There has been a strong revival in occupier and investor activity in the major UK regional office markets recently, reversing the trend seen since the Global Financial Crisis and confounding the current slowdown seen in regional retail markets. Last year saw 10 million square feet of office space let, some 12% above the ten-year average. At the same time, total investment in the regions reached £7.6bn in 2017, 24% above the level recorded during 2016 and 14% above the five-year average.*
The question is what is driving this increased demand and how sustainable is it? Which cities and regions are expected to have the strongest growth prospects and which ones will be the most resilient, in the face of an increasingly uncertain economic outlook post-Brexit?
Five key drivers of occupier demand
Several positive economic and property market drivers have combined over the last few years to create favourable conditions in many of the major regional towns and cities for office occupiers. While local market conditions and economic factors continue to be critical in differentiating the prospects for the occupier markets in different regions and cities, there are some key structural and cyclical factors which many of the strongest office markets have in common:
Demand continues to outstrip supply despite new large-scale developments
A combination of weak economic conditions in the years after the financial crisis and a lack of access to finance for developers as banks were unwilling to lend on regional offices, meant more profitable opportunities were to be found in office-to-residential conversions. This saw rents fall modestly in the regional office sector, whilst land values and building costs continued to see above-inflation rises. As a result, until very recently there has been very little development, constraining supply.
These tight supply conditions are now easing slightly with some major new office developments of grade A space and refurbishments of grade B space taking place in the major cities. However, since there is very little speculative development occurring, there is still an underlying shortage of modern quality stock to match demand in the regions.
Major requirements from public sector occupiers
The public sector accounted for the highest proportion of total take-up in the regions in 2017 at 22%, driven by large Government Property Unit (GPU) deals. After eight years of austerity in the public sector, government departments are under huge pressure to reduce their costs, so they have been consolidating their property portfolios and relocating to cheaper premises in the regions.
Demand for co-working and flexible office space
The last two years have seen increased demand from occupiers for co-working and flexible office space solutions at the same time as major co-working operators have expanded their presence in the regions. Savills report that the serviced office sector rapidly expanded in 2017 in the regions, with 592,000 square feet of space taken, a 172% increase on 2016.
The largest operator, WeWork, has recently opened two new offices in Manchester and is now close to establishing its third site in the city by partnering with Amazon, which has a 70,000 square foot requirement for short-term flexible office space in the city. We expect this trend to increase across the regions as WeWork and other co-working operators continue to work with large corporates to fulfil demand for shorter-term, flexible office space before considering a long-term option.
TMT occupiers looking to attract the best talent to the regions
In addition to small-scale start-ups, the regional office markets are also seeing increased take-up of large-scale grade A office space from a more diversified range of occupiers than the traditional public sector and business services occupiers. For example, the technology, media and telecom sector (TMT) was a major driver of demand in the regions in 2017, accounting for 19% of total take-up. This was double that of insurance and financial services (8%).
Young professionals in the media, creative and tech sectors are increasingly looking to live and work in regional city centres where accommodation costs are cheaper than London. They are not willing to compromise on quality of life though as they are also looking for an enhanced workplace experience, better quality of life and having a sense of place in a community.
UK regional office take up by sector
Source: Savills Research.
In order to attract the best talent to their organisations in the regional cities and tech clusters, the big tech and creative industry employers are working with their landlords to provide a wide range of services and additional amenities in their office buildings. Some grade B space is being refurbished and converted into high quality grade A space with additional facilities or mixed-use schemes in city centres.
Business confidence returns to the regions with stronger employment growth
Increased business confidence has led to rising business activity in all regions of the UK except the North East, according to the latest NatWest UK Regional PMI indicator (June 2018). Employment levels have also risen consistently over the last few months in every region except Wales. Rising business confidence and increased employment growth are expected to continue, leading to an expectation of expansion in the take-up of office space and rental growth prospects in the regional cities. However, these positive demand drivers mask significant variation in the economic and office market prospects for individual regional towns and cities. This is a result of many factors, including differences in productivity, innovation, skills, employment, housing, transport infrastructure, demographics and digital connectivity.
Digital tech sector hotspots
The digital tech sector is a high growth sector and a major source of employment growth across the UK. From 2014 to 2017, digital tech sector employment rose 13.2%. Its workers are typically more productive, on average by £10,000 per worker and jobs requiring digital tech skills command higher salaries.** But the sector is far from uniformly distributed across the UK and neither is it the sole preserve of large metropolitan cities. The UK has digital suburbs, not just cities, with the highest “digital tech density” in South East regional suburbs such as Guildford, Aldershot, Slough and Heathrow. Meanwhile, although London has the second most connected tech ecosystem globally after Silicon Valley, it has a digital density below the UK average.***
Clusters where we see a high digital density also tend towards a higher productivity per worker, with these areas concentrated in suburbs starting from London and extending along the M4 corridor and spreading to Southampton and Portsmouth.
Digital suburbs uncovered across the UK
Not surprisingly, amongst the towns and cities seeing the strongest office rental growth, many are situated in the digital tech clusters. Basingstoke, with a digital density three times the national average due to its cluster of IT businesses, saw the highest headline rental growth in 2017 at over 40%. Newbury, which has the highest digital density in the UK at 15.5, saw prime headline rental growth of over 30% in 2017, with Bristol at 14%.**** These towns are forecast to continue to be amongst the top performers in terms of rental growth this year, but the pace of growth will moderate compared to the strong growth seen last year. In general the tech-focused smaller and medium-sized towns and cities will outperform the largest regional cities such as Birmingham and Manchester, where rental levels are higher and although they are expected to continue to increase further, it will not be at the same pace, as they have already seen strong rates of growth.
South West & South East offering the best investment prospects
While London is always likely to remain a highly attractive market, the regional office markets currently offer a compelling alternative to investors looking for better value and growth prospects, as well as geographic diversification benefits. We expect a combination of positive structural property market fundamentals and sustainable economic, demographic and employment growth factors to continue to drive positive rental growth in most office regions, although the pace of growth will vary significantly between cities and regions. Those office markets situated in the digital tech clusters in the South East and South West will be amongst those which we believe will offer the strongest rental growth prospects to investors over the next few years.
*Source: Savills Research
**Source: The Tech Nation Report 2018
***Digital density measures digital tech specification in clusters compared to density in the UK
****Source: PMA, 2018
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