Structural changes effecting the UK office market will play out over several years
The roll-out of a vaccine that is 90%+ effective will encourage some to say that patterns of occupation and the demand for office space will revert to “normal” after a brief respite. But for others the COVID-19 pandemic has provided a catalyst to re-think the future of the workplace. It is possible that many businesses will seek to shrink their office estate and develop a ‘flexi” model. One incentive is the drive to net carbon neutrality by 2050: a reduction in space occupied in glass clad towers, which require heating in winter and air conditioning in summer, can support net zero targets. As can reductions in the number of employees commuting daily into central locations. Structural changes effecting the office market will play out over many years.
How did leasing activity fare across the UK in Q3 2020?
Across each of the core Central London sub-markets of the City, West End and Midtown, Q3 take-up was 80% or more below the 10-year quarterly average. In Q3 core City take-up fell 61% with lettings totalling just 166,000 sq ft compared to the 10-year quarterly average of 1.49m sq ft. The situation was similar across Central London’s other sub-markets. No lettings at all were completed in Docklands—an outcome which was not even experienced during the Global Financial Crisis of 2008.
As in the Central London markets, take-up in the regional office markets in Q2 and Q3 represented a substantial decrease on the quarterly average rate of take-up over the last 10 years. The solitary exception being Edinburgh where 453k sq ft was let in Q3 compared to 10-year quarterly average take-up of 167k sq ft.
Is availability of regional and Central London offices at historical highs?
Availability rates across the regional markets rose after the Global Financial Crisis, peaking at 18% in 2014. By the end of 2019, the availability rate had declined to 10.7% compared to its long-run average of 13.6%. However, since the start of the year the availability has edged back up to 11.8%. Birmingham, Glasgow, Leeds and Manchester all have double digit availability rates. The availability rate in Bristol is 9% and Edinburgh 8%.
In Q3 2020 availability increased across every Central London submarket. Availability has increased across all bar one of Central London’s sub-markets on a 12-month view. The single exception is the Docklands, where there has there been a slight decrease in availability of 3% or 80,000 sq ft. The availability rate in the City is now 12%. The West End and Midtown sub-markets have the lowest availability rate at 7% and 6% respectively.
There is a perception that the amount of “grey” space which is neither occupied nor on the market to let is growing. Businesses may be reluctant to shrink their real estate portfolios until the full implications of the pandemic-driven move to “WFH” have been revealed.
What is happening to rental values and rent free incentives?
Market rental values typically have a lagged reaction to macroeconomic events. Consequently, in the core Central London markets decreases in rental values are barely visible, yet. There are signs of a softening market as rent free periods start to lengthen. Typically, an occupier can expect to receive 26 months’ rent free on entering a 10-year lease. This is a 3-month increase on the terms available in Q2.
Market rental values in the regional office markets have also reacted slowly to the pandemic recession. Across all centres rental values deceased by just 0.4% in the 9 months to the end of September 2020. This average masks variations in rental growth between increases of 1.0% in Birmingham and 2.3% in Bristol; and decreases of 1.0% in Manchester and 0.7% in Edinburgh.
Who invested in office property across the UK in Q3 2020?
In Q2 and Q3 total investment spending from all sources into Central London offices amounted to £1.45 billion of which 86% or £1.24 billion came from overseas investors. Nine of the ten largest purchases in 2020 were made by overseas investors including Link REIT from Hong Kong acquiring 25 Cabot Square, E14 for £367.9m. The Malaysian Employees Pension Fund acquired Premier Place, EC2 for £322m. L&G were the largest UK investor, purchasing 14-26 Great Smith Street, SW1 for £300m.
In Q2 and Q3 total investment spending from all sources into the ‘Big 6’ regional office markets amounted to £184 million of which 22% or £40 million came from overseas investors. Only two of the eleven £10 million plus transactions were made by overseas investors. These were Elite Partners Capital £40 million acquisition of 150 Broomielaw, Glasgow and the purchase of 3-4 The Embankment, Leeds by UKRO from Hong Kong for £20.5 million.
How far have Central London investment volumes and capital values declined?
Investment into Central London averaged £723m in Q2 and Q3. This is 61% lower than Q1 (£1.84 billion) and 73% lower than the long run quarterly average (£2.7 billion).
Capital values in the core Central London markets deceased by 3% in the 9 months to the end of September 2020 driven by a decline in rental values of 1% and a softening of yields that contributed -2%. In the fringe markets capital values have decreased by 6% in the Docklands, and 4% in the City Fringe.
How far have regional investment volumes and capital values declined?
Investment into the regional office markets for Q2 and Q3 averaged £92m, this represents a substantial 73% decrease on the quarterly average rate of investment over the last 10-years (£342m).
Capital values in the regional office markets have decreased by 3.4% in the 9 months to the end of September 2020 driven by a decline in rental values of just 0.4% and a softening of yields that contributed -3%. Capital values have decreased by 6% in Manchester and 4% in Glasgow and Birmingham. In Leeds office capital values have remained stable so far.