Office market update Winter 2023

Looking up at London skyline, office buildings

The flight to quality continues

In short: There has never been such a divergence between prime and secondary office space before. This is still being driven by companies downsizing due to changing working patterns, as well the need to meet higher net-zero requirements, drawing demand to the best-in-class buildings in terms of ESG. This is a structural change in the office sector which is still being absorbed, so capital values are still under pressure, but there is appetite among some investors for best-in-class office space, or secondary space where there opportunity for change of use.

UK office vacancy rate rises again.  Some eye-catching leasing deals in the City of London in recent months has not been enough to offset the weak demand for offices across the rest of the country. The UK vacancy rate has edged up to 7.9%, up from 7.7% in August, and up from 5% before the pandemic. The weak demand, a result of more working from home and increased ESG requirements from companies as well as more challenging economic conditions, coincides with a strong pipeline of office stock. Some 10.8 million square feet of office space was delivered in the 12 months to the end of September, up from 8.8 million square feet in the previous 12 months.

There is currently more than 110 million square feet of vacant office space in the UK – the highest level in nearly a decade, and this will rise to 140 million square feet by 2025 according to CoStar.

Office vacancy rates

Vacancy rates have edged up in all large key city markets in England in Q3, as shown in the chart above.

The impact of working from home has not yet been fully felt across the office market. Even though the number of office-based jobs rose 4.1% in the 12 months to Q1 this year, demand continue to be weak, signalling that firms are still adjusting to the seismic shift in mobile and hybrid working experienced during the pandemic.

While jobs numbers have proved resilient so far, the weaker economic outlook over the next year indicate there could be headcount reductions, putting further downward pressure on office demand.

Not all offices are the same however, and some are enjoying stronger levels of demand despite these headwinds in the market. These best-in-class offices are the best located with top amenities and ESG ratings, helping them entice workers into the office, and meet the their own challenging net-zero goals. Outside London, the office market clustered around Cambridge and Oxford corridor is particularly strong.

Capital Economics highlighted the two-speed office market earlier this year when it noted the expanding spread between prime and non-prime office assets in the South East, which reached 160 points in Q1 2023.

Prime offices have propped up rental growth, along with increased incentives from landlords for occupiers such as longer rent-free periods. However, the challenges in this market which is currently characterised by high levels of supply and weaker overall demand will put downward pressure on rents through 2024.

London office leasing activity picked up in Q3, but even so, net absorption was still in negative territory as the volume of stock being delivered to the market outpaced a series of large lettings deals. The vacancy rate continues to climb and is now at a 20-year high of 9.2%, up from below 5% at the start of 2020. Delivery levels are set to remain high, meaning the vacancy rate is unlikely to fall into 2024. But as with the UK market, there is a clear distinction between best-in-class office space in the capital, compared to poorer quality stock.

Central London office net absorption

Location is also key across the capital – with several large leasing deals in the city, including Kirkland & Ellis, the law firm, taking 174,000 of option space at 40 Leadenhall underlining the attraction of the City, even as the vacancy rate is in low double digits. The Corporation of London recently highlighted the potential for more tall towers in the city, underlining the confidence in this geography in spite of the headwinds. To the east, the vacancy rate in Canary Wharf and Docklands is at 14%, rising to 19% for the fringe areas, as several large companies, including HSBC, have opted to shrink their floorplate and move west into the city.

In the West End, a tighter supply of office space has kept the vacancy rate relatively low. In turn, areas with lower vacancy rates are seeing more upwards pressure on rents, but rental rises remain modest.

London rents central offices graph

As can be seen in the chart above, MSCI data shows that average rents for central London offices have started to rise. However, this masks what is happening under the headline in terms of 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, where the vacancy rate is highest, will come under most pressure. The increasing supply of smaller Cat A plus buildings, for which there is good demand, may also be putting some upward pressure on headline rents, as these can command higher rates.

WeWork, a very large occupier of office space in central London, with 2.89 million square feet over 36 buildings, filed for bankruptcy in early November. It says this action relates only to the US, but the company has significant space in the north of the City of London, and in Southbank. The BBC reported that it was closing an office close to Blackfriars south of the river.  Markets will be watching as the company attempts to renegotiate its leases.  

Investment levels pick up slightly.  The strong start to the year in office investment wasn’t sustained, falling back in Q2. Investment levels rallied a little in Q3, but on an annual basis, investment in offices is still at a 14-year low at £8.8 billion. Higher financing costs, higher vacancy rates and weaker sentiment are acting as a drag on prices and activity, especially for non-prime assets, and are likely to continue to do so until halfway through next year. The appetite for prime assets is slightly stronger, and yields for these assets has stabilised, especially where investors can take advantage of lower entry prices.

There could be more stock coming to the market, especially secondary stock, as owners choose to divest rather than re-finance. Property funds are also divesting assets, with higher outflows than inflows of offices from open-ended property funds for the last 16 of 17 quarters, according to a recent report from React news. Increased stock levels will put further downward pressure on capital values.

