Investors have seen mixed messages over recent months with the rise in popularity of hybrid working evident, while many business leaders have called for a return to the office full time. Further to our previous article considering headwinds for the commercial real estate sector, and what borrowers can do, we examine in further detail the commercial office space market and the opportunities available to landlords.
Hybrid working has resulted in a reduced need for office space, leaving many secondary, out-of-date assets empty. There is, however, increased demand for prime office space, creating an opportunity for landlords looking to invest in new or refurbish existing office space. Failure to respond to these market changes may be costly.
Employees now favour collaborative working environments situated in prime locations, which are environmentally sustainable. During the first half of 2024 alone, 62% of the UK's Big 6 regional cities office take-up was for prime office space
This is 33% higher than the ten-year long-term average. Increasing demand is leading to higher premiums, as occupiers are willing to pay more for prime space. Between Q1 2023 and Q1 2024, the UK Big 6 regional cities have seen a 7% increase in rents for prime office spaces.
There is a notable absence of prime office space outside of the UK Big 6 city centre office markets, which currently represents
This is reflected in the additional premium payable in cities such as Newcastle and Sheffield, where prime rents saw over a
However, the demand for prime office spaces has resulted in occupiers avoiding secondary office buildings that do not offer collaborative workspaces and which do not comply with changing preferences for higher energy efficiency ratings. Many existing office spaces will require enhancements to avoid being left stranded.
The UK's ambition to achieve net-zero emissions by 2050 has led to an increasing demand for office spaces with outstanding energy efficiency ratings, despite the Government withdrawing its proposed measures that would have enforced a minimum EPC rating of C for all leases by 2028.
The combination of a high interest rate environment and escalating material and build costs has led to a lack of prime office space being developed in the regions. As such, there is insufficient prime office space available to satisfy current levels of demand. In 2023, BREEAM-certified building projects commanded a 41% rental premium compared to non-certified projects, highlighting the potential for significant returns for investors who can act quickly. Major examples include the Met Tower in Glasgow, Havelock in Manchester and 24-25 St Andrew Square, Edinburgh.
As at Q4 2023 ,the UK office vacancy rate climbed to 8%, and it is projected to increase by an additional 2 percentage points by the year end. This rise is attributed to the continued challenging economic outlook for 2024, which is expected to lead to higher unemployment at end of the year.
As outlined in our article from February 2024, it is estimated that nearly 40% of outstanding UK property loans are set to mature in 2024 and 2025. With declining office property values, negative equity situations may become unavoidable.
This could impact the level of borrowings that lenders are willing to provide to support landlords in their efforts to enhance existing office spaces.
Additionally, expensive finance costs may render existing development plans financially unfeasible. As such, those with existing liquidity have an advantage in the current market.
This is something we are seeing first hand having been engaged to advise a number of corporates in negotiations with lenders regarding the financing position following a reduction in value of assets. Even those assets considered prime are susceptible to the same challenges.
Investors and financiers should assess the feasibility of refurbishing existing secondary office spaces, considering factors such as potential cost, available funding, and physical risks.
If not viable, landlords may find success repurposing existing office spaces for alternative uses, such as residential units or education facilities. Converting existing secondary office spaces into residential units is helping the rebalancing of city centre real estate.
The cost of conversion or re-purposing of office space can be significant. Should additional liquidity be required there are a number of financiers active in this market who vary in risk appetite and covenant flexibility to suit individual needs.
Given the approaching maturity of numerous UK property loans, borrowers need to communicate with lenders, investors and stakeholders at the earliest opportunity. Alternative options may be available to borrowers, such as injecting owner equity, extending repayment dates and negotiating additional security.
We are seeing more and more examples of this across the commercial real estate market and are well placed to advise owners with over leveraged property loans coming to maturity.
Where investors require support in providing credence to proposals or negotiations with financiers and other stakeholders, an independent view can be of value.
Financiers may require proposals to be challenged, including the robustness of assumptions prior to any actions being taken.
As always, those businesses who consider options early, and seek independent advice that supports decision making are most likely to prevail in what is an ever changing environment.
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