Office market weathering the storm better than expected

With rental growth in prime London offices set to outpace the rest of the country, the doom mongers predicting permanent working from home (WFH) and office flight have so far, it seems, been on the wrong tack.

Quarter 1, 2022 has seen rent returns rise as UK commercial property recovery generally has been gaining pace, also in warehousing and logistics as well as retail parks. The government’s drive to prime the regions in its levelling campaign, supporting communities’ recovery across the UK, it is hoped, will further boost commercial property.

In it latest RICS Commercial Property Survey, agents are reporting a considerable increase in the number of new tenants looking to rent UK commercial property, “with the uplift particularly prevalent in prime London office space.”

Says RICS:

“Respondents to the survey saw a notable increase in UK office demand in Q1 2022 with the net balance improving to +30% from a flat picture at the end of 2021.”

This shows a significant change in sentiment, which was also beginning to appear in the retail sector, with occupier demand approaching net neutral (-1% net balance). That’s the first time the measure has been anywhere near neutral since early 2017.

Taking in commercial property as a whole, it’s the first time since 2015 that a net balance of +32% of respondents in the RICS survey reported an increase in occupier demand at all levels and across sectors (retail, office and industrial uses).

RICS property agents reported that investor enquiries also saw a substantial increase in early 2022, with the strongest figure since Q3 2015, and a net balance of +32%. RICS says that for the first time since 2017 investment enquiries are now net positive across the three traditional market sectors: office, industrial and retail.

The impact of working from home (WFH)

There’s been much discussion in the media about the impact of home working on city centres, transport, retail and offices. The COVID pandemic disrupted labour markets dramatically during 2020 and 2021, when millions of people were furloughed or losing jobs.

There was a rapid adjustment to homeworking by many thousands as offices were closed to all but a few staff. Many other workers in the vital services were deemed essential and continued to work: in hospitals and grocery stores, on refuse collections and in warehouses, as well as the police and to some extent, the courts.

The post-pandemic economy will undoubtedly change, in many cases for the better, with more flexible working, more omni-channel retailing and home delivery, with much enhanced productivity and innovation through the proficient use of technology.

The question on everyone’s mind in commercial property is, “what affect with this have on rental demand, will occupiers require less space and therefore economise by downsizing?”

Toby Courtald CEO of Great Portland Estates (GPE), one of London’s biggest landlords has conceded that offices will never be quite the same, never as busy as they were before the pandemic, though he is adamant that those who have been predicting “the death of the office” have got it wrong.

GPE owns a multi-billion pound mainly office estate in London and has also swung back into profit this year announcing an end-of-year profit of £167 million at the end of March. The estate’s portfolio valuation increased by £2.65bn or £6.1%, across the year. During the year the property RIET agreed new leasing deals of £38.5 million, a figure that went well beyond the company’s expectations.

The nettle that most office landlords appear to have grasped is they will need to adapt their office space to the post-pandemic requirements, along with the changes needed to meet the new environmental standards, most notably insulation, energy efficiency and air quality. These changes will involve substantial new investment.

In British Land’s case, office investor demand, according to RICS, rose from a net balance of +5% at the end of 2021 to +23% in Q1 2022, and the net balance of respondents predicting a rise in capital values for the prime office sector is the most positive since Q4 2019 (+37% net balance).

With the increase in occupier demand for new office space, rents are expected to rise with a net balance of +19% of survey respondents expecting a rise, compared to +7% in the last quarter of 2021.

Rents for prime office space in central London are anticipated to outpace most other UK regions, while the South East is the only region in which secondary office space is predicted to see growth.

The latest research published by RICS in March has shown that high-quality and well-managed commercial real estate – such as prime office space – is integral to levelling up UK towns and cities*, and one of the asks of the research is that UK Government support commercial real estate, and promote investment in it, to secure levelling up across the UK.

Tarrant Parsons, RICS Economist, says:

“The latest survey feedback points to demand from both occupiers and investors gaining momentum over the quarter, with the office sector in particular now showing signs of recovery.

“This has led to an upgrading in expectations for capital value and rental growth across prime offices, while the prolonged downward trend in portions of the retail sector also now appears to be easing.

“That said, given the current headwinds facing the UK economy in form of sharply rising energy prices, higher interest rates and general cost of living pressures, there is understandably a lot of caution regarding the potential impact this could have on market conditions going forward.”

Jonathan Hale, Head of Government Affairs at RICS, adds:

“UK commercial property is clearly still attractive to investors and UK Government should work across the country to engage with the sector to build on this positive outlook.

“The recent RICS commercial real estate impact report emphasised the key role that the commercial property sector currently plays in the UK and its future role in driving forward economic recovery across the UK.

“As town centres, high streets and offices start to recover following the pandemic, a thriving commercial real estate industry will be crucial to support the government’s levelling up and net zero ambitions in the months ahead.”

Warning: of course, all of this was in the last period: in these times of rapid economic changes things can turn around quickly. With a raging war in Ukraine, inflation approaching double figures and a threatened recession the picture may be less optimistic in 12 months’ time?

Full RICS survey report here.

*This data follows the publication of the RICS Commercial Real Estate impact report, which found that high-quality and well-managed commercial real estate is integral to levelling up UK towns and cities and contributing to better spaces and amenities for local communities. The sector’s contribution – across retail, office and industrial uses – makes up 3.3% of the total UK GVA, employs 3.5% of the total workforce and generates 2.5% of the UK tax revenues.

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