4 minutes to read
The next phase of office market evolution is in full flow. It is predicted that office stock in England and Wales could reduce by 47m sq ft or 5% of total stock over the next 10 years.
Factors such as the shifting parameters of office demand, the rising costs involved with capital expenditure, outward yield shift, and unsupportive rental levels are challenging the viability of continued office use in non-core secondary/tertiary markets. Consequently, a significant proportion of existing office stock may soon be obsolete. Owners and buyers are considering alternative strategies to find an asset ‘Purpose’ and maximise ‘Performance’.
In short, investors now have a decision to make. Factors such as investment timescales, debt exposure, and risk appetite play a role. Liquidity and optionality are key decision drivers. Exploring asset (Re)Positioning is essential in determining these, and numerous ‘Growth’ sectors are actively seeking development opportunities around the UK.
Living sectors, for example, are continuing to evolve and grow significantly, with Buildto-Rent (BTR), senior housing, and student accommodation maturing as investment avenues. Demand for student living typically increases during economic dislocations as people return to education looking to upskill, and more college leavers choose to attend university before entering the workplace.
Other residential offerings will continue to face an excess of demand to supply. Affordability constraints in the private sales market (driven by higher mortgage rates), for example, will continue to drive solid rental demand and underpin expectations of robust rental growth, supporting the BTR market. In areas with an ageing population, demand for senior housing will also continue to grow.
From a commercial standpoint, Industrial and Logistics continues to prove resilient. The work at Bennet Court in Reading is a good example of where an office complex of two L-shaped buildings is to be demolished and replaced with a new logistics warehouse. Specialist sectors are additionally entering the investor attention sphere, especially Life Sciences, which has grabbed greater attention since the COVID-19 epidemic. The convertibility of offices to laboratory space appears an attractive option if the building envelope allows, with a recent example being Kadans repositioning space at 20 Water Street, Canary Wharf, into wet lab space. Moreover, the growth trajectory of data centres is steep, buoyed by new technologies such as AI and the digitisation of every facet of society and business. Segro, for example, paid £425 million ($570m) for an office park opposite the Slough Trading Estate and merged the two to develop a cluster of data centres. New sectors are also emerging. Examples of open storage, EV infrastructure, R&D space, and film studios are growing in the real estate landscape.
The challenge now is matching obsolete office sites with the most valuable alternative use.
Local Authorities are vital in unlocking these sites, with planning at the epicentre of any (Re) Positioning play. New planning regulations have open possibilities for much of this type of stock. In early March 2024, the announcement of new flexibilities on permitted development removed the size limit (previously 1,500 sq m) and the three-month vacancy rule. The effect of these changes on the liquidity and value of many office buildings across the South East located outside of an Article 4 direction is beginning to filter through.
Even so, not all offices are suitable for conversion to another use type or are in locations appropriate for residential use. In these cases, exploring alternative uses with the local planning authorities is critical, either informally, via a pre-application or a formal planning application. With both cost and timing implications, not all investors will have the appetite for this route. Pricing will need to fall further in this instance, enabling a buyer to justify the investment timeframes and risk of unconditional site purchases.
With opportunistic buyers still mostly adopting a ‘wait and see’ approach on office redevelopments, particularly outside London, a re-purposing strategy may encourage a return through 2024. Private equity funds, a key player in the office sector through the Global Financial Crisis (GFC) recovery years, look set to capitalise on the falling values and higher returns. Shortterm high-yielding income will prove attractive, providing much-needed returns while navigating the UK planning system.
Across the South East, there is still a high number of occupiers who own their buildings. Many are dated accommodations that no longer fit their purpose. Rather than embarking on a large redevelopment project, occupiers favour leasing best-in-class accommodation and liquidating existing sites. With speed and ease of exit preferred, these sites can offer buyers a compelling opportunity, particularly those with higher target returns and who are willing to bid unconditionally.
Many offices are at a crossroads in their life cycle. ‘Purpose’ is being considered more diligently than ever to preserve future value and maximise ‘Performance’.