Investment market overview
Office investment outside of London reached £7.7bn in 2017, 30% more than in 2016, in a clear sign that the slowdown in office investment beyond the M25 has begun to reverse.
Indeed, the pace of activity is increasing. After a relatively slow start, investment in the second half of the year was over twice as high as in the first, and the sense of momentum was heightened as a number of significant transactions were announced (but not completed) in the final months of the year.
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Office investment outside of London reached £7.7bn in 2017, 30% more than in 2016, in a clear sign that the slowdown in office investment beyond the M25 has begun to reverse. Indeed, the pace of activity is increasing.
After a relatively slow start, investment in the second half of the year was over twice as high as in the first, and the sense of momentum was heightened as a number of significant transactions were announced (but not completed) in the final months of the year.
Overseas investors accounted for around 40% of purchases during 2017, with domestic institutions making up a further 22% – shares that on the face of it have changed little in previous years. Yet the most recent quarterly statistics show a clear rise in the share of both of these two purchaser types, to the extent that they jointly accounted for well over 60% of purchases by volume in the last two quarters of 2017. Meanwhile, private investors eased back.
So what has been driving the interest in regional markets? On the occupier demand side, there is no doubt that the fundamentals have been improving across a number of fronts. 2017 saw jobs growth across most of the UK’s regions, boosted by high-profile private and public sector relocations of office staff to regional cities.
Meanwhile, on the supply side, the delivery of new office space has remained relatively subdued, exacerbating the shortages of modern office stock in many of the largest cities, and leading to stronger prospects for rental growth.
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The ever-present hunt for yield has clearly also been supportive of investor interest. Making the inevitable comparison to London pricing, both overseas and domestic investors alike have benefited from higher yields when purchasing offices in the UK’s regional cities, even when the assets and covenants have been of similar quality.
But while prime office yields in London remained unchanged throughout 2017, recently announced deals suggest that for regional cities, yields are still under downward pressure for the best stock. The regional cities’ yield advantage over London remains sufficient to generate strong competition from investors, but this in turn will begin to erode the differential.
Ultimately, cautious optimism on occupation markets, combined with robust investor demand is supporting return expectations. Performance data from IPD shows that while capital growth in regional markets typically lagged the London market in 2017, values have been steadily improving. This, combined with a stronger income return than for London offices, has meant that total returns in regional office markets have in many cases been higher than for London.
Outlook
The latest IPF consensus report shows the range of forecasts for UK office returns in 2018 is wider than for any of the other major property sectors, highlighting the degree of uncertainty about the outlook.
However, recognising that 2018 is likely to see performance moderate across all sectors, we nevertheless see plenty of reasons to expect a buoyant regional office market in 2018, not least due to the variety of capital sources active in the UK.
Having initially been less active buyers post-referendum, institutional funds have been increasing their share of regional offices purchases, and are under significant pressure to deploy further capital.
London and parts of the south east markets remain too competitive and/or expensive for some such funds, meaning prime offices in regional locations will be an attractive alternative – as long as the stock can be found.
As the UK faces a period of moderating growth and uncertain politics, prime assets with attractive income profiles could prove scarce, due to the difficulty that owners will face in recycling capital effectively. Some will calculate that only premium pricing will compensate for the challenge of reinvesting, and absent this, will prefer to hold. As a result, demand for good quality secondary assets may pick up.
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Overseas investment rose up in the last quarter of 2017 and we expect further interest in 2018. One reason is that the weight of capital targeting prime offices in European cities has driven yields to unprecedented lows, and has left many UK office markets looking comparatively better value.
We expect this will cause some European investors to reappraise the UK, adding to the overseas demand already active in regional UK cities.