The UK office market has been dominated over the last two years by references to a ‘structural shift’ generated by the changing ways that use and occupy the workplace. While there’s no question this shift is happening, it’s also important to note the current cyclical challenges for landlords, which arguably outweigh any long-term demand dynamics.

Despite the drive for right-sizing from office occupiers, the sustained demand and requirements for office space in key locations throughout the UK is clear, and in fact is underlined by our research showing that prime office rents have grown averaging a 4.2% year-on-year increase over the post-Covid-19 period. However, one of the main enemies of landlords over this same timeframe has been the speed of decision, or indeed indecision, from occupiers who have deferred capital expenditure decisions resulting in below par take-up across many parts of the UK. Coupled with outward yield movements, weak sentiment has resulted in value erosion. 

Flight to quality and location have undoubtedly been key aspects for occupiers who are making decisions around real estate. With occupier tastes now even more sophisticated, landlords have been faced with the harsh reality of new and increased capital expenditure (capex) costs, which have been inflated by escalating material and build costs. However, it is these offices that can offer the best in class space and sustainability ratings in strong locations that will reap the benefits, not to mention see the future proofing benefits when the EPC ratings come into effect for a minimum C level in 2027. With a strong occupational narrative and continued reduction in supply, these properties are expected to be a catalyst for better than average rental growth over the short to medium term, which also presents a compelling investment case.

This drive for the top end office space has created an inevitable and stark polarisation in the market, albeit there remains appetite from smaller occupiers with a less ambitious price point who are looking to high quality refurbished stock that has a nod to ESG and can meet their requirements. In this smaller tier, and to an extent the mid-tier relocation bracket, cash is king. We are increasingly seeing turn key solutions being sought by occupiers wishing to reduce cash heavy fit-out exposure and preferring to pay higher rents for quality fitted solutions.

At the other end of the spectrum, office assets in specific micro locations throughout the UK where the hybrid working model has resulted in a significant reduction in demand and subsequently take-up, combined with the growing capex and ESG requirements, has resulted in these spaces looking increasingly stranded. In these instances repurposing may be the only solution. Furthermore, the Government’s recent announcement regarding more favourable Permitted Development rights may see a spike in residential conversions, although it should be noted that offices do not typically convert easily to apartments. 

It seems that polarisation will continue this year in the office market. Occupiers will carry on seeking the best space and those landlords that are able to deliver with a focus on future proofing will reap the rewards. Conversely, landlords that are capital constrained and unable to react to increasing demands from their customer base, along with ESG requirements, will see voids and vacancy rates increase. Interestingly from an investment perspective, for some buyers, 2024 will present a window of opportunity. With values bottoming out and a stifled supply pipeline, those that are brave enough, have access to capital and are able to identify the nuances of occupational demand, may find this an opportune moment to invest.

Further information

Contact James Evans

Office & Business Space