a reconsideration of the construction industry is to be expected in the medium term. The increasing demand, and thus value, of recyclable building materials as well as the already noticeable shortage of primary raw materials will permanently change the question “Demolition or renovation?”. Today’s construction standards, for example due to the use of composite materials, which make recycling more difficult, are unlikely to be able to meet the increasing demand for these materials. In the medium to long term, this will push the industry to set new building standards and make recycling a matter of course.  

Chapter 3 Leasing market