Knock on wood, cross your fingers and, for goodness sake, only whisper it, but it looks like 2015 could be the year the recession finally ends in the UK’s regions.
Last year investors, growing both in confidence and capital, had started looking beyond the safe but pricey capital and were taking a gamble on some rather attractive yields further afield.
This year, those tentative steps have become a stampede.
According to figures from Carter Jonas, investment in UK commercial property is set to exceed £70bn in 2015, making it the highest ever. Not since the recession. Ever.
Nearly £50bn of deals had been completed in the first three quarters [of 2015?], and Q4 volumes are predicted to exceed £20bn, based on deals already in the pipeline.
And investment in offices over the first three quarters has risen by 13% against the same period in 2014.
“There is still plenty of capital chasing commercial property, with this year set to be record breaking,” says Darren Yates, head of research at Carter Jonas.
Confidence has returned. The prospect of rental growth now seems likely, whereas before it was a pipe dream. And the money just keeps on coming.
“The weight of money in the markets has remained high,” says Vail Williams partner Richard Dawtrey. “This has led to some very aggressive bidding by investors hoping to make returns off future rental growth.” He adds that this was particularly apparent in August and September of 2015.
More importantly, this isn’t just in London. Earlier this month Knight Frank declared that 2015 was seeing the highest investment volumes outside the capital since the glory days of 2007. As of Q3, total investment stood at £3.1bn, with just over £1bn spent in Q3 alone.
According to Knight Frank’s figures, this is a 73% increase on last year.
“The increase in occupier activity in the regions, though somewhat behind the London curve, is good news,” says Stephen Hodgson, head of Knight Frank’s regional network. “And very fortuitous for those investors that entered the regional markets first.”
But does this confidence have a basis in fact? Or is it largely driven by the hunt for attractive yields?
London yields have now contracted so often they are harder than flint. The investment herd has now rediscovered the regional cities. But their stampede has, inevitably, led to prime yields hardening in eight of the 10 regional cities. In Bristol and Leeds yields have been crunched by 50bps.
And those yields are predicted to become even less attractive, says Lee Elliott, head of commercial research at Knight Frank. “With the weight of money targeting markets outside London rising, we expect bidding to become more aggressive and put pressure on pricing.”
But the firm’s statistics show that, while investment may have been at a record high in Q3, lettings had slumped. Total let space across the 10 regional cities was 36% less than the previous quarter. Meanwhile rents showed no real uplift, with prime headline rents merely holding firm.
But there are striking exceptions. In Sheffield rents increased by 15%, to £23 per sq ft. In Newcastle lettings more than doubled over the quarter to 107,812 sq ft. This increase represents the highest amount of quarterly take-up recorded in the city. The year-to-date total, 208,120 sq ft, is 34% ahead of the same period last year. And take-up in Manchester – which saw the lion’s share with 379,976 sq ft, or 28% of the combined total – increased by 6% over the quarter and was 40% above the five-year quarterly average.
Elliott argues that these exceptions are set to become the rule, citing forecasts which predict rental growth in eight of the 10 regional cities by the close of 2015. And Carter Jonas’s investment partner Mike Prosser thinks that yields will find a natural holding point in the first quarters of 2016.
That is certainly the hope of the investors. “Looking to 2016, we would not expect to see further yield compression,” says Hermes’s Taylor. “However, we do expect to see decent rental growth for the right buildings in emerging locations benefiting from enhanced infrastructure, public realm and other amenities.”
The big bet is on the economy, and occupiers, expanding as confidence continues to return. “Regional opportunities have become more attractive to investors as leasing markets have strengthened,” says Elliott, arguing that investor appetite is indeed being supported by a desire by occupiers to take more space.
This is certainly borne out by the figures, with overall take-up for the year at a five-year high of 4.8m sq ft. The level of active requirements has also increased to 4.5m sq ft in Q3, a rise of 4.5% over the quarter. The total, as at Q3 2015, is 22% above the five-year average.
Demand, even for the smaller established cities, such as Oxford, Cambridge and Bath, has risen sharply as a result, partly in recognition of their strong performance in 2014. “However, supply is also restricted in these locations,” says Yates, “which could add to downward pressure on yields.”
But there is plenty of potential danger.
The spectre of a rise in interest rates in H1 of 2016 is now become more likely. The EU referendum will certainly stall investment, as this year’s general election did, and, depending on the result, could be devastating to the UK economy. And the Chinese economic slowdown also holds the potential to crush the occupiers’ optimism and the investors’ hopes of rental growth.
But the bigger danger is structural. “The occupational market is lagging behind some predictions that are driving investment decisions,” says David Tonks, senior director at Cushman & Wakefield.
The crucial questions, he says, are where and when will the occupational market catch up with the investment market? “In the regional capitals, such as Birmingham, Manchester and Bristol, this should happen in the short term,” Tonks maintains. “But in certain second-tier towns and cities the occupational market is unlikely to catch up in this cycle.”
Prosser doesn’t think that this will deter investment. “When viewed against current bond rates, property yields still offer good value and, with rental growth coming through, there is still an incentive to invest in UK commercial property.”
And Vail Williams’ Dawtry agrees.
“We see no immediate economic reason for a commercial property market slowdown particularly when rental growth is being achieved,” he says.
Indeed, once international investors become more confident about investing in the regional cities, the volumes could go even higher. In 2015, according to Savills, 51% of investment in UK offices was by non-doms, but they only accounted for 17% beyond the M25.
Imagine what will happen once China discovers Bristol…
