Investor activity subdued in Q1
Investment volumes across the regional office market have been subdued in the first quarter of the year, with turnover reaching £547 million, which was 53% below the five-year average. Pricing has remained static since the start of the year, with the prime regional office yield standing at 7.00% which is the highest level since July 2009. The South East region has also experienced significant outward yield movement, with the prime yield standing at 7.50%.
The largest transaction that completed in Q1 2024 was CBRE Global Investors acquiring HALO, Bristol, for £70 million – the building comprises 116,000 sq ft and was fully pre-let to Osborne Clark and Deloitte. Focussing on the Greater London & South East region, the largest deal was Jestar acquiring The Hive, Wembley, for £38 million, reflecting a yield of 11.50%.
Price discovery has remained challenging to achieve across the market, with a mismatch in pricing expectations between vendors and purchasers persisting, resulting in limited transactional activity. Many investors have priced in anticipated base rate and swap rate cuts into their pricing expectations. Economists are forecasting base rate cuts to not be as aggressive when compared to the beginning of the year. The previous expectation was that there would be an uptick in transactional activity in the second half of the year. This will probably be delayed to Q4 2024, depending on the result of the upcoming general election.
The prime regional office yield gap to central London is at its widest level in over 30 years
Sentiment towards offices from investors remains challenging with a lack of active buyers in the market. Ongoing concerns on the future of office demand arising from changing working practices have resulted in weaker investor demand. A new normal level of take-up is starting to be established in the occupational market with a clear flight to quality, evident from occupiers. Take-up in the Big Six regional cities at the end of Q1 2024 was 6% above Q1 2023. Furthermore, take-up in the Greater London & South East region (excluding central London) in Q1 2024 was a 35% increase on the same time period last year.
The improving sentiment in the occupational market has, however, not been mirrored in the investment market. When reviewing the MSCI Office Rest of South East and Rest of UK Capital Growth Index, the data shows a 36% and 34% fall in values since July 2022. This trend is also evident in the Savills Prime Office Yield data series, with the current yield gap between prime regional offices and central London offices standing at 238 basis points. This is the widest gap since 1992, which can provide a generational buying opportunity for first-mover investors into the sector and region.
Commercial Estates Group have recently launched EQ, Bristol, for sale, which will test the investor appetite for prime best-in-class office buildings in the regional markets. The scheme is currently being speculatively developed and comprises 200,000 sq ft. It has achieved the highest office rent across the regional cities and is 84% let during construction. The quoting price is £116 million, which reflects a yield of 6.35% or 6.70% for the special-purpose vehicle.
A lack of prime transactional evidence has made ascertaining prime pricing challenging. The proposed sale of EQ will help establish a benchmark for prime pricing in the current market and may stimulate further investment activity.
The lack of available best-in-class space across the regional office market has shifted the market dynamics to be more in favour of the landlord.
This trend has been evident when reviewing the term certains achieved on prime buildings across the Greater London & South East (excluding central London) region. On average, best-in-class buildings are securing tenants for longer time periods. The average term certain achieved since 2022 on prime best-in-class buildings is 7.5 years, whereas this falls to six years on non-prime assets. Notably, 35% of lettings on prime buildings have a term certain over ten years.
It is expected that this trend will continue as the supply of prime space continues to diminish across the region, with greater tenant competition ensuing to secure best-in-class space.