Interest rate rises in the UK appear to have peaked, with the Bank of England declining to raise them further at the beginning of Q3. This is likely to increase investor confidence in the UK commercial property market and turn focus towards rental growth and future prospects.
The October 2023 Market in Minutes report from Savills shows that the commercial sector accounts for a big proportion of all property transactions in the UK, with offices making up 26% of all trades so far this year.
This puts the office market in prime position to lead the next market cycle as we look ahead to 2024. Rental growth in the sector reported by Savills shows a yield of 5.25% in London and 6.25% in the regions as of Q3 2023. The latter represents year-on-year growth of 1.5% and is a demonstration of the good health of the national offices sector.
The latest Office Market Figures Report from CBRE delves into this trend more deeply and offers more detail for analysis.
According to the report, office take up in UK markets over the last quarter totalled more than 1m sqft, and more than 2m sqft over the first half of the year. While this is a fall in total floorspace compared to the previous year, the rental growth mentioned previously can be attributed to a consistent level of demand.
Overall demand in the sector has stayed resilient over 2023. Business services (20%) have been responsible for the highest share of take up so far this year, and banking, finance and professional accounting (all 17%) are following not far behind.
Notably, demand is concentrated in newly completed or refurbished spaces rather than older existing stock. This also perhaps gives some context to reports that office vacancies in London are at a 30-year high.
In reality the London “office rental recession” described by Jefferies in September 2023 – which estimates a 20% retraction in the capital’s office sector – doesn’t quite tell the whole story. It appears that the fall in office rentals may be largely restricted to older buildings and spaces which don’t meet modern requirements.
For example, the demand for Grade A office space – either new or refurbished – remains strong according to the Autumn Market Update from Cluttons as the “flight to quality” continues in the capital and across the rest of the country. Yields between prime and non-prime space are diverging in recognition of this trend.
As always, the best offices will remain in demand, and businesses which want the highest quality spaces continue to have no issue paying higher rents. It is likely that the move towards hybrid working patterns will continue over the rest of the year and into 2024, and this will have ongoing effects in the market.
From the occupier’s point of view, this brings two main conclusions. Firstly, if your business is planning to move anytime in the next few years then it may be advisable to begin looking now and get plans in motion as soon as possible. The best spaces are in high demand and the new Grade A spaces are not being delivered to market quickly enough to meet that demand.
Secondly, it is worth bearing in mind that ESG requirements will shape future office needs. One of the reasons for the falling popularity of non-prime spaces is that they are not as environmentally friendly as new or refurbished Grade A spaces.
Environmental reporting is becoming more stringent, and the bigger the company the more work it is. The space a company occupies is a big part of their overall environmental footprint and so sustainable offices are more desirable than ever. Businesses have to consider the environmental impact of their office and may need to think about moving to a newer, high performing space if necessary.
As we look ahead to 2024, the UK office market is in an interesting place. While there may be twists and turns ahead, the underlying trends are becoming clearer and we expect to see new and refurbished Grade A office spaces become even more popular, and perform even better, over the rest of the quarter and into next year.
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