Offices - UK Cities: Not business as usual
Darren Mansfield explores the immediate impact and potential consequences of COVID-19 on UK office markets.
5 minutes to read
What we know
Still a willingness to transact. In the marketplace, there is still a willingness to continue transacting but because of the challenges with conducting due diligence, the velocity of deal flow will slow down in the months ahead. In Scotland, the closure of Registers of Scotland will limit transactional ability further. Offices at Meadowbank House in Edinburgh and St Vincent Plaza in Glasgow have both been closed due to coronavirus.
Development: a mixed picture. Expected timing of projects underway could now shift as construction activity stalls as a response to COVID 19. Works in Scotland have already been advised to cease on all but essential buildings such as hospitals.
This stance is yet to be imposed in England although construction is being largely scaled back to adhere to social distancing measures. Work on several sites for High Speed 2, for example, has ceased. More positively, there are examples of a longer-term view and preparing for a restriction-free marketplace. Recommitment of plans by Scarborough International Properties, Bruntwood and Opus this week further examples the long-term growth projections for the UK cities held by developers.
The market is more balanced than pre-GFC. Office vacancy levels across the UK cities are much lower with the combined city average closer 8% today compared with 11% in 2008. Moreover, the development pipeline is equally as limited. As March 2020, there is around 7m sq ft scheduled for completion over the next three years, of which of 4m sq ft is speculative. This compares to 15m sq ft at the onset of the GFC meaning market oversupply is less of a risk today.
Don’t forget the Budget. The March 2020 budget made much of the desire to boost spending beyond London and the South East. It outlined £242m of funding for new City and Growth deals, while eight metro mayors, including the newly announced West Yorkshire mayor, will receive London-style funding settlements worth £4.2bn in total. There is also an expectation of 22,000 civil service roles moving out of London over the next decade. We expect all this, combined with local infrastructure improvements, to add to the already strong momentum being seen in the UK’s key cities.
What we expect
Occupier requirements deferred. Whilst businesses take stock of the increasingly challenging business environment, a likely strategy regarding future real estate needs will be to defer any major decisions until greater clarity is known. Instances of requirements being placed on hold will therefore increase in the coming months albeit so far there are only a few examples of complete withdrawal.
Projects to face delay. The reconfirmation of development proposals and the commencement of works is some instances is underlining the positive long-term view on growth in the UK regional cities. In the short term, although Government measures to counter COVID 19 have so far been only advisory toward construction activity, some contractors have already elected to close sites. Consequently, the timing of projects underway will now shift outward. For the UK regional cities, 2020 was expected to be the peak of the current development cycle. This spike in space delivered will now clearly be smoothed beyond this year.
UK Cities development completions assuming 6 months delay.
Source: Knight Frank
Risk aversion will place greater importance on digital connectivity. The social distancing strategy has created an immediate impediment to businesses operations across the spectrum. Digital infrastructure has quickly become an organisation’s principal foundation of business continuity. Therefore, cities, districts and buildings that have made infrastructure a priority will find additional favour as firms become more risk averse.
What we question
What will the market balance be post crisis? Because demand has slowed at the same pace as supply, a supply and demand imbalance may not be as pronounced as recorded after previous economic shocks. Should an early breakthrough materialise on the Covid 19 crisis, a rebound in activity could be swift. What cannot yet be factored in however, is the scale of tenant release space that will derive from business casualties.
What impact will development delay have on the occupational market? Any delay in building work will create particular challenges for occupiers where that space is currently under negotiation, a pre-let has been agreed or a lease taken after works had commenced. Occupiers that fall into these categories will have mostly signed these new contracts having decided to either exercise a break option on an existing lease or pursue a new space move in anticipation of lease expiry. Many pre-completion deals will have conditions to provide some degree of compensation to the occupier, in the event of a delayed completion. However, depending on individual circumstances, delay could create a gap between the exit timetable under the existing lease and the commencement of a new occupation.
There are three main groups of outcomes:
Firstly, for contracts still being finalised, this could mean occupiers simply choose to hold over, extend or negotiate new terms at their existing occupation. Secondly, an occupier may seek to bolster the late delivery compensation clauses in the final version new agreement. Lastly, for those already committed by an agreement for lease, although any delay compensation will reduce exposure to financial disadvantage, in practical terms interim space provision may be needed. This could mean a rise in short term contracts with serviced office operators. Short term lease extension requests are also likely to rise, albeit landlord compliance may depend on whether such leases have security of tenure.
Will there be a push in businesses recalling operations from overseas? There is some debate emerging which suggests a sustained drive in business creating new jobs in the UK to replace those that were previously moved abroad. Examples of this are few at present, but the additional scrutiny afforded to operational risk is a clear consequence of a post crisis environment meaning that greater consideration will be the result. Of course, this would generate new space requirements.