The office market is weathering the storm better than expected

With prime office rent growth in London set to outpace the rest of the country, pessimists predicting permanent work from home (WFH) and office theft have so far, it seems, been on the wrong track.

The 1st quarter of 2022 has seen rental yields increase as the UK commercial property recovery generally gathers pace, also in warehousing and logistics as well as retail parks. The government’s willingness to prime the regions in its leveling campaign, supporting the recovery of communities across the UK, it is hoped, will further boost commercial property.

In this latest RICS Commercial Property Surveyagents report a huge increase in the number of new tenants looking to rent commercial property in the UK, “with a particularly widespread increase in prime offices in London”.

RICS says:

“Survey respondents 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 starting to show in the retail sector, with user demand moving closer to net neutrality (-1% net balance). This is the first time the measure has come close to neutral since early 2017.

In tertiary real estate as a whole, this is the first time since 2015 that a net balance of +32% of respondents to the RICS survey reported an increase in demand from occupants at all levels and in all sectors (shops, offices and industrial uses).

RICS estate agents reported that investor inquiries also saw a substantial increase at the start of 2022, with the highest figure since Q3 2015, and a net balance of +32%. RICS says that for the first time since 2017, investment demand is now positive across all three traditional market sectors: office, industrial and retail.

The Impact of Working From Home (WFH)

The media has been talking a lot about the impact of working from home on city centers, transport, businesses and offices. The COVID pandemic significantly disrupted labor markets in 2020 and 2021, when millions of people were laid off or lost their jobs.

There has been a rapid adaptation to working from home by thousands of people, as offices have been closed to all but a few staff. Many other workers in vital services were deemed essential and continued to work: in hospitals and grocery stores, at garbage pick-ups 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 omnichannel retail and home delivery, with much improved productivity and innovation through the use efficient technology.

The question on everyone’s mind in commercial real estate is “what effect will this have on rental demand, will occupiers need less space and therefore save money by downsizing ?”

Toby Courtald, CEO of Great Portland Estates (GPE), one of London’s biggest landlords, has admitted that offices will never be the same, never as busy as before the pandemic, although he is adamant on the fact that those who predicted “the death of the office” were wrong.

GPE has a multi-billion pound office park in London and also returned to profit this year by reporting a year-end profit of £167 million at the end of March. The valuation of the estate’s portfolio increased by £2.65 billion or 6.1% during the year. During the year, the RIET property secured new tenancy agreements for £38.5 million, a figure which far exceeded the company’s expectations.

The nettle that most office owners seem to have understood is that they will need to adapt their office space to post-pandemic requirements, as well as changes needed to meet new environmental standards, including insulation, efficiency energy and air quality. These changes will involve substantial new investments.

In the case of British Land, investor demand for offices, according to RICS, increased from a net balance of +5% at the end of 2021 to +23% in the first quarter of 2022, and with the net balance of respondents predicting an increase of the capital value for the prime office sector is the most positive since Q4 2019 (+37% net balance).

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

Prime office rents in central London are expected to outpace most other parts of the UK, while the South East is the only area where secondary offices are expected to see growth.

The latest research published by RICS in March showed that high-quality, well-managed commercial property – such as prime office space – is integral to leveling up UK cities*, and one of the demands of the research is that the UK Government supports commercial property and encourages investment in it, to ensure leveling across the UK.

Tarrant Parsons, RICS Economist, says:

“The latest survey feedback indicates that demand from occupiers and investors is accelerating in the quarter, with the office sector in particular now showing signs of recovery.

“This has led to improved expectations for capital value and rental growth in prime office space, while the prolonged downward trend in parts of the retail sector also appears to be easing.

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

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

“Commercial property in the UK is clearly still attractive to investors and the UK government should work across the country to engage with the sector to capitalize on this positive outlook.

“The recent RICS report on the impact of commercial property highlighted the key role that the UK commercial property sector currently plays and its future role in driving the continued economic recovery across the UK. .

“As town centres, high streets and offices begin to recover from the pandemic, a thriving commercial real estate sector will be crucial to support the government’s leveling and net zero ambitions in the months to come.”

Warning: of course, all this happened in the last period: in these times of rapid economic change, things can turn around quickly. With war raging in Ukraine, inflation approaching double digits and a looming recession, could the picture be less rosy in 12 months?

Full report of the RICS survey here.

*These data follow the publication of the RICS Commercial Real Estate impact report, who found that high-quality, well-managed commercial property is key to leveling up UK cities and contributing to better spaces and amenities for local communities. The sector’s contribution – through retail, office and industrial uses – accounts for 3.3% of total UK GVA, employs 3.5% of the total workforce and generates 2. 5% of UK tax revenue.

About RICS – Everything we do is designed to bring about positive change in built and natural environments. Through our respected global standards, world-class professional progression and reliable data and knowledge, we promote and enforce the highest professional standards in the development and management of land, real estate, construction and infrastructures.

Our work with others provides a foundation for confident markets, paves the way for better places to live and work, and is a force for positive social impact.

Jose C. Birney