2024 marks a turning point for the UK’s office markets, with many heading into an acute supply crunch, according to the latest Regional Office Report from Lambert Smith Hampton (LSH).
Improving economic conditions over the first half of 2024 have translated into robust take-up across the UK’s regional office markets. There has been signs of renewed occupier confidence with the return of ‘big ticket’ leasing deals, including BNY Mellon’s 196,400 sq ft lease at 4 Angel Square, Manchester – the largest regional office deal in over four years.
This was one of four deals of over 50,000 sq ft recorded during Q3 2004, compared to a tally of just two during the entirety of 2023.
Despite fresh political uncertainty, 2024 overall is shaping up to be solid year for take-up. Space under offer and likely to transact in Q4 indicates that take-up across the 15 key regional markets will hit circa 8.1m sq ft in 2024, improving by 11% on 2023’s total and only marginally below the post-pandemic best of 2022.
Core city centre locations have shown much greater resilience than the out-of-town markets. The Big Six city centres, comprising Birmingham, Bristol, Edinburgh, Glasgow, Leeds and Manchester are on course to see annual cumulative take-up fall just 2% short of the ten-year annual average in 2024. In contrast, the combined out-of-town markets are expected to see take-up slump to a 15-year low.
Most striking is the relative scarcity of prime space, with schemes delivered over the past two years letting up rapidly. Characterised by high quality amenities and strong ESG credentials, prime space makes up only 7% of total supply, falling from a 10% share 12 months ago, despite a flurry of completions over the period.
Deliveries of prime schemes have come almost exclusively in the Big Six, albeit aggressive take-up has left some with an acute shortage. Manchester city centre has only 94,000 sq ft of prime space available, while Birmingham leads with 542,000 sq ft, albeit a significant tranche is under offer.
Robust demand for this new generation of best-in-class buildings continues to drive impressive rental growth at the prime end of the market. Across the 15 key regional city centre markets combined, prime headline rents are on course to increase by 6.2% on average in 2024, accelerating from 4.5% in 2023 and the strongest in 18 years. Bristol is on course to see a major step change in tone, with its prime headline rent on course to rise by 21% in 2024 and break through the £50 per sq ft mark in Q4.
Reflecting heighted developer caution over the past two years, LSH’s research highlighted an acute lack of pipeline schemes to replenish levels of high-quality supply. A flurry of completions in Q4 leaves only 1.5m sq ft under construction, a third of which is in Manchester, while only circa 800,000 sq ft is deemed likely to commence construction speculatively in 2025, the lowest level of construction starts in the regional markets since the wake of the GFC in 2010.
The looming supply crunch is made more acute given accelerated rates of obsolescence stemming from tightening legislation on energy performance standards, with minimum standard set to rise to EPC-grade C by 2028. LSH’s analysis of the EPC register reveals that 54% of stock across the 15 key markets is heading towards non-compliance in 2028, most notably Leicester (74%), Nottingham (63%) and Bristol (62%).
Meanwhile, in the investment market, larger lot-sized deals made a welcome return in Q4, driven by improving sentiment and much-anticipated interest rate cuts. After a very subdued year to Q3, Q4 volume across the regions is expected to rebound to c.£650m, which could be the strongest quarter since Q4 2022 and closely in line with the five-year quarterly average.
However, while prime yields have stabilised and competitive tension has seen a marked revival at the quality end of the market, pricing discovery continues for secondary assets, despite an already-severe correction over the past two years. However, there is clear evidence from bidding activity that the depth of demand across the Investor spectrum is starting to build.
LSH’s analysis reveals significantly enhanced liquidity and prompt speed of sale for assets with a high EPC rating, a fact that should encourage appetite to upgrade secondary assets to meet looming standards.
Peter Musgrove, senior rirector and head of regional offices, said: “The regional office markets find themselves at an inflection point, with a recovery in occupier demand on a collision course with a severe lack of high-quality supply. Accordingly, rental growth has been strong, with occupiers motivated by a ‘fright to quality’, pitting them in a race to secure space amid an increasingly limited choice of prime options.
“An acute lack of anticipated development starts in 2025, as it stands, points to a serious supply crunch of high-quality space by 2026/27. However, with occupiers effectively being forced into more energy efficient buildings through legislation over the coming years, depressed secondary values provide investors with a huge opportunity to improve existing buildings to the required standard”.
Charlie Lake, senior director at LSH, added: “While there is no doubting the improving sentiment in the investment market for quality assets, recent shifts in interest rate expectations are likely to delay short term expectations on yield compression. Meanwhile, with development starts looking relatively fallow in 2025, there is a clear opportunity to exploit historically low values through repositing to plug the development lag that will hit in 2025.
“The market bears all the hallmarks of a new cycle beginning to unfold. Alongside strong overseas demand, the government’s planned shake-up of the UK pensions environment points to a revival of in institutional activity over the coming years, which should help to rightfully restore regional offices as a core part of the UK investment landscape over the coming cycle.