The first half of 2017 saw transaction volumes in the UK regional office market fall 45 per cent year on year to £2 billion, compared with £3.7 billion in the first half of 2016 (H1). One key reason for this is a lack of tradable office stock on the market, as investors have begun to find the overall costs of buying and selling increasingly unattractive in a low-return environment. This has coincided with a rise in the amount of capital-seeking opportunities for regional offices, which has ultimately increased potential for further yield compression.

Source: Property Data

Compared with other asset classes and investment types, prime office yields in the UK’s regional cities still remain particularly attractive at 5.25 per cent. By contrast, FTSE 100 dividend yields stand at 3.7 per cent and come with a degree of risk, while 10-year Government bonds currently return just 1.3 per cent per annum. Focus Economics forecasts that 10-year Government bond yields will increase gradually but still remain below 2.5 per cent until late 2021. By contrast, prime office yields in the City and West End of London currently stand at 3.25 per cent and 4 per cent respectively, though they benefit from a lower liquidity risk.

Source: Investing.com, MSCI

A further concern eating into nominal returns is rising inflation, which has increased to 2.6 per cent. As a result, many parties are looking to buy new office stock rather than develop it, due to rising construction costs. We expect this to add pressure to already tight occupational markets across the UK’s regional cities – for example in Manchester where office take-up in the first half of 2017 was 13 per cent up on the 10-year average for H1.

Overseas investors have certainly recognised UK prime regional offices as attractive in terms of yield and remain the most active buyers in this market, accounting for 35 per cent of total transaction volumes in H1 2017. This attractiveness has no doubt been further enhanced by the benefits of a weak sterling when buying in other currencies.

We are also beginning to see UK-based institutional buyers return to the prime regional office investment market, as sustained net inflows of capital enter their funds. This is adding to downward pressure on prime yields, which is therefore not putting landlords under any pressure to sell.

The combination of low interest rates and ‘cheap’ sterling with robust occupational demand for regional office space means the investment credentials of this asset class remain very appealing. So while opportunities remain scarce in the current income driven environment, UK prime regional offices look well-placed to deliver for the astute investor.

Further information

Read more Spotlight: Regional Office Market Review & Outlook