2011 East Midlands commercial property market review and 2012 preview from DTZ in Nottingham

Helen Longstaffe, Head of Office agency at DTZ in Nottingham, reviews the offices market:
“At the start of 2011 there was a general expectation that the fragile state of the EU would impact on occupational demand across all sectors of the office market. Concerns about the economic backdrop did largely prove to be justified in a number of markets where increasing supply and limited occupational demand have had a tangible effect on activity levels.

Nottingham has proved to be reasonably resilient with a good level of activity over 2011, deals of particular note include, Browne Jacobson (60,000 sq ft) and Potter Clarkson (42,000 sq ft). However, overall take-up, whilst in excess of the annual average, is likely to be down on the levels seen in 2010, which were bolstered by the letting to E.ON.

Availability of Grade A accommodation within the city centre continues to dwindle, which will have a knock on effect with the Grade B market, particularly where landlords have been prepared to carry out a good level of refurbishment and can offer air conditioned space.

The unfolding debt crisis in the eurozone continues to adversely affect confidence amongst occupiers and a number of potential requirements across the Midlands region are known to have been put on hold or delayed during Quarter 4 2011, pending more predictable trading conditions.
As we enter 2012 the prevailing economic conditions are reflected in the nature of active demand for office space, dominated by local cost conscious occupiers. The substantial majority of enquiries involve occupiers seeking to take advantage of a lease expiry or break clause within their existing accommodation and this looks set to continue.

The combination of fragile occupational demand and the widely reported challenges in the funding market suggests that speculative development will be largely absent from the market for at least two years, increasing the prospect of refurbishment projects, particularly by larger funds.
The varied nature of space available in the market has meant that occupiers considering relocation are still able to secure flexible lease terms and exceptional value for money. This will generate further demand over the next 12 months as occupiers take the opportunity to move into better quality accommodation. Consolidation also continues to be a key driver of demand and this trend looks certain to continue into 2012.

Looking ahead to 2012, the challenging market conditions will no doubt provide opportunities for both occupiers and investors and the business change that is inevitable over the next 12 to 24 months will result in sustained activity amongst both occupiers and investors.”

Philip Glenn, Head of DTZ’s Nottingham office comments on the outlook for the secondary market in 2012:
“There is increasing quantity of secondary stock either on the market or anticipated to land shortly. This combined with a tough leasing market means that investors are becoming increasingly selective and very careful attention is being paid to the capital expenditure that properties require.  If CAPEX is directed at defensive measures to shore-up existing income profile, purchasers are seeking higher returns and lower prices or are walking away.”

“Regional office and retail markets will be buffeted by the impact of austerity measures and due to the overhang of office supply. This reflects the impact of job losses in government employment levels which will flow through to building occupancy and also affect retailers as unemployment rises in exposed areas. Grade B and C space accounts for 80% of the available office space outside London and totals approximately 10.8m sq ft – this compares to 6m sq ft in 2006. Some local markets will find the going tougher than others with existing supply of Grade B and C space equating to around 3.75 years take-up average.

“London is demonstrating declining availability but centres such as Newcastle have 6 years of supply and Manchester and Birmingham have 4.5 and 5.75 years respectively – this is more than the average. The availability in Nottingham is of a similar magnitude. The declining availability of Grade A office space, as these let up, will provide asset-enhancing opportunities for refurbished and repositioned offices but only those in the best locations.”

“The secondary market is multi-layered ranging from the ‘good secondary’ with well-located buildings but shortening income profiles where opportunities exist to enhance value through refurbishment and re-letting – to the ‘poor secondary’ or tertiary where properties are often suffering from functional obsolescence, are in peripheral locations with short lease terms to poor covenants. The prospects for these properties are poor and values are, and will continue to, drift out.

“Categorising secondary property is fraught with difficulty and the only answer is to assess each property individually examining how it sits relative to its peer group both locally, regionally and in some cases nationally, in order to judge the income story through tenant retention of existing tenants as well as letting vacant space.  Judgement on this is key as it drives the assumptions on unrecoverable costs, such as empty rates, which can have a material impact on returns and the potential for exit.”

“Whilst London dominates the share of the investment trade in the UK, the purchasing of portfolios has proved attractive to a number of purchasers as it provides a pooling of risk through the provision of diverse geographical markets and avoids exposure to single tenant risk.”

“Although the background to the secondary market is generally gloomy there are winners – those properties providing annuity style income with good tenants in place are much sought after and geography is no barrier to this.  The best located and best quality properties within the micro-locations with the best re-letting story will outperform in 2012. Those properties with a mix of short income streams, poorer build quality and weaker covenants will expect to see further and sustained outward price movement.”