By Iain Withers

LONDON (Reuters) -Demand for premium office space in cities like London and Paris is heating up as more companies order staff back to the office, but investment is lagging and could worsen a supply crunch, property sources said.

Many businesses are rolling out stricter return-to-office mandates, including JPMorgan, Amazon and Royal Bank of Canada. Others like UBS and Deutsche Bank have told staff not to work both Fridays and Mondays from home.

The trend is reflected in falling vacancy rates and record office rents in prime locations such as central London.

Yet investors remain reluctant to buy properties or commit to building new ones due to uncertain pricing and high borrowing costs.

"The pendulum has swung... We've got pent up demand, and then we've got a shorter level of supply, particularly quality supply," said Lee Elliott at property agency Knight Frank.

The office vacancy rate in central London fell to 7.1% in March, according to agency Savills, down from a post-pandemic peak of 8.7% and the lowest since 2020, but higher than the roughly 5% level in pre-pandemic 2019.

Average prime rents in the central City and West End districts were at near-record levels in March, Savills data shows.

However, the picture is less rosy outside the centre. The vacancy rate across London as a whole rose to 10.9% in the first quarter, according to CoStar data, the highest in more than 20 years, as occupiers shunned older, out-of-town properties.

The mixed picture is weighing on investment. Office sales in Europe last year slumped to their lowest level since 2009, while transactions fell 18% year-on-year in the first quarter, according to MSCI data.

In London, only about 4 million square feet of new office space is planned to complete in 2027 and 2028 - less than was delivered in 2025 alone, according to Deloitte.

Planned London office sales by Brookfield and Nuveen were shelved this year after bids fell short of expectations, although there are signs of improved appetite for some trophy assets - Blackstone is among bidders for a Paris office block with a price tag of 700 million euros ($812 million).

Some companies are also cooling on the downsizing trend, with just 21% of occupiers looking to cut space in a recent Knight Frank survey - the lowest level in seven years.

HSBC is moving its headquarters in London to a building roughly half the size, but has realised it will lack sufficient space and is assessing other options including retaining smaller offices elsewhere in London, a source familiar said.

An HSBC spokesperson declined to comment on its options.

With limited new supply, improving demand could ultimately benefit second-hand office space.

Around 30 large companies are each looking to lease more than 100,000 square feet of office space in London - equivalent in total to at least 40 soccer pitches - according to Kevin Darvishi, leasing director at office developer Stanhope.

"Frankly there will not be enough space...for even half those occupiers to move," he said.

($1 = 0.8624 euros)

(Reporting by Iain Withers; Editing by Tommy Reggiori Wilkes and Toby Chopra)