Whether it is AstraZeneca moving to a new 37,000 sqft headquarters at King's Cross Central, Google’s acquisition of 408,000 sqft of offices at Central St Giles in Paddington or Omnicom’s acquisition of the 450,000 sqft Bankside buildings, recent activity suggests the office market is not dead.
While London saw its highest quarter of occupier activity since before the pandemic at the end of 2021, according to Gerald Eve, this trend is certainly not exclusive to the capital. There was NatWest’s purchase of 368,319 sqft at 1 Hardman Boulevard in Manchester, the biggest regional office deal of 2021 until Segro broke that record a few hours later with its 958,000 sqft purchase of an office portfolio in Slough.
But there are patterns to discern behind the headlines with this activity primarily being led by a gravitation towards best-in-class space and increased demand for buildings with strong ESG credentials. When looking at activity in the sub-prime office market, where ESG performance is less pronounced, the picture is different.
“Our data shows that net absorption in the best-quality, 5-star buildings has been positive throughout the pandemic, with all the demand losses coming in buildings rated 4-star or below,” says Mark Stansfield, Head of UK Analytics at CoStar. “Firms are seeking such space to attract staff, welcome clients and meet growing ESG requirements, even if many take less space overall as home working becomes more entrenched.”
Savills backs up this point in its December 2021 UK Regional Office Investment Market Watch report: “The demand in the market is polarised with prime opportunities which can satisfy ESG criteria and provide medium-long term income being actively targeted.”
“Firms rush to snap up a dwindling pool of
high-quality, highly sustainable space.
However, amid this flight to offices with high ESG credentials, one issue continues to be ignored – that of the embodied carbon emitted in producing materials. For example, the production of steel and cement alone makes up between 16-18% of global CO2 emissions annually. What is more, the Royal Institution of Chartered Surveyors estimates that 35% of the lifecycle carbon for a typical office development is emitted before the building is opened. Therefore, while it is correct to say that a new build will be more energy efficient – and demolition will no doubt be the best option for many buildings to make way for new development – it would also be worth challenging whether the difference in energy efficiency on some sites is worth the CO2 cost of production.
Regardless, this flight to quality comes at a cost, both in the purchase price but also rent levels. “Strong demand for the very best space has pushed prime rents upwards even as average rents have fallen,” says Mark Stansfield. “Record rents have been recorded in nearly all major markets over the past year or so as firms rush to snap up a dwindling pool of high-quality, highly sustainable space. This comes at a time when average asking rents across the country are falling.”
“One thing is for sure – it cannot just be about new builds.
The Thames Valley, for example, saw four new lettings in 2021 that smashed through the record rents for the region, with InterContinental Hotels Group, InterSystems, Neilson Financial Services and NetApp all taking up BREEAM Excellent office space in Windsor at rents 7-10% up on the previous record set in 2017.
So, with activity at the top end of the market fuelling growth and, to some extent, skewing the overall office picture, a few big questions are left to be answered: what will happen to the sub-prime office stock, what will be the impact on those organisations unable to afford a green premium and what will it all mean for ESG? One thing is for sure – it cannot just be about new builds.
Renovating, upgrading and repurposing of old stock needs to be part of the solution to create a more balanced market. As such, with organisations battling to lure employees back into the office and rebuild their office cultures, it is clear that ESG can act as a powerful driver for growth.
Author & contributor
Author: Alan Corcoran, Partner, Real Estate - Shoosmiths
Contributor: Mark Stansfield, Head of UK Analytics - CoStar
Disclaimer
This information is for general information purposes only and does not constitute legal advice. It is recommended that specific professional advice is sought before acting on any of the information given. Please contact us for specific advice on your circumstances. © Shoosmiths LLP 2024.