Where are we now?
There is currently a lack of appetite for speculative development. Rising construction costs have squeezed developer margins over the past 18 months, and with build cost inflation set to reach 2.9% during 2017, developers have become increasingly cautious over the feasibility of new build schemes.
There is however, a sustained level of demand for space in many of the regional cities alongside a lack of stock, which is influencing demand for refurbished office space. Landlords are looking to refurbishments to capture rental growth and ensure that their product gets to market ahead of the next development cycle.
The market is starting to see a "new generation" of refurbishments which offer a higher quality product than ever before. Refurbishments need to add an extra dimension to make them an attractive alternative to new builds, and we are now seeing a number of landlords spend more on the reception area/lobby as well as installing gyms and cafes to give them an extra edge.
Occupiers' attitudes to refurbished space have improved and rather than being considered inferior, "back to frame" schemes are now becoming interchangeable with new build stock.
Whilst refurbishments can act as the value option for occupiers who require more affordable rents, if they are the only option, they are often more than good enough for most occupiers.
As an example, Helical’s pro-active ongoing refurbishment of Churchgate House in Manchester has moved the asset from an historic rolling void of circa 20% to now being fully let. Occupiers have been attracted to a new reception incorporating touch down space, collaborative working areas and a high quality cafe, this has also contributed to moving rents on within the building.
Growth of the refurb
Regional office markets are currently seeing an influx of refurbishments, due to a dip in the development pipeline.
The refurbishment market has grown considerably across the UK regions over the last five years. For example, during 2016, refurbishments accounted for 25% of Manchester's Grade A take-up, making it a significant contributor in the market. We expect this proportion to increase during the next 12-18 months.
In the absence of Grade A office space, we have seen a number of comprehensively refurbished offices delivered. Significant buildings include Programme, Bristol (120,000 sq ft) and 55 Spring Gardens in Manchester (56,000 sq ft).
Refurbished space has helped to satisfy the trend for non-traditional office space. The ‘defurbishment’ (see The birth of the defurb) was typically the home of the creative or start-up. However, more professional occupiers including lawyers, accountants and engineering firms, are now looking for a more creative internal fit-out to inspire staff and attract a younger workforce.
As the current availability of new build Grade A space in the regional cities is so scarce, developers have looked to refurbishment schemes in the fringe markets. Historically, fringe refurbishments were undesirable, but with many cities seeing the city core expand outwards, fringe locations are becoming increasingly popular. For example, Birmingham has seen significant refurbishment activity around the vicinity of the inner ring road on both Great Charles Street and Suffolk Street as the traditional core expands, complimenting the redevelopment of New Street Station and Paradise Circus.
One particularly active business sector within the refurbishment market has been the tech sector because the rents have generally been more affordable. With tech growth forecast to see around 104,000 jobs over the next five years, we expect to see sustained demand for refurbishments.
However, refurbished rental growth in Bristol has outstripped new build rental growth following a lull in speculative developments. Bristol has seen refurbished rents rise 51% over the last five years, from £18.50 per sq ft in 2012 to £28 per sq ft in 2017, closing the rental differential with new builds from £9.50 per sq ft to only £0.50 per sq ft over this period (see Figure 1).
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