South east market update 18th May 2017

The evolution of the South East of England through significant regeneration and infrastructure development will drive talent to its commercial centres, especially Ealing, Maidenhead and Reading, Croydon, Watford, Oxford and Cambridge and Brighton, according to Knight Frank’s ‘The M25 Report’. This year’s 25th annual launch of the report unveiled a range of insights into how the key UK office market is developing. CoStar News reviews.

Occupational story

Knight Frank head of national offices Emma Goodford said the market was in a good place in terms of the cycle.

Take up across the South East was 768,000 sq ft, 19% down on the previous quarter but just short (-3%) of the 10-year average for a first quarter period. At the end of Q1, the amount of space under offer in the South East totalled 600,000 sq ft, the majority of which is located in the Thames Valley, KF said.

Goodford said the immediate aftermath of the EU referendum vote last June had seen a fall in named demand of around 1.2m sq ft from 6.7m sq ft but said there had been “no big collapse” and the market was returning to pre-Brexit vote figures. There is now 5.3m sq ft of named demand in the South East.

Goodford said there had been a marked move to smaller deals with sub 20,000 sq ft lettings up 20% in the last six months. Interestingly though Q1 provided a small anomaly in that 11 mid-range deals of 20,000 sq ft to 50,000 sq ft completed, the highest quarterly total within this size band since 2014.

She said it was clear international corporations were deferring deals with 30% of named demand now contemplating a regear, up 15% from the period pre vote.

But Goodford added that diversity of the occupier base was “cushioning the blow”. In particular Goodford flagged up the law sector, where there will likely be significant consolidation, and the pharmaceutical sector “which does not need to be in the EU”.

In addition 90% of take-up is either new or Grade A across the region apart from the M3 where it is around 75%.

Goodford said it was hard to say that infrastructure improvements such as the Elizabeth Line and Crossrail 2 were having an impact yet as in the last 10 years just two deals involved a company moving more than 10 miles and just five were “truly footloose”.

More flexible five-year terms lettings are significantly more prevalent.

Rents are still moving up across the region with Maidenhead, Reading and Watford “charging forward”.

Goodford said KF still forecast rents hitting £42 per sq ft in Reading and Maidenhead in the next two years but the focus for growth is best quality space.

Next year active development “slows to a trickle”. Over 800,000 sq ft of speculative space came to the market in Q1, the highest quarterly total for a decade with vacancy rates in each submarket increased by 0.4% but all well below respective long-term averages.

This low vacancy level compared to the long-term average is set to combine with 2.5m sq ft of lease events next year Goodford said, meaning there is a clear need for stock particularly given the continued appetite for office conversion to residential.

Goodford said: “We would advise go big because scale will matter. It is a good time to develop before the development pipeline dries up given the lease events. Demand will emerge and rental values will grow.”

Investment

Q1 2017 represents the most active start to a year since 2006, with 27 transactions completed and investment volumes at £540m, lower than in Q4 2016 but 7.5% above the 10-year quarterly average.

UK buyers returned this quarter, responsible for 87% of investment turnover in the quarter. The figures represent a strong return to the market by UK institutions, which had retreated post the EU referendum vote. Last year overseas buyers accounted for 51% of the market KF said.

Prime office yields remained at 5.25% in Q1, unchanged for the past 12 months KF said.

Tim Smither, head of national office investment, said the weight of money targeting assets in the South East, coupled with the low level of stock, could result in yields hardening to 5% in the coming months.

“The prospect of genuine rental growth, cheap debt and most recently, a favourable exchange rate will further support investment in the South East in 2017.”

Smither said local authorities will continue to be a major player in the market having driven 20% of all transactions in 2016, something that was forcing foreign investors to consider sub 10 year income investments.

The market will also be defined by a lack of stock with most parties asking where they can recycle capital if they sell, Smither said.

Smither said: “A lack of stock will see pricing harden leading to further sales in the second half of the year.”

The hotspots

Knight Frank’s The M25 Report identified the following hotspots for the commercial real estate investor:

Ealing, Maidenhead and Reading - The completion of the Elizabeth Line will enhance office market performance at disembarkation points, with Maidenhead and Reading in particular continuing to push office rent records to forecast new highs of £42, and reflecting possible percentage increases of 11% and 17% respectively (As of May 2017: £38 and £36.75 have been achieved). The line will also be the catalyst for speculative new development in Ealing, with rents forecast to hit £45, having already achieved £36.25

Croydon - The Government is looking to consolidate its regional public services to fewer hubs, making Croydon an ideal candidate. Opportunistic investors should focus on schemes which were previously purchased for residential and now have renewed viability as office schemes, as rents push toward mid £30’s per sq ft. (As of May 2017: £34)

Watford – The momentum in the Watford office market is evident, with 100,000 sq ft of take-up secured as of April 2017, against a long-term annual volume of 137,000 sq ft. This momentum is further reflected in strong demand from a diverse range of occupiers and rental growth of 13% over the last 12 months, with further headroom for growth. Prime rents were previously forecast for £32.50 in 24 months’ time, but this could be exceeded, with £35 per sq ft now a possibility – an 11% possible increase (As of May 2017: £31.50)

Oxford and Cambridge – Two towns at the centre of the knowledge economy. Oxford and Cambridge see continued Research & Development investment from the pharmaceutical and motorsport industries. Cambridge has already shown strong rental performance, encouraged by excellent connectivity to Kings Cross. Oxford shows a 20% rental discount to Cambridge, with performance restrained by lack of supply of development sites in the city centre.

Brighton – Sectors such as Tech and Creative are drawn to Brighton’s life style appeal and strong academic infrastructure. The market already has a base of well-established occupiers and there is great opportunity for rents to exceed £30 per sq ft.

The South East is home to more than 900,000 businesses and contributes £249bn in economic output per annum, a contribution second only to Greater London. London Heathrow and London Gatwick provide the region with international connectivity, and the development of the Elizabeth line will continue to make the region a key destination for international companies looking for a foothold in the UK marketplace.

This increased connectivity will encourage a pool of young talent already questioning the affordability of Central London to flood to the South East markets, subsequently creating a concentration of growth in larger commercial centres.

Goodford, Head of National Offices, said: “The M25 and South East market has evolved over the last 30 years on the basis of physical infrastructure enhancement. The next phase of its evolution will be driven by the demand for human capital. This brings into play those centres with strong university throughput, sense of place, connectivity, urban amenity and affordability. Our eight market hotspots reflect this.”