This article was originally published in Winter 2019.
With Brexit uncertainty hitting London hardest and high-grade office supply tight in the capital, investors are looking to other UK cities
Brexit and now the general election have been driving the current state of uncertainty in the UK property market. With declining prime property prices in London, the spotlight on residential property has shifted to emerging regional hotspots. Major provincial cities have reported an increase in average asking prices. According to Zoopla data, Leicester has been experiencing the strongest market conditions of any UK city, with house price growth of 4.8% in the year to the end of August 2019 – compared with less than 1% in London. A similar shift is becoming increasingly apparent in commercial real estate. As the dynamics in London and the regions change, the divergence between these geographic markets presents unique investment opportunities. But what is driving the change?
The first factor is investor demand. In the face of ongoing political and economic uncertainty, overseas investors are exercising caution. London’s exposure to Brexit-related concerns, such as its impact on the services and financial sectors, has led to delays in investor spending decisions in the capital. Outside London, regional cities with opportunistic strategies are less reliant on inward investment and therefore stand out more strongly on investors’ radar, as pricing and activity in the capital remain extremely competitive.
Recent figures prove this: Savills found that investment into the regions now stands at a 55% share of the UK total, compared with the five-year average of 35%, as a result of record low yields. Meanwhile, City of London investment totalled a little over £800m in the second quarter of 2019, down 18% quarter-on-quarter and 76% below the long-term average, according to Knight Frank.
This slowdown in investment activity in London could in part be attributed to the lack of assets for sale, as vendors have been slow to pull the trigger and put assets on the market. While this may be true, particularly for retail assets, it is likely that assets are not being priced at their current book value, which has deterred vendors. Against this backdrop, there is stronger demand in the regions, which have seen an increase in inward investment as development in major provincial cities continues.
A second factor in this change in dynamics is the office market. Office take-up in the capital has been mixed. While demand for grade A central London office space remains strong, this has not been mirrored for other grades. CBRE data shows that central London office occupancy has increased by 11% from Q2 to Q3 of 2019, to 3.4m sq. ft, exceeding the ten-year quarterly average of 3.3m sq. ft.
However, given the limited supply of grade A space, property investors are ensuring they diversify outside of London.
The major regional cities have continued to show strong occupational demand. The undersupply is putting firm upward pressure on prime office rents in many locations, with record-high office rents being achieved in Birmingham, Cambridge, Leeds, Manchester and Oxford. This growth is expected to continue. The economy in the North West
is projected to grow by 2.1% in 2019, making it the fastest-growing UK region this year. Manchester, which has attracted more foreign direct investment in the past decade than any other city outside London, has this year seen the highest first-half office take-up figures on record. While available office supply continues to fall, it is currently adequate to meet demand.
Overseas investment continues to drive the office market, with data from Avison Young showing that it accounted for 85% of transactions during Q2 of 2019. While flexible workspace activity in particular dominates the market, office investment volumes in regional cities are expected to continue on an upward trajectory. Concerns persist
that a messy Brexit will disproportionately affect London commercial property over the equivalent regional markets. This is due to the likelihood of some businesses reviewing costs – and financial services businesses in particular moving functions out of the UK, primarily affecting London. Meanwhile for the regions, as outlined in the recent Queen’s speech, a forthcoming white paper will set out the government’s strategy for “unleashing regional potential in England”. UK-wide economic prospects could in fact support commercial property in the regions.
Commercial property markets are likely to remain volatile, while questions remain over Brexit and the UK’s relationship with the EU. The commercial property market is generally robust, but regional cities clearly have the upper hand, with the exception of grade A London offices where the supply/demand imbalance will continue to make them attractive. UK real estate as an asset class remains a safe haven, and overseas investors continue to benefit from the weakened currency. Investors would be wise to focus efforts on these growing cities, which could deliver record rental income and good yields.