There was also a slowdown in investment levels in Manchester in Q3, with investment in offices in the year to the end of September totalling £261 million, down from the five-year average of £588 million, and £1.3 billion registered in 2021. But in line with the prevailing trends in the market, the exceptions in this downbeat landscape are well-located prime assets, especially where there is wider regeneration or development. For example, in August, Sensible Properties Limited purchased Cardinal House, 20 St Mary’s Parsonage for £11 million from The Derwent Group. St Mary’s Parsonage, to the north of Spinningfields and close to the river is undergoing regeneration. Another exception is the sale of One Angel Square (329,000 square feet) which sold in late October 2023 for £140 million at an net initial yield of 8% – one of the largest single-asset transactions outside London for several years.  

The appetite for business and science parks let to life sciences remains stronger than traditional offices, meaning pricing has held up better, especially in areas around Oxford and Cambridge.

In London, investment levels have also slowed. The rolling annual total of investment into the capital to Q3 was just £7.5 billion, the lowest level since 2009. The stronger West End market bucked the trend to an extent, accounting for more than half of office deals in Q2 this year, worth £600 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. Overseas investors are also seeing opportunity, given the relative weakness of the pound to the dollar.

Brookfield, the Canadian asset manager, bought 77-78 Grosvenor Street for £100 million in June 2023, with an eye to redevelopment later this year.

But in less buoyant markets, investment conditions are tougher. Cheung Kei was reported by Bloomberg to be looking for a buyer for 20 Canada Square for £250 million, after purchasing the property for £410 million six years ago. It has now called in receivers for the building. However, it is not all downbeat, as Brookfield has fully let it’s Cargo building at 25 North Colonnade, which it redeveloped after purchase in 2014, and is now seeking a buyer.

UK office yields graph

London office yields

Key investment deals:

Property AddressTown /CityDateYield (%)Sale Price (£m)Buyer
142-150 Wardour Street, W1LondonQ3 2023 £132mHines
Old Broad, Lion Plaza EC2London Q3 20236.0%£209mLion Plaza Propco Ltd
32 Jamestown Road, NW1LondonQ3 20235.4%£75m 
1 Sovereign StreetLeedsQ3 20237.0%£38.5mCiti Private Bank
The Halo, Temple StreetBristolQ2 20235.6%£72.3mCBREIM
St James Square, Dalton PlaceManchesterQ2 20235.8%£30mKarrev Real Estate Fund +1
Source: Cluttons, CoStar

Key statistics:

Offices Q3 2023 unless otherwise statedCentral LondonManchesterKey Regional cities
 Current Quarter (last quarter/5 yr av)Current Quarter (last quarter/5 yr av)Current Quarter (last quarter/5 yr av)
Occupier   
Availability rate10.6% (10.7%/9.4%)  10.9% (11.1%/10.2%)9.7% (9.7%/8.9%)
Vacancy rate9.9% (9.8%/6.6%)  9.2% (8.8%/6.9%)7.9% (7.9%/5.8%)
Rental growth % annual1.38% (1.56%/0.2%)3.9% (1.3%/3.4%)2.4% (2.8%/3.7%)
Quarterly take up sqft1.9m (1.9m/2.6m)  0.34m (0.46m/0.48m)1.04m (0.86m/1.4m)
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£62.23 (£61.64/£59.84)  £20.89 (£20.53/£19.00)£20.02 (£19.96/£18.52)
Supply   
Completions (net delivered) sqft763,378 (-68,000/741,000)228,145 (0/146,125)252,600 (261,579/542,474)
Total under construction sqft9.0m (10.0m/8.1m)1.6m (2.0m/1.8m)2.9m (2.9m/4.0m)
Investment   
Quarterly Sales volume ££581m (£789m/£1.7bn)£40m (£1m/£138m)£210m (£197m/£418m)
Average yield %4.5% (NIY)  7.4%  8.5%  
Prime yield % October 2023 (Q2 2023)City: 5.5% – 5.75% (5.25%) West End: 4.0% – 4.25% (3.75% – 4.0%)6.25% – 6.5% (6.0%)  6.25% – 6.5% (6.0%)  
Source: Cluttons, CoStar, MSCI. Key regional cities: Birmingham, Bristol, Manchester, Leeds. Central London: City, Canary Wharf, West End and Southbank *data can be lagging

The information provided in this report is the sole property of Cluttons LLP and provides basic information and not legal advice. It must not be copied, reproduced or transmitted in any form or by any means, either in whole or in part, without the prior written consent of Cluttons LLP. The information contained in this report has been obtained from sources generally regarded to be reliable. However, no representation is made, or warranty given, in respect of the accuracy of this information. Cluttons LLP does not accept any liability in negligence or otherwise for any loss or damage suffered by any party resulting from reliance on this publication.

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