An overview of the UK office market is provided below, however, if you would like data on individual markets or an in-depth review of the occupational and investment markets, please visit the PULSE.
A welcome return for larger deals
Q2 take-up was strong, boosted by a marked increase in larger transactions following a relatively quiet period in Q1. UK-wide take-up of 6.8m sq ft in Q2 was up 12% on the previous quarter and 7% on the ten-year quarterly average, impressive considering elevated levels of uncertainty around the recent General Election and more generally over Brexit.
The return of larger deals was also reflected in take-up of grade A space, which was up 55% on Q1’s nationwide total and accounted for 58% of the total space transacted. This was the first time since prior to the recession, now almost a decade ago, that grade A space accounted for the majority of take-up.
Quality refurbishments fill the void
UK-wide availability fell 3% in Q2 to stand at 53.2m sq ft. The fall was largely accounted for by the regions, with availability outside Central London falling 4% during the quarter. Supply fell across all the Big Six markets, but most notably in Bristol, where it fell by 14%.
Reflecting a number of completions, UK-wide speculative development under construction fell by 2% during the quarter to stand at 12.1m sq ft. Benefitting from shorter lead-times, developers have turned to quality refurbishments to capitalise on levels of tight grade A supply. Key examples in the Big Six include Programme, Bristol (120,000 sq ft) and 55 Spring Gardens, Manchester (55,000 sq ft).
Tight supply keeps pressure on rents
Seven of the 52 Pulse markets recording prime headline rental growth during Q2, compared to eight in Q1. Leeds recorded the strongest increase, rising 9% to £30.00 per sq ft on the back of Burberry’s deal at 6 Queens Street. The only three markets to record a fall in prime rents over the quarter were the London submarkets of Canary Wharf, City Core and South Bank, albeit they were marginal reductions.
Positively, as good quality supply is tight across the majority of the UK’s regional markets, this should mitigate any falls in prime headline rents. Meanwhile, with speculative developers remaining cautious over new-build, there is evidence of stronger momentum the refurbished market.
Rental levels for good quality refurbishments have increased sharply in some locations, such as Bristol, Leeds and Manchester, with the discount to new-build narrowing to an all-time low in Bristol. ‘Differentiated’ product in fringe locations, targeted at smaller, value-seeking occupiers is expected to emerge as a key source of supply over the next 18 to 24 months.
Subdued quarter for office investment
Following a solid start to the year, total UK office volume was relatively subdued in Q2. £4.3bn of assets changed hands in the quarter, down 20% on Q1 and 24% below the five-year quarterly average.
Strong appetite from Germany
While overseas investors were less acquisitive compared with the previous quarter, they were nonetheless net buyers of offices to the tune of £1.4bn. They were also behind eight of Q2’s ten largest office deals, all of which were in Central London.
At £1.1bn, German investors recorded their second largest quarterly volume on record in Q2. However, this comprised only four major assets in Central London, and included 78 Cannon Street, EC4. However, as usual Far Eastern buyers dominated overseas volume, acquiring £1.4bn of offices. The largest Far Eastern deal was Cheung Kei Group’s £410m (5.35% NIY) purchase of 20 Canada Square, Canary Wharf.
In keeping with a trend seen since the start of 2016, UK institutions were quiet on the buy side in Q2 with net selling of offices amounting to £1.0bn. Institutions continued to cash in on Central London offices, disposing of £1.1bn worth of assets in Q2.
Pricing for prime assets holds steady
Prime office yields were broadly steady throughout the UK during Q2, although stronger sentiment towards Scotland in the wake of the General Election pushed prime Glasgow yields down by circa 25bps to 5.75%.
Meanwhile, however, the average transaction yield for UK Offices moved up by 50 bps in Q2 to 5.23%, with upwards movement seen across all subsectors except for offices parks. While this partly reflects increased caution towards riskier, secondary assets, it is also partly attributable to a lack of prime stock on the market.
Despite an uptick in 10-year gilt yields at the beginning of July, in relative terms UK real estate pricing remains extremely attractive by historic standards. With little prospect of an immediate or sharp increase in interest rates and strong demand from both overseas and domestic investors for secure income, prime yields are relatively settled.
Improving return outlook to boost liquidity
Despite signs of moderating growth in the economy, the occupier market has confounded initial expectations of a downturn in the wake of last year’s Brexit vote. The fundamentals are relatively sound, with above average take-up in Q2 and tight supply evident throughout most markets. While rental growth has slowed, the corrections that many had feared have not materialised.
The recovery of capital values and ongoing growth in rents in the 12 months since the Referendum has prompted investors to raise their total return aspirations significantly for 2017. This improving picture should encourage more stock to the market and, while Q3 may prove to be quiet as it often is over the summer, Q4 could be a busy quarter.
There is also a real window of opportunity to reposition assets in growth markets through good quality refurbishment, especially within the UK’s tightly supplied regional markets.
For more information, please visit the PULSE or contact:
RESEARCH - Izzy Watterson
OFFICE ADVISORY - Tony Fisher
CAPITAL MARKETS - Charlie Lake