Strategic office retrofitting - Stockholm

• Quality commands premium despite vacancy: Despite near 15 percent citywide vacancy in Stockholm, upgrading conventional office space to high quality delivers an average 22 percent rental premium across the region, with best-performing central locations achieving 10–12-year payback periods.

• Supply window creates opportunity: With total development volumes down 25 percent since 2021 and minimal new construction initiated, representing only 0.6 percent annual stock addition through 2028, first movers in strategic retrofits are positioned to capitalise on the quality gap in Stockholm's market, where premium space commands significant rental uplifts.

• Location determines viability: Central submarkets i.e. CBD, Östermalm and Eastern Kungsholmen offer compelling retrofit economics with short payback periods, while peripheral locations struggle despite sometimes higher percentage premiums. Building on JLL's international study across selected EMEA cities, we've leveraged the methodology to analyse Stockholm's office market. This local application of our European framework provides insights into Stockholm's retrofit potential, highlighting similarities and differences with other major European markets.

Our comprehensive analysis examined +1,600 new office leases signed between 2020–2024 across Stockholm's diverse submarkets, assessing the potential impact of upgrading from Silver rent level (40th–75^th percentile) to Platinum (90th–95th percentile). Our methodology combined current market conditions with historically validated upside patterns: using today’s rents for our baseline while calculating percentage upside based on historical contract analysis. This approach ensures financial projections reflect both current market and established premium patterns across market cycles. We deliberately excluded the top 5 percent of rents (typically associated with new construction) to provide realistic retrofit targets. The analysis covered 16 submarkets across Stockholm, providing locational and financial similarities, from established core areas to emerging locations, with calculations controlling location and timing to isolate quality-specific premiums. Leases below 200 square metres were excluded to avoid noise (excess volatility) and focus on the midto- large tenant segment that drives the core office market.

Our analysis employs several conservative methodological choices that likely understate the true retrofit potential across Stockholm. By using the Silver bracket (40th–75th percentile) as our baseline, we've excluded many buildings currently performing below the 40th percentile that would see significantly higher rental premiums and shorter payback periods when upgraded to Platinum quality Similarly, our definition of Platinum (90th–95th percentile) deliberately excludes the top 5 percent of rents in each submarket, ensuring our premium calculations represent realistic targets for retrofit rather than new development benchmarks.

Retrofit measures range from light to deep scope. While light retrofit encompasses minor upgrades to a single aspect or feature of the building (i.e., LED upgrades or BMS optimisation) with no disruption to occupants, medium retrofit focusses on fundamental changes to multiple building systems, such as heating, ventilation and air conditioning (HVAC) upgrades, window replacements and lighting overhaul. Deep retrofits involve fundamental interventions in structural, technical and functional building elements, transforming outdated buildings from low rent Bronze levels to Platinum. In our analysis, we focused on a medium retrofit approach, upgrading conventional office assets from Silver to Platinum standard. For these retrofit costs, we applied medium retrofit CAPEX benchmarks derived from representative case studies. This approach, combined with our medium retrofit benchmarks across submarkets, means that strategically selected assets could deliver substantially better returns than our market-wide figures suggest.

The data reveals dramatic variations in retrofit investment potential across Stockholm's 16 submarkets, with premiums ranging from 10 percent to nearly 40 percent, and payback periods varying from 10 years in Östermalm and CBD to 33 years in Nacka/Sickla. These variations stem from two critical factors that define investment viability: base rent levels and premium potential. This highlights why strategic submarket selection and careful asset targeting are essential to maximise retrofit returns.
 

• Tier 1: These central submarkets offer the strongest financial returns with payback periods of <12 years, combining strong base rents with solid premium potential.

• Tier 2: These established locations deliver compelling investmentcases with payback periods between 12–18 years.

• Tier 3: These areas require more careful asset selection, with some showing high percentage premiums but extended paybacks due to lower base rents (between 18–25 years payback periods).

• Tier 4: These locations face structural challenges that extend payback periods beyond 25 years, typically due to either already elevated quality levels limiting premium potential or low base rents that restrict absolute premium value.

The data reveals several crucial insights for investors:

1. The premium value disconnect: Percentage premiums can be misleading investment indicators. While some peripheral submarkets show Stockholm's highest premium, its low base rent results in long payback periods. Similarly, Östermalm and Söderort have nearly identical premium percentages but deliver dramatically different absolute premiums and payback periods (10 vs 31 years). This demonstrates why investors should focus on absolute values rather than percentage increases.

2. Location premium remains decisive: Central submarkets consistently outperform peripheral areas in payback terms. The CBD demonstrates this with short payback, despite a below-average premium percentage (17 percent vs 22 percent citywide average).

3. The quality differentiation paradox: Some submarkets face structural challenges regardless of premium potential. Newer development areas like Hagastaden show limited premium potential (10 percent) due to already elevated baseline quality, while peripheral areas sometimes show large percentage increases but insufficient absolute value due to low base rents.

These patterns highlight why strategic submarket selection is the foundation of successful retrofit strategies in Stockholm, with prime areas offering compelling returns, despite higher acquisition costs, while high percentage premiums in peripheral locations often fail to deliver adequate financial performance. Based on our analysis, these underperforming peripheral markets are mainly exposed to locational obsolescence factors, with vacancy rates up to 26 percent. To sustain asset value in such locations, investors should consider a deeper retrofit scope through repositioning or repurposing.

