Green Shoots And Stranded Assets: Why The UK Office Market Is Springing Back

If you want disappointing news about the office market, it's easy to find.

London and the south east look particularly sluggish: Colliers' Q1 snapshot of the entire London market suggested sluggish take-up at 2M SF, the lowest quarterly figure since Q2 2021, and if you strip out the pandemic, the lowest since Q2 2016 in the wake of the Brexit vote.

The firm's analysis of the south east was every bit as gloomy. Researchers recorded Q1 take-up lower than any point in the last year, and 25% below the 10-year quarterly average, despite a few localised bright spots.

Yet look beyond the headlines and there are signs a potential recovery is already well underway. Green shoots are springing up in places.

“It's not so much that the office market is starting to recover, it's been recovering for a while," said Andrew Cooke, Savills associate director in UK tenant representation.

The explanation is that, after a decade or more of low interest rates providing a fair wind for real estate, rusty and slow-moving market mechanisms are being oiled by necessity. Now, at last, they are swinging into action.

A neat summation of the problem for the office market, and its potential solution, is provided by a property occupier that is also a property market-maker.

Late last month JLL signed up for new offices in central Birmingham. The firm will take 14K SF on a 10-year lease at Birmingham City Council/Federated Hermes' 280K SF One Centenary Way, part of the £1.2B Birmingham Paradise redevelopment. Neighbours will include Goldman Sachs. It will occupy just over half of the fourth floor in an all-electric, low-carbon building festooned with sustainability benchmarks including SKA Gold, BREEAM Excellent and WELL Gold standards.

JLL Midland Region Head Stuart Smith said that although the firm had a longlist of four sites, they ended up with a shortlist of one. “This was our preferred option by a long way,” he said. “Amenities, sustainability, the way the floor divided, the occupier mix” were all tipped in Paradise's direction, he added.

In Birmingham, as in many UK regional cities, the tide has turned against blanket work-from-home. Office for National Statistics monitoring of Pret a Manger sandwich shops suggests regional transport hubs are at about 90% of pre-pandemic capacity, but regional towns back to 119%. London is still below normal levels, but Manchester is well above (120%) and so is Yorkshire (121%).

The latest data on the Birmingham market — released this week by the Birmingham Office Market Forum — showed a nuanced picture. While the Forum described Q1 as “a stop/start quarter” and reported take-up down in line with the London and south east trends (155K SF, a slide from 175K SF in Q4 2022), the devil is in the detail.

The detail to look for is the Grade A take-up. In Birmingham as much as 60K SF was for Grade A floorspace, a slice of the market with distinctly limited supply, a limited supply getting more limited as time goes on. In Q1, for instance, Grade A supply went up by 180K SF net, of which 60K SF was immediately let (including the JLL deal).

The position is similar in Manchester where data showed take-up down (211K SF in Q1, compared to 427K SF in Q4 2022) but the proportion of Grade A take-up beyond expectations: In a normal quarter Grade A floorspace accounts for around 30%-40% of transacted floorspace. In Q1 2023 the figure was closer to 70%.

That lettings success comes at a price for landlords. But the evidence suggests the price — in term of rent free periods — is diminishing.

Incentives are one way to measure the progress. “Before the pandemic you might see nine-12 months rent free on a five-year term for good quality to prime floorspace," Savills' Cooke said. "In midpandemic, 2020, I got 18 months' rent free on a five-year term because landlords wanted to get people through the door. We're not at that level now, but we're not yet back to pre-pandemic levels. It's more like 12-14 months rent free, and probably a bit more if the quality of the build is a bit less."

Avison Young's central London rental heat map suggested similar rent-frees in the capital: 24 months on a 10-year lease seems standard everywhere.

Proof that the top slice of the market is adjusting rapidly comes in the form of rental data that shows accelerating prime rents in the capital and the major regional markets: Birmingham, Bristol, Leeds and Manchester all picked up speed and are now at, or over, £40 per SF, driven by tumbling Grade A availability. Colliers data suggested Grade A supply fell by 10% in Birmingham prompting a headline rent rise of 8%; in Leeds Grade A supply fell 8% and prime rents nudged up by 6%.

In London more than 1.3M SF of office space was leased at rents higher than £100 per SF in 2022, according to data compiled by adviser CBRE.

West End rents topped £165 per SF (at 65 Davies Street) and even the more cyclical City market has started to move, with rents reaching £75 per SF, up from £72.50 and the first forward movement for three years.

The dynamics of supply and demand suggest that, even with demand subdued, this trend is set to continue. CBRE data shows a pipeline of 7M SF delivered in 2023, of which about half is unlet. But this figure falls off a cliff in the next three years thanks to cautious developers pausing decisions over a tricky 18 months. Around 2M SF of new unspoken-for floorspace in 2024 sinks to barely 1M SF, then vanishes altogether as 2026 peters out.

Developers in all the big cities know that luck and judgment have combined to create a good opportunity: Developments like Hammerson's 200K SF Drum retail-to-office repurposing in Birmingham would not be happening otherwise.

Where this happy story breaks down is for the less glamorous floorpsace — the potentially stranded assets where rents are not high enough to justify the kind of up-scale refurbishment they probably need. But even here, the market mechanism — rusty from disuse during the last decade or more of relative monetary stability — is kicking in.

“Demand for top-end floorspace outweighs supply and the next 18-24 months will see rents go up as a result," Cooke said. "But there's also a large market of Grade B space that doesn't cut it any more, and whilst some occupiers will always be happy with this quality, demand for floorspace in this category is reducing too.”

The short-term solution is to fit out small suites (3K-5K SF) ready for potential occupiers: In a crowded market it helps if your office building stands out. In the longer-term rising rents in the Grade A market will help make Grade B stock look more attractive, but experts told Bisnow these buildings will, sooner or later, need very extensive refurbishment or repurposing. They can't carry on as they are.

Tom Newman, fund manager at Schroder Real Estate, is watching closely, particularly those smaller regional markets where the return to office work is slower or more hesitant. He said landlords are undoubtedly feeling pressure — but it's mostly pressure of the good sort.

“We're noticing occupiers with a lot of uncertainty about how much floorspace they need, so they're asking for short-term leases and lease extensions where they are unsure, but refurbishments are attracting occupiers and we are still hitting headline rents, or doing better," he said. "We have a building in Leeds where rents have moved on by £2 per SF with each deal we've done.

“The big cities, Oxford and Cambridge, justify refurbishment capex, but elsewhere the market is patchy and yes landlords are having to incur capital expenditure to attract tenants.”

Newman said landlords are taking a hit, and find coping with flexible leasing — and the continual churn of occupiers with the associated long-term risk of higher vacancy levels — something that's hard to bear, though bear it they must.

There's also more systemic changes afoot as these trends play out, Newman said. “The concern is that the stronger office locations get stronger, and the weaker get weaker."