UK office refurbishments

Office refurbishments in UK regional cities
 
Office refurbishments in UK regional cities

22 June 2017, by Clare Bailey

With a tight supply schedule and sustained demand for good quality office space in the regions, refurbishments are providing the quality floorspace required to accommodate demand going forward

 

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).

FIGURE 1

Cities with a low differential between refurbished rents and top rents will see the strongest growth in top rents

 
Figure 1

Source: Savills Research

Leeds' rental differential stood at £0.50 per sq ft until Q2 2017, when top new build rents jumped from £27.50 per sq ft to £30 per sq ft. We believe that the top rent increase was down to the low differential which has subsequently risen to £3 per sq ft, re-rating the market.

Flight to quality

It is widely accepted that the UK regions are currently at their lowest level of Grade A availability on record, which has reduced the relative risk of a refurbishment project.

In a time where returns will be income led, we are seeing a 'flight to quality', as landlords comprehensively refurbish secondary space to attract and retain tenants. This acts to maximise rental income, attract higher tenant covenants and enhance capital value and longevity of the asset.

There also lies an opportunity cost associated with a comprehensive refurbishment in the loss of rental income over an 18-month period when the building is undergoing works. The rental value of new developments in some smaller regional markets is too low for new development to be viable, so refurbished space is the best alternative.

The introduction of Permitted Development Rights (PDRs), has seen the conversion of office to residential across the regional markets. However, with a shortage of office space and rising rents in the regions, we are seeing fewer conversions of office stock under permitted development rights and developers now turning their attention to refurbishments.

From an investors' perspective, strong rental growth in refurbishment opportunities resulted in secondary yields hardening. The prime/ secondary yield spread in Manchester now stands at as low as 100 basis points, half that of 12 months ago.

What next for refurbishments?

So have refurbished rents peaked and what impact will this have on new build rents?

Figure 1 shows Savills top rental growth forecasts for the regional cities to end 2018. We expect Bristol to be the next city to see a step change in top rents, driven by both a shortage of new build product and a record low refurbished/new build differential of only £0.50 per sq ft (see Figure 1 above). We expect new build rents to reach £33.50 by the end of 2018, reflecting an 18% increase on current levels.

38% of the total speculative space being delivered in the UK regional cities over the next three years will be in the form of refurbishments, which will act to lift average rents. We feel that we are now at the stage in the cycle where there is an opportunity for landlords to refurbish secondary stock in search of rental uplift and an improved covenant.


REGIONAL REFURBISHMENT TOP PICKS

Where do the refurbishment opportunities in the UK regions lie?

Refurbishments are being delivered within the UK regions and will continue to do so over the next 18 months. A range of refurbished, defurbished and fully redeveloped office product is currently available and offer each occupier a unique working environment.

Below are Savills Research's regional refurbishment top picks:

 
Regional refurbishment top picks
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Key Contacts

Clare Bailey

Clare Bailey

Associate Director
Commercial Research

Savills Margaret Street

+44 (0) 20 7409 8863

 

Mike Barnes

Mike Barnes

Research Analyst
Commercial Research

Savills Margaret Street

+44(0) 203 107 5459

 

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