Rising occupier engagement meets slow supply: rental pressure intensifies.
Limited supply of best-in-class space across the UK cities is prompting earlier occupier action ahead of lease events, with the constrained development pipeline compounding competitive market pressure.
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A lack of available best-in-class office space across the major UK markets is encouraging occupiers to agree on lease terms much further in advance of lease events. In 2023 for example, 25% of take-up in Leeds was either a pre-let before construction started or a lease agreed upon after commencement but before practical completion of a building.
What does the current office supply landscape look like?
Although the overall office market vacancy rate has risen gradually across the UK cities since early 2020, this has mainly comprised poorer quality stock. At the end of 2023, the weighted average total vacancy rate across the ten regional cities was 9.8%. If considered for new and Grade A space, this rate falls to just 3%.
What section of the market is most affected by the reduction in supply?
Larger occupiers are experiencing acute difficulty in securing the ‘right space’. On average, market engagement has grown to more than 30 months before a lease event. In Bristol, there are currently two law firms with a combined total of nearly 200,000 sq ft of requirements, circa. 30 months ahead of their lease events, whilst in Edinburgh, there are a trio of requirements totalling 130,000 sq ft across a variety of sectors. To contextualise, just two available buildings in Bristol can support a requirement of 50,000 sq ft or above, and none in Edinburgh presently.
Is a developer response expected?
At the time of writing, high build costs and falling market rates limit build viability in the main UK cities. Knight Frank’s tender price index indicates that costs increased by 3.5% in the UK in 2023 following double-digit rises in the previous three years. This is expected to rise to 3.6% by 2027. Capital values have fallen in tandem, with yields moving out by circa 100bps over the past 12 months.
Are there any other factors affecting office supply?
In some markets, conversion to alternative uses is compounding the pressure on office supply. Obsolescence rates are accelerating, influenced by both conformity to ESG criteria and the rapid shift in occupier preference. In Edinburgh, for example, a route of interest is offices to hotel use, given Edinburgh’s high tourist numbers. Works at 28 St Andrew Square illustrate this, as consent was given for a major office redevelopment but is now under offer for hotel use.
What does the narrowing of supply mean for rental values?
With occupiers targeting spaces that support ESG commitments and talent, attraction and retention strategies, competitive pressure has led to upward pressure on prime rents. On average, prime rents have increased by 5% since Q4 2022, with Edinburgh, Glasgow, Leeds, Manchester and Newcastle recording rises greater than this. Seven of the ten major UK Cities studied have experienced rental growth in the past 12 months.
What next?
There will be no significant change in the supply landscape in the short term. At the time of writing, 4.1m sq ft of office space was under construction, with delivery scheduled within the next three years. Of this, 3.0m sq ft is speculative, albeit much of this space will likely have been leased before practical completion. Therefore, further rental growth is forecasted for the coming 12 months as the supply squeeze continues.