Stockholm's office market presents an intriguing opportunity landscape. Despite elevated vacancy levels averaging 15 percent citywide (with CBD at 8 percent), the market shows strong rental premiums for high-quality space. This paradox highlights the quality-focused nature of tenant demand—a trend consistent with other European capitals as identified in JLL's broader European research. The limited development pipeline amplifies this opportunity. New construction will add only an average 0.6 percent to Stockholm's office stock annually until 2028, with relatively more concentrated in the CBD where almost 1.0 percent p.a. will be added during the same period.

Additionally, few retrofits are currently scheduled for the coming years, creating a significant opportunity window for early movers. Total ongoing new development and retrofit office volumes combined across Stockholm are 25 percent lower today than witnessed four years ago.

Like trends observed across Europe, where "total office construction across Europe peaked in 2020 and has since dropped 24 percent," Stockholm faces a looming supply constraint for premium office space.

While our study focused primarily on rental premiums, it's crucial to note that these figures likely understate the full investment potential of strategic office retrofits. The actual return is likely to be higher as the rental premium analysis does not factor in additional value drivers beyond direct rental increases.

These additional value drivers include:

1. Reduced operating costs: Energy-efficient systems and modern building management technologies typically reduce operational expenses by 15–30 percent through medium retrofit, improving net operating income beyond the headline rental increase.

2. Shortened void periods: Quality space leases faster, reducing costly vacant periods. JLL European data shows premium space typically has 40–60 percent shorter letting periods than average quality space in the same submarket.

3. Capital value enhancement: Premium buildings typically command lower investment yields (often 25–50 basis points) due to their reduced risk profile and stronger liquidity. This yield compression, combined with the stronger capital growth patterns observed in high-quality assets, creates value appreciation beyond the direct rental premium effect.

4. Enhanced marketability: Premium buildings attract a wider tenant pool, including multinational and credit-worthy occupiers that may not consider average-quality space, reducing leasing risk and potentially commanding stronger covenant premiums.

5. Sustainability benefits: As carbon regulations tighten across Europe, buildings with enhanced energy performance may avoid potential carbon taxes and penalties that could impact lower-quality assets. This might also unlock opportunities for green financing to a larger extent than prior to any retrofits.

6. Enhanced tenant retention: Premium quality space typically improves tenant satisfaction and retention rates. While not directly measured in this study, JLL European research indicates that upgraded buildings experience 15–25 percent higher tenant renewal rates. This reduces turnover costs and provides more stable income streams, which are particularly valuable in submarkets with longer void periods.

7. Micro-location enhancement: Strategic retrofits can elevate an entire micro-location's market position, which is particularly valuable for investors with multiple assets in the same area. By upgrading the quality profile of a specific district, investors can create a 'halo effect' that enhances the value of their entire portfolio in that location.

Our study, while data-driven and wide-ranging, has certain methodological limitations that should be considered when interpreting the results. We applied standardised retrofit costs across all submarkets to maintain analytical consistency, though in practice these would vary based on building age, condition and technical specifications. Our analysis also excludes tenant-specific adaptation costs, focusing instead on building-wide improvements that landlords would undertake. These fit-out costs are typically included in assets’ base rent. This approach aligns with our broader European methodology, ensuring comparability across markets. When these limitations are considered alongside the additional value drivers discussed earlier, the investment case for strategic retrofits might change, either for the better or for the worse. Importantly, while individual payback periods might shift if varying retrofit costs were applied, the relative performance of submarkets would likely remain consistent.

Stockholm's 22 percent average premium positions competitively within the European range identified in JLL's broader European study. Like other European capitals, Stockholm shows 'polarised opportunities' across submarkets, with 38 percent of areas delivering potentially strong returns on investment. The average 15-year payback period in Stockholm aligns with European trends where strategic retrofits can deliver compelling risk-adjusted returns, given the interplay between competitive pricing and supply imbalances. Stockholm, like other European capitals, features 'demand hotspots' where critical factors converge: affordability, desirability, viability and availability. Östermalm and Eastern Kungsholmen are examples of opportunity zones in Stockholm, comparable to London's Fitzrovia and Victoria. These submarkets offer investors compelling economics—providing discounts to CBD rents while still generating attractive returns on retrofit investments.

For investors and developers, Stockholm's market offers opportunities:

• First-mover advantage: With few retrofits scheduled, early entrants can capture premium-seeking tenants

• Submarket targeting: Data shows specific submarkets offering superior returns

• Quality focus: The premium for Platinum space indicates strong demand, despite overall high vacancy

• Asset-specific opportunity: Given our conservative baseline using the Silver bracket (40th–75th percentile), assets currently performing below this level may offer even greater upside potential

• Beyond rental premium: The total investment case is strengthened by operational savings, reduced voids, enhanced marketability and potential yield compression

Stockholm's retrofit potential mirrors the European trend of 'compelling financial incentives' driving future investment appeal, particularly with the 'first-mover advantages' for developers embarking on retrofits now. Office assets in struggling submarkets are increasingly vulnerable due to extended payback periods, high vacancy and accelerating obsolescence. Financially sustainable solutions require retrofits, aligning with building specifics, occupier needs and market dynamics. A comprehensive obsolescence assessment is vital to evaluate risks and potential upside. As JLL's European research notes, "As the market matures, investment activity will likely diversify across submarkets following occupier patterns." Stockholm appears well-positioned for this trend, with our data showing viable retrofit opportunities across multiple submarkets.