Office market update Spring 2024

Structural change continues.

In short: The structural change in the office market is ongoing, with strong appetite for best-in-class office space which meets high net-zero requirements and insipid demand for secondary or tertiary space. The investment market was quiet overall in 2023, although some notable deals were struck where pricing was competitive. The receding cost of finance this year as base rates fall could spur more activity, especially for space which is ripe for change of use, re-development or value-add.

UK office vacancy rate rises again. The UK vacancy rate continued to climb in the final quarter of 2023, ending the year at 8.2%, compared to 6.8% at the end of 2022, a rise of more than 20%. More office space is staying empty due to weak demand amid hybrid working, as well as net-zero requirements and a downbeat economic landscape. At the same time, the delivery of office stock remains high compared to historic levels, with nearly 8m square feet of office space delivered across the UK in 2023. Some 110 million square feet of office space in the UK is currently vacant, and this volume is set to rise by another 30 million square feet by next year – taking the vacancy rate to 10%, according to CoStar.

It is not a one size fits all story for office markets however. Some large deals across key cities and differences in the pipeline mean that vacancy rates fell in Leeds, Manchester and Bristol in Q4, although in all cases, vacancies remain far higher than the 5-year average.

The employment picture remains resilient, but the relatively weak economic outlook for this year will result in more headcount reductions, which will affect overall demand for office space.

At the same time, some companies are investing more in their offices to encourage workers back to the office. Demand for best-in-class offices in the most coveted locations, with high-end amenities and ESG ratings, is moving against trend, especially in central London, and the Cambridge to Oxford corridor. Net absorption for 5 Star offices as rated by CoStar, which represent best-in-class,  has remained positive in the last 4 years, and will remain positive this year, while there has been negative absorption for offices rates 1 Star (the lowest rating) to 4 Star since 2020, and this trend is expected to become even more entrenched this year.

Rental growth edged upwards in Q4, with all office rental growth at 2.3% in December, compared to 1.9% in Q3. This growth is heavily weighted towards best-in-class offices, where higher demand amid tighter supply is putting upward pressure on rents, and activity in this sector will be dominating headline rents. Landlords are also encouraging take up with other incentives such as longer rent-free periods. Rents in many areas of the country will not be keeping up with this headline rates.

London office: Flight to the centre. Leasing activity rose again in Q4 after a solid Q3, but the large pipeline of stock means that net absorption was negative for the year, after being positive in 2022. The vacancy rate for London has risen again to 9.3%, up from around 5% at the start of 2020, and the highest level in two decades. There is around 20.4 million square feet of office space currently under construction across Greater London, the highest level in more than 10 years. As this stock comes online, it will keep the vacancy rate higher.

Looking at net absorption in the central London office market shows a different picture, as shown in the chart below, with positive absorption in Q4. This central London market incorporates some of the markets with a higher proportion of best-in-class new-build which is in high demand, as well as the Mid-Town and West End market which is chronically undersupplied.

In the West End, the tighter supply of office space has also kept the vacancy rate relatively low, and put more upward pressure on rents than in the City.  

The rental chart from MSCI data above details what is happening in terms of headline rents, but there are significant variations when it comes to location and type of building. There are many examples of rents stagnating or declining for buildings that fall below the best-in-class standard due to increasing supply outside the West End. The large pipeline of space coming online in the City will put downward pressure on rents, even as demand remains resilient, while rents in Canary Wharf, and Hammersmith, where the vacancy rates are highest, will come under most pressure. The increasing supply of smaller Cat A+ buildings, for which there is good demand, may also be putting some upward pressure on headline rents, as these can command higher rates.

Investment levels low in 2023.  Investment activity across the office sector was at a 14-year low in 2022 at just £8.3 billion. Higher financing costs, higher vacancy rates and weaker sentiment continue to act to act as brake on prices and activity, especially for larger assets and non-prime assets. The prospect of rate cuts later this year is opening the way for a pick-up in activity in H2, although the market for ‘value-add’ investors is already getting busier especially around London’s West End.

Headline office capital values have fallen by an average of 33% over the last four years, but even so, there is evidence of office assets in regional cities still selling for well-below asking prices at higher yields. The continuing re-basing of office values will make this asset class more attractive to investors however, and when the cost of finance recedes later this year, activity could pick up for assets which offer the opportunity for value-add or change of use.

