Kista at the Precipice - How the Collapse of the Kista Office Market May Help to Rebalance the Wider Stockholm Office Market

Is Kista investable? We do not think so.

It has been almost nine years since we last visited the office submarket Kista in the Nordic Insight. At that time, in 2016, a high and rising vacancy rate had set off our internal alarm bells and caused us to label the submarket as un-investable. Our last asset in Kista, Hornajfjord 1, was sold in 2015.

Fast forward to today, and the state of this submarket is worse than we possibly could have imagined in 2016. Some of the underlying causes were apparent in 2016, but new issues have also emerged during the past five years, and these are not just related to the Covid-19 pandemic.

With the Kista office market now in tatters, is this the low point and is the submarket again investable? We do not think so. We expect that we will continue to see a deterioration for several years to come. Further, there are risks with the submarket’s dependency on Ericsson, which has highlighted it may leave (although we think that is unlikely).

There is a silver lining to these issues in the Kista office submarket. As tenants leave Kista in droves, we expect they will absorb vacancies in other established office submarkets, helping to offset the negative effects of the remote work trend.

What is Kista?

Kista is a community in Northern Stockholm, some 10 kilometers northwest of central Stockholm. The community is effectively split by the commuter train line. To the east, buildings are dominated by low-income housing. To the west lies one of Stockholm’s most established white-collar office areas. The office market comprises approximately 850,000 square meters and has traditionally been one of, say, the top six, seven, office submarkets in the Stockholm metropolitan area. As per October 2024, Cushman and Wakefield estimated the vacancy rate to be 36%.

1980-2010: Kista´s Rise as Sweden´s Tech Hub

The 1980s marked the start of Kista's transformation. The Swedish government, recognizing the potential of the IT sector, initiated efforts to develop Kista as a center for technological innovation. The establishment of a branch of the Royal Institute of Technology, the top-tier Swedish university, and collaborations with Ericsson, a major Swedish telecommunications company, laid the foundation for Kista.

During the 1980s Kista saw the construction of its first major office buildings. Ericsson, moving its headquarters to Kista, became a catalyst for growth, attracting other tech companies and creating a demand for office space. The local infrastructure was improved to support the influx of businesses, with new roads and public transportation links enhancing accessibility.

The 1990s were characterized by rapid expansion. The boom in the IT sector, coupled with Sweden's commitment to fostering innovation, led to a surge in demand for office space. Kista Science City was established, branding the area as a global technology hub. This period saw an influx of both Swedish and international companies, including IBM and Microsoft, setting up offices in Kista.

The office market in Kista expanded accordingly, with numerous high-rise office buildings and business parks developed to accommodate the growing number of tech firms. The completion of the Kista Galleria, a major shopping and commercial center, further enhanced the district's appeal.

The early 2000s brought challenges with the burst of the dot-com bubble. The global downturn in the tech industry led to a temporary slowdown in Kista's office market. Vacancy rates increased, and rental prices stagnated. However, Kista's strong foundation in telecommunications and its strategic efforts to diversify its business base helped it weather the storm.

The early 2010s witnessed a renewed period of growth and innovation. The rise of mobile technology, cloud computing, and IoT fueled further expansion in Kista. The district's office market thrived as new tech startups and established firms sought to capitalize on the collaborative environment.

During this period, there was a shift towards more sustainable and flexible office solutions. Companies began to demand environmentally friendly buildings and adaptable workspaces.

2014-2019: Early Onset of Problems

The fortunes of Kista are in some ways linked to the fortunes of its dominant tenant, Ericsson.

In March 2000, at its peak, a market cap of $366 billion meant that Ericsson ranked high globally in terms of valuation. Ericsson, which had made Kista its home, required vast amounts of space by itself. Further, there were many tenants who wanted to sit near Ericsson.

In contrast, by late 2024, Ericsson’s market cap did not even make the top 10 in Sweden (it currently ranks in place 14) and would rank about 300 in the S&P 500. The number of employees at Ericsson fell from 105,000 in 2000 to 56,000 in 2005. Even today the number of employees, at just under 100,000, is lower than it was in 2000.

With Ericsson less of an anchor, the attractiveness of Kista started to decline.

Further, crime rates started to rise in the area.

2020-2024: Covis-19 and Beyond

The Covid-19 pandemic brought new challenges to the Kista office market, as it did globally. The shift towards remote work and hybrid working models led to an increase in vacancy rates initially, as companies reassessed their office space needs. Many businesses opted for smaller, more flexible office arrangements or delayed long-term leasing decisions.

