The rise of co-working and northshoring, along with increased infrastructure investment, are benefiting regional cities at the expense of London

While continental European real estate has become ever more expensive since the Brexit referendum, the UK market has, after a very short-lived liquidity blip, largely flatlined in terms of pricing. Political risk factors clearly have pushed a dark cloud over the market, but I would argue the pessimism is overdone and there are attractive risk-adjusted returns.

Any research report on the status of the regional office markets will testify that the total supply of space and vacancy rates have both been falling consistently since their peak in 2012, leading to favourable market dynamics for landlords. What has caused these trends, and will they continue?

The factors responsible include: changes in permitted development rights for conversion to alternative uses; the rise of co-working; northshoring; a reduction in development capital; and changes in public sector infrastructure investment.

The change in planning law granting a permitted development right (PDR) of offices to residential use without needing planning permission has led to a large loss of office floorspace across the UK. The British Council for Offices estimated in 2017 that there had been a loss of 10.4m sq. ft across the country since the introduction of PDR. If PDR continues in any form, office supply will be further eroded and residential uses will be encouraged in city centres.

Meanwhile, co-working operators such as WeWork and Spaces have expanded from London into the regions. Serviced offices have long featured in UK cities, so why the explosion of such space now? Essentially, the internet has lowered transaction costs in the service sector, undermining the traditional advantages of economies of scale. This has led to the growth of small businesses and thus potential tenants for co-working operators. 

While the sector players are now facing mixed fortunes, if the drivers of co-working continue then opportunities will remain for traditional landlords to offer design-led fit-out, great amenities and indeed a greater degree of lease flexibility – because medium-sized tenants find co-working expensive. The shrewd landlord can offer these tenants lower occupational costs and greater control than serviced offices while replicating amenity provision.  

Regional office markets are also benefiting from the trend of northshoring: moving knowledge-based functions away from expensive locations in central London to regional cities where accommodation and labour are cheaper and pools of graduate talent can be accessed. This is happening particularly among legal and finance firms.

Some examples include: 

• Ashurst now has a headcount of more than 300 at its Glasgow office, which houses its global business service functions as well as traditional law functions. 
• Silver Circle law firm Bryan Cave Leighton Paisner moved its paralegal division to Manchester in the summer of 2014, and more than 100 staff are now employed there. 
• Latham & Watkins opened its IT and technology support office in Manchester in 2015. 
• Freshfields, having already relocated its back-office services to occupy 40,000 sq. ft at Arndale House in Manchester, subsequently doubled its Manchester office space to 80,000 sq. ft in a new development at One New Bailey, Spinningfields. A Freshfields spokesperson said the latest move “gives us both the high quality and attractive location we want for our staff. The developer has granted us valuable flexibility to adapt, up or down, the amount of space that we occupy to reflect the evolving needs of our clients and our business.”
• In late 2018, Barclays announced it would occupy the Buchanan Wharf campus development on the Clyde in Glasgow to house its technical functions and operations team. Once completed the campus will accommodate up to 2,500 additional staff, doubling Barclays’ current Scottish workforce. Barclays has an option to extend its campus by an additional 210,000 sq. ft in a second phase of the development.

Northshoring provides demand for larger floorplates and increases high-value professional employment in regional cities, increasing labour pools for future service firm spin-offs and new businesses. I believe this trend will grow in intensity as London becomes, for some businesses, less attractive.

Reduction in development capital funding is also a factor, though. Estimates suggest that development debt has fallen from 27% of total lending to real estate in 2009 to less than 3% in 2017.This fall in funding has caused a virtual stop in the delivery of new space to the market, which has prompted large tenants to consider their real estate options further in advance. Many mid-sized occupiers increasingly stay put, unless forced into a move by expansion or corporate events. 

If you think lenders are about to open the floodgates to development finance, then you might expect regional markets to see more supply – but my sense is that the memories from the global financial crisis are still too strong for this to happen.

Meanwhile, UK regional cities are benefiting from public sector infrastructure improvements, transforming the accessibility of locations or transforming the skills base of a local economy. Some of these examples are:

• Manchester/Salford is seeing the development of MediaCity into a world-class digital media hub, with the relocation of BBC Sport, Children and Music services; the £1bn Manchester Airport Terminal Transformation Programme; and Metrolink (tram) extensions including a second city-centre crossing and an extension to the airport (both now completed) as well as a new Trafford Park/Trafford Centre line (under construction).
• Birmingham’s airport runway extension was completed in 2014; the redevelopment of New Street station is also completed while that of Snowhill station is under way; the HS2 rail link is also under way; construction is also in progress for 2022 Commonwealth Games facilities.
• Leeds has benefited from the relocation of Channel 4.

Governments of all political flavours are keen to endorse policies to rebalance the economy and support activity in the Northern Powerhouse, so this powerful trend looks set to continue. On balance I conclude that the UK regional office markets have a strong tailwind for outperformance, especially if purchases are made when the markets are fearful(to quote Warren Buffett).