Future Shock: the Coming Wave of Office ObsolescenceExecutive Summary

WHAT IS THE MARKET EVIDENCE?

These trends are already apparent in the market. Office investment has been in decline as a percentage of the UK total since 2014, with activity increasingly focussing on a smaller set of investable office assets.

Vacancy rates are pushing outwards in many out-of-town locations – with the notable exception of the particularly dynamic Oxford-Cambridge corridor – and office investment has stalled. Activity has remained relatively robust in more urban settings, particularly Central London.

For example, while leasing volumes across the UK over the past two years are 24.2% down on the 10-year average, they are just 8.5% and 9.4% down in Leeds and Birmingham city cores, respectively, while in the core City of London, they are not down at all.

Elsewhere, where there is a greater diversity of products and locations, this spread is enormous compared to other sectors, demonstrating how concentrated value has become in the top end of this market. Investment demand for poorer office stock (in terms of location as well as quality) has been virtually non-existent, while pricing has been under extreme duress. The recently announced Permitted Development Rights for conversion to residential may change this in some locations, but the overall picture will remain. These patterns are likely just the start of the process of polarisation and redundancy in the office sector.

WHAT ARE THE IMPLICATIONS?

By combining the assessment of “viable” refurbishment and where EPCs fail to meet the 2030 criteria, it is estimated that at least 25%-30% of the UK’s office stock is likely to become permanently redundant over the next few years. These are assets where the local economic and market conditions will not support adequate refurbishment. In some of these cases there will, of course, be obvious and viable changes of use – but not always.

Furthermore, obsolescence will not be equally distributed around the country; the proportion struggling will be rather lower in Central London and other major city centres. It is vitally important that investors begin the process of understanding which buildings can be feasibly refurbished into viable offices, and which will require alternative uses, or even – taking account of concerns around embodied carbon – demolition and reconstruction.

Above all, there will be a need for investment in the existing stock (where it is in the right locations). The big question is where this capital will come from. Overseas investors may find the risks and processes too challenging, although there will be local partners with expertise available for partnership. With the winding down of many Defined Benefit pension schemes – which were major investors in commercial property – domestic capital looks less plausible as a source in the short term, although local authority schemes are, in some cases, still looking for stock.

Defined Contribution schemes, which are now the major destination for pension capital, face challenges in investing in illiquid assets, given their need for flexibility. Scale is also an issue. These will be overcome in time, but the gap may need to be filled by private equity and other opportunistic/value-add investors, assuming their return requirements are realistic.

At the time of writing, the government has reintroduced rules around Permitted Development that will allow offices to be converted to residential without planning permission. It is important to emphasise that this will not apply in areas with Article 4 exemptions, which cover central London and many other office-heavy areas outside the capital. It will enable the easy conversion of more isolated offices, although it may be time-limited given the recent change of Government.