We argue that while the Covid-19 pandemic affected office markets all over Sweden, the effect, however, was larger for Kista than in many other markets. There are a few notable reasons for this:

- The Kista market is home to many large multinational corporations. Multinational corporations typically had more stringent lockdown policies than more locally managed companies. Hence, the employees in Kista grew more accustomed to working from home than they did elsewhere

- Tenants with large floorplates, we find, have typically made more adjustments to their space needs in the post Covid-19 environment. Many of the tenants in Kista have large floor plates and large rental units

- The Stockholm office market is undergoing a high degree of bifurcation, and Kista is on the losing end. The Kista office market does not have the level of service and amenities required to make it attractive for employees to return to the office.

In 2023, Royal Institute of Technology, the major Swedish technological university, announced that they will shut their campus in Kista and instead move research and teaching to their main spaces in central Stockholm.

An Unsafe Environment Starts to Play a Role

Anecdotal evidence suggests that tenants perceive the office area to be unsafe, so much so that tenants avoid walking alone and at certain times of the day. While unlikely to be the deciding factor, we expect that this fact will weigh on tenants’ willingness to lease space in the area.

Such unsafe environments often take a long time to remedy; there is no easy fix.

The Difficulty with Expectations of High Capital Expenditure in a Low-Rent Area are in our experience, tenants in Kista have grown accustomed to, and ask for, a rather high-quality space, commensurate to that seen in the areas closer to the city center, where rents are much higher. At the same time, they are not willing to sign longer leases than elsewhere. The consequence of this is that a large part of the rents from the assets are used to fund tenant improvements, perhaps more so than we see in other office submarkets. For this reason, it is, in our experience, difficult to get investments in Kista to deliver cash returns, and as an investor you become overly dependent on capital growth.

What the Future May Hold

Despite the attempts to stem the tide, we think there is a high risk that the Kista market will continue to deteriorate over time, and that the vacancy rate will exceed 50%.

Recent rumors that Ericsson may be looking to move had a notable effect on the share prices of listed companies with large exposures to Kista, such as Corem. While we think it is likely that Ericsson will stay in the area, it is important to consider what might happen if Ericsson decides to leave. The Swedish publication Fastighetsvärlden noted in October 2024 that they believe that the market vacancy could hit 65% if Ericsson decides to leave. We believe that this assessment is reasonable. Fastighetsvärlden believes that a more likely scenario is that Ericsson would leave, say half of their space, which would result in a vacancy level of ca 50%. We, too, think that this is a reasonable base case scenario.

We see little chance that any new tenants would come in to fill the potential new vacancies, therefore, a vacancy level of 40-50% may persist for some time.

Property owners would need to consider alternative uses for their properties. It is, however, not apparent what these alternative uses would be. Over the longer term, some of the assets may be converted to residential use. Though, the large, deep floor plates and relatively low ceiling heights for many of the buildings will pose a challenge for anyone seeking to undertake a conversion.

Coor’s move to Solna is a recent example of a move by a tenant from Kista for the benefit of another submarket. Another example is CGI, which, in 2023, moved from Kista to Solna. Microsoft packed up and moved to Urban Escape in the city center in 2019. KTH has given notice that it will move its operations in Kista to their existing campus in central Stockholm. Just to name a few examples.

Conclusions and Implications for Investment Strategy

We argue that the deterioration in the Kista office market has reached a point where we expect that the vacancy risk will continue to rise. The market is likely to be in a downward spiral, where fewer companies and people, reduced services and restaurants, and a diminishing reputation will lead to more tenants leaving, further reducing availability of services and restaurants, and further tarnishing the area’s reputation, and so on. At this stage, landlords offering lower rents is unlikely to stem the exodus.

This office submarket remains overly dependent on Ericsson, and while we think they will stay, they have highlighted that they may leave. Even if they stay, they are likely to leave a significant amount of space, driving the vacancy level in the area to above 50%.

The problem with safety and security is an issue for the area for which there are no quick fixes; it may take years to come to terms with these issues. Companies will continue to relocate to safer neighborhoods.

For these reasons it is our view that the Kista market is un-investable and will continue to be so for the foreseeable future. Buyer beware.

The perils faced by the Kista office market mean that tenants will continue to vacate and relocate to stronger office locations, helping to increase occupancy levels in other Stockholm submarkets. Indeed, the upside to the situation in Kista is that the exodus of tenants will help to balance other, stronger, office submarkets.