What’s next for offices?
Historically, offices were a relatively safe and secure investment. However, this was before the global pandemic and its impact on working practices, the effect of ESG requirements and the significant changes in the UK economy.
In this article, we look at each of these factors to understand what the impact has been on offices and what the future looks like.
Change in working practices
The global pandemic vastly accelerated the move to remote working. As a result, many businesses concluded, that to a greater or lesser extent, they could reduce the amount of office space that they required and significantly reduce their occupancy costs with an element of remote/hybrid working.
What we are now seeing is that businesses are reducing the amount of office space that they utilise, but they are either significantly improving the quality of the space they occupy or are moving to better quality Grade A or Premium rated office space.
The requirement for businesses to occupy better quality space is, in part, to attract employees into offices, taking a greater consideration of their wellbeing requirements and to assist in attracting new employees in the current “war for talent”. The result of the move to better quality space is a surplus of sub grade A space which will have to either be upgraded or repurposed. Whatever option is taken will result in a significant investment by the owners of these properties. Fortunately, there are Government incentives for some capital works to bring buildings up to standard in the form of Capital allowances.
Environmental, Social and Governance (ESG)
Developers of office buildings must now consider ESG during construction. Occupiers will increasingly insist on energy efficient and sustainable buildings, both in terms of ongoing costs and their business’s perception to the world at large. In addition, institutional investors will only invest in sustainable buildings and lenders, particularly when looking at long term facilities, and will now take into account the sustainability of a building in terms of its construction when considering whether to make an advance and the cost of that borrowing.
Furthermore, Government policy is pushing the industry towards considering ESG with the introduction of Minimum Energy Efficiency Standards (MEES), and the requirement for energy performance ratings to assess a building’s energy efficiency ranging from A (most efficient) to G (least efficient). From 1 April 2023, it has been unlawful to let a property with an F or G EPC rating, and from 2025 all newly rented properties must reach an EPC rating of C or above, with any existing rented properties having to meet this standard by 2028.
The UK Economy
The current position of the UK economy is impacting on values and the ability to raise finance. At the time of writing this article, Base Rate is 4.5% and five and 10-year gilt rates are 3.6% and 3.9% respectively. When considering these rates against prime yields for offices in The City and West End of London, which are 3.5% – 4%, and provincial offices of 5% – 5.5%, the yield gap between a risk -free return and investment in prime office looks marginal and suggest that yields will start to lengthen with the resultant negative impact on values Given the current uncertainty around values, it is no surprise that investment volumes have reduced over the last several months. A further reason that investment volumes have fallen is likely due to lenders being more cautious with conservative lending covenants in terms of loan-to-value and interest cover requirements.
In my view there remains a strong argument to invest in premium/grade A offices as there is still demand for these buildings by occupiers, despite the current uncertainty around values. What is clear is that any office buildings not meeting the highest standards will require significant investment to bring them up to standard or to be repurposed.
For further information or advice on your property investments, contact Howard at HFreedman@geraldedelman.com.