RICS survey shows signs of commercial property recovery
The 2024 RICS 1st quarter monitor for the UK commercial property market indicates tentative signs that the market is moving into a recovery phase, though there is still ample evidence that there remains a challenging backdrop.
Higher borrowing rates are holding back investments along with other structural headwinds such as a weak economy, online shopping, working from home (WFH) and environmental concerns.
However, RICS reports that respondents to their surveys have formed the view (35%) that the market has “reached a floor” for the current cycle, or has at least “entered the early stages of an upturn” (38%).
The monitor indicates that a gap appears to be emerging between rising office demand in the capital, against a subdued picture for the rest of the country. (89%) of respondents were citing more repurposing of office space for other uses, and (52%) of respondents reported increased downsizing involving office tenants, over the previous twelve months.
Secondary offices are showing negative rental projections, with remote working and the non-domestic Minimum Energy Efficiency Standard (MEES) continuing to have an impact on the commercial office sector. Tenants are increasingly going for prime, energy-efficient offices to minimise their running costs, as well as insulating themselves from potential future retrofitting costs.
Rents are expected to rise over the next 12 months for both primary and secondary industrial units, but while prime offices are also expected to see a rental increase, the picture is not so rosy for secondary offices and retail units.
RICS reports London remaining ahead of the rest of the country, “with rent expectations at +54%, reflecting its significant lead in tenant demand. This represents the strongest reading for Central London prime office rents since Q1 2016,” says the report.
RICS Senior Economist, Tarrant Parsons, has said:
“Although sentiment remains relatively cautious regarding the near-term outlook across the UK commercial property market, the latest survey results do show some signs of recovery coming through. For one, occupier demand growth now appears to be gaining traction slightly, supported by the broader economy seemingly returning to growth following a brief recession late last year.
“Moreover, the prospect of interest rate cuts later this year have already led to an easing in credit conditions across the sector, marking the first such improvement in our feedback since 2021. This should begin to support investment market activity as the year wears on, which, in turn, will likely see a more stable picture emerge for headline capital values.”
Dominic Collier, Senior Public Affairs Officer at RICS, says:
“We welcome the latest survey results indicating signs of recovery starting to emerge. Yet at the same time, the uncertainty around non-domestic MEES is continuing to impact the sector. RICS is urging for decisive action in setting clear and achievable MEES targets.
“The current proposed timeline and trajectory are increasingly viewed as unrealistic, and there are concerns about the lack of implementation mechanisms. Without action, there is a risk that up to 50% of commercial buildings could be stranded by 2035.
“RICS is advocating, collaborating and engaging with key stakeholders such as the Department for Energy Security and Net Zero (DESNZ), and the Built Environment Committee, to drive meaningful progress and help establish clear, realistic, credible and forward-looking non-domestic property MEES targets.”
Significant repurposing of office space seen across the UK
While rents are expected to rise over the next 12 months for both primary and secondary industrial sites, and prime offices are also expected to see a rental increase, significantly, secondary offices show negative rental projections.
WFH and Minimum Energy Efficiency Standard (MEES) are continuing to impact this sector of commercial office space. RICS found that tenants increasingly prefer prime, energy-efficient units to minimise immediate costs as well as their potential future retrofitting costs.
Rising office demand in London contrasts with a subdued picture for the rest of the country with much more repurposing activity taking place there. Office space is being reclaimed for other uses as office tenants' require less space due to WFH. This shift is very evident over the past 12 months.
In London, office demand showed a significant increase during Q1 2024 while elsewhere in the UK the picture is either flat or slightly negative. Also, with retail demand, it is showing stronger momentum in London than other parts of the UK. Meanwhile demand for industrial property remains steady, with most regions reporting positive sentiment.
The pandemic brought about a seismic shift in the dynamics of office and company working. WFH and flexible schedules, remote working, working on the go, have all contributed to a new working model that affects the space requirements particularly for offices.
Couple that with the requirements of improved energy efficiency for buildings to meet MEES standards, leading to net zero, still clouded in uncertainty as to the practicalities, and you have a heady mix. It’s a minefield for landlords, particularly those with secondary commercial buildings. Many of these will require substantial new investment to make them attractive for new tenancies.
Forward-thinking landlords are looking to new innovative ways to adapt or even repurpose their buildings, measures that are designed to improve the attractiveness for new commercial tenants, or provide facilities for residential or leisure uses.
Many companies have adopted WFH and other flexible working policies which have resulted in some of their work areas remaining empty when not all their employees are in the office all of their working time. Companies (employees) may then consider downsizing, reducing the available space they need for a reduced workforce, otherwise consolidate space or sublet.
Alternatively, some companies will still need their existing space for times when all of their staff are in the office together, for example many companies insist on having full staffing in the office 2 or 3 days per week, often between Tuesday and Thursday.
There are also the considerations of expansion: will the company need more space if it is growing. This may mean they will retain the additional space, at least for the time being.
However, as companies get accustomed to using more innovative working methods and new digital tools for their remote meetings, and other forms of collaboration, they are more likely to require less physical office space in the future, particularly those working outside of the capital.
Tenant’s will in future seriously weigh the cost of having empty office space, space which will significantly add to their leasing costs. These fixed costs, rent, utilities, business rates and maintenance, are a burden many businesses in the current economic climate would rather do without.
Similar to offices, there is a need to repurpose retail space in many locations. This change has been identified as the biggest concern for local authorities, landlords, developers and other town centre management professionals by the trade body Revo and property agents and consultants Lambert Smith Hampton (LSH).
Projections reveal that up to 40% of shops will need to reinvent themselves for other uses: change into anything from food markets to all sorts of residential or leisure uses. Many town centres in the provinces will otherwise “wither on the vine” as demand for physical retail space wanes, many local authority leaders claim.
The research from Revo and LSH reveals that (61%) of their respondents believed that between 20% and 40% of retail space needs to be reinvented over the next five years, either for leisure, hospitality, health, civic use or residential, with (12%) of those surveyed claiming even more space than that will need to be repurposed.
The issue of repurposing, the survey found, soured high above other economic worries such as high inflation, recession, the business rates burden and competition from online shopping.
Vivienne King, the chief executive of Revo had said:
“There is a danger that if our towns don’t transform then some will wither on the vine before the decade is out,”
Steve Norris, head of regeneration and planning at LSH, has said:
“This shows the scale of the challenge town centres are facing and the radical surgery required.”
However, Norris said it was not “all doom and gloom for town centres” as “we are entering into one of the most exciting and creative periods in their long history as it is not just about retail any more. It could be a town centre renaissance”.
At a conference held in London last summer, attenders talked about bringing homes, offices, food and drink venues, entertainment and markets into space no longer required for shops.
Creating green space and more attractive in-town spaces - where local people can spend time, without necessarily feeling the pressure to spend money - were seen as being an important part of reviving town centre spaces. Towns that have taken a real battering because of the rise of online shopping, particularly during Covid, and the cost of living crisis, need to be thinking outside of the box!
The disappearance from many regional town centres of large store chains: BHS, Debenhams, Topshop, and several others, and the continuing closures of other important town centre destination stores, such as the M&S, House of Fraser, and John Lewis, has left many town centres with massive voids and retail space that will be very difficult to fill with other retail alternatives.
Tags:
Comments