Investment activity in Manchester was also well below the average last year. Investment volumes totalled £279 million in 2023, compared to five-year average of £566 million, and £1.3 billion peak registered in 2021. Institutional investors have been noticeably quieter in the market, although other investors are still interested in best-in-class well-located offices, although at relatively lower prices. The sale of Co-op’s headquarters at One Angel Square (329,000 square feet) which sold in late October 2023 for £140 million at a net initial yield of 8% is an example of this, a very large office sale for the UK, but down from an initial asking price of £210 million.  

Demand is strongest where there is also an opportunity for re-development or adding value, creating Grade A office space in locations which are still showing healthy levels of demand. Multi-let buildings, which offsets some income risk, are also popular. Overseas investors are also seeing opportunity, given the relative weakness of the pound to the dollar.

Capital values for business parks have fallen sharply since November 2022, and with a 16% decline in 2023 alone, widening to a 20% decline in London and the South East. Investor appetite is limited however as there is less opportunity for change of use to residential. However, parks let to the burgeoning life sciences sector are drawing more attention especially around Oxford and Cambridge.

In London, investment levels have also slowed. The annual total of investment into the capital in 2023 was just £5.7 billion, the lowest level since 2009. Refinancing issues should spur more activity this year, although in line with trends observed recently, investors will be looking for keen pricing. The fact that London’s office market has re-priced more quickly than other European cities could also encourage additional investment this year. The Bloom building in Clerkenwell sold at a yield of 5.3% late last year, some 100bps higher than sale of Kaleidoscope Farringdon in 2022.  

Overseas investors still dominate this market as they look for diversification and safe-haven assets and take advantage of the currency play. UK institutional investors are less active on the buy side, and this trend is unlikely to change in 2024.

Key investment deals:

Property Address	Town /City	Date	Yield (%)	Sale Price (£m)	Buyer
Vogue House, 1-2 Hanover Square, W1	London	Q1 2024	–	£73m	Global Holdings
5 Churchill Place E14	London	Q1 2024		£110m	Ariomori Investment Ltd
10 Bricket Road	St Albans	Q1 2024	7.0%	£23.3m	Chelsea and Kensington Council Pension Fund
Spitalfields House, 110–114 Middlesex Street, E1	London	Q1 2024	7.0%	£35.47m	Remake (French Property Fund)
125 Shaftesbury Ave WC2	London	Q4 2023		£148m	Edge UK Management Ltd
1 Angel Square	Manchester	Q4 2023	7.8%	£140m	Menomadin Group
Dingwall, 1 Ruskin Square	Croydon	Q4 2023	6.0%	£115m	HMRC
Bloom Clerkenwell, EC1	London	Q4 2023	5.3%	£230m	UBS Asset Management
Bury St, Quebec Building	Salford	Q4 2023	7.5%	£850,000	Shenton Group

Key statistics:

Offices Q4 2023 unless otherwise stated	Central London	Manchester	Key Regional cities
	Latest quarter (Previous quarter/5 yr av)	Latest quarter (Previous quarter/5 yr av)	Latest quarter (Previous quarter/5 yr av)
Occupier
Availability rate %	10.1% (10.6%/9.7%)	10.9% (10.9%/10.2%)	9.9% (9.9%/9.0%)
Vacancy rate %	9.9% (9.9%/7.25%)	8.9% (9.2%/7.2%)	8.1% (8.2%/6.0%)
Rental growth % annual	1.5% (1.4%/0.4%)	4.9% (3.9%/3.3%)	3.3% (2.8%/3.3%)
Quarterly take up sqft	4.7m (1.9m/2.3m)	0.5m (0.34m/0.47m)	0.7m (1.3m/1.3m)
Prime headline rent per sqft Q4 2023	£130 psf (West End) £82.50 psf (City)	£40 psf	£42 psf (Bristol, Birmingham) £37psf (Leeds) £29 psf (Newcastle)
Average rent per sqft	£58.82 (£58.03/£56.01)	£21.47 (£20.89/£19.35)	£20.60 (£20.29/£18.86)
Supply
Completions (net delivered) sqft	166,105 (763,378/284,866)	44,289 (148,337/160,558)	147,934 (250,866/296,581)
Total under construction sqft	10.1m (9.0m/8.5m)	1.9m (1.5m/1.9m)	3.5m (2.9m/3.9m)
Investment
Quarterly Sales volume £	£658m (£581m/£1.7bn)	£190m (£36m/£131m)	£210m (£197m/£418m)
Average yield (NIY) %	5.3%	6.7%**	6.7%**
Prime yield % March 2024 (Q4 2023)	City: 5.50% – 5.75% (5.50%-5.75%) West End: 4.0% – 4.25% (4.0% – 4.25%)	6.50% – 7.0% (6.50%-7.0%)	6.50% – 7.0% (6.50%-7.0%)

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