by Tim Horsey
Even the most casual observer of the commercial property market does not need to be told that 1987 was an exceptional year. Investment Property Databank’s analysis of the holdings of 60 institutions (valued at £16bn and representing more than a third of all institutional property) confirms that after five years of relative stagnation, total returns have leapt to more than 20%. Offices was the sector which contributed most to this outstanding performance, with a total return of 28.9%. Institutions benefited from the fact that 53% of their total holdings are tied up in offices.
London dominated the scene: more than three-quarters of institutional office holdings are located in the Greater London area, and total returns in the City (42.5%) and the West End (including Holborn/Fleet Street, 36.4%) were far in excess of those achieved elsewhere in the UK. Capital values were pushed up by an increase of rents of around one-third, and also by a slight reduction in yields. Some 73% of new investment purchasing by funds was concentrated in central London, though this was around 5 percentage points lower than in 1986, suggesting that the escalation of values had to some extent been anticipated.
Deregulation of the City’s financial markets and the Big Bang are now almost prehistoric, but the forces which were then unleashed are still working themselves out, with vital implications for property activity — even if the universe now appears somewhat more chaotic in the light (or darkness) of the Black Hole which swallowed a lump of stock value in October, and sucked in with it some of the expansion plans of the more vulnerable players. Many commentators expected that property would not escape the ensuing devastation, but the effects were clearly two-fold: first, a short-term slow-down in the rate of take-up of space in London offices, but second, and perhaps more crucial in the long term, a relative improvement in the image of property compared with other investment assets.
For most of 1987 the market in office property followed the feverish activity on world stock markets: foreign banks increased their presence in the world’s third financial centre, and property companies added their weight to the accelerating bandwagon, with the banking sector’s money in their pockets. In this frenetic atmosphere the property-holding institutions, and most especially the life funds with big City holdings, reaped the rewards of their commitment to central London locations. Although some large schemes were institutionally funded, this is now the exception rather than the rule. New orders for commercial building have grown by 140% between 1984 and 1987 in London, and the vast proportion of this is financed by banks through the property companies.
Institutions increased their purchases of office property in London in 1987, but also took the opportunity of high prices to increase their sales. Overall there was a very small positive net investment in central London but a total net withdrawal from the office sector, with institutional sales exceeding purchases.
The capital’s prime office market has spread into the West End and “Midtown” area adjoining the City, to the extent that in 1988 rents of £60 have been achieved on both sides of Fleet River. As demand has burgeoned supply has shown a predictable inelasticity, especially where the requirement of expanding firms has been for centrally located, prestige, large, hi-tech floorspace with an imitation Kew Gardens in the centre. In this context it is perhaps surprising that central London properties constructed in the 1980s provided investing institutions with an inferior total return (36.2%) to those constructed in the 1970s (41.2%), the 1960s (45.4%), and even before (39.4%). One explanation might lie in the superior location of older properties, and another in the lower running costs of older, less sophisticated and smaller buildings.
Returns achieved in the provinces were uniformly inferior to those in the London market, no individual region attaining a total return of 20%; institutions have come to appreciate this divergence in the past few years, and only the South East region has a sizeable share of portfolio value (11.3%). The return achieved by offices in the South East at 10.8% was, however, inferior to that in some other regions, in particular the North (17.7%), East Anglia (18.4%) and the Midlands (14.9%). Office users like to concentrate in centres and the capital has come to dominate the South as never before; even growing locations such as Reading have not yet come to feel the full force of the London market, though rental growth at 14% in 1987 surpassed that experienced in most other provincial centres.
A changing pattern of ascendancy among provincial centres is discernible from the evidence of rental growth, with Leeds, Edinburgh, Glasgow and possibly Bristol attaining the top rank, while Liverpool, Newcastle and Aberdeen appear to be slipping down the hierarchy. Leeds in particular has shown an impressive surge of demand during the past year, with rental gains nearing 22% and development activity continuing unabated in 1988 (as witnessed by the current interest of Mountleigh). Glasgow’s widely publicised revival is reflected in a rental value growth of 15%, though prospects for further growth may be limited by the large number of developments soon to be completed and the extensive stock of period property ripe for refurbishment. Edinburgh has undergone a transformation similar to the capital’s, though less violent, with accountants and lawyers complementing the primary financial demand for office space.
These regional centres have benefited from the general shift in the UK economy towards the service sector; so have those formerly prominent centres which now seem in danger of eclipse — every sizeable provincial centre in the country has experienced an improved rental growth in 1987 compared with 1986. Even in Newcastle, where ERV growth was low in 1987 (2.66%), this still represented a marked improvement on 1986 when a negative figure was obtained. Southampton was another centre which showed significant progress, with rental growth climbing from 2% in 1986 to over 8% in 1987. Manchester has seen considerably better rental growth over the decade than its close neighbour Liverpool, and though neither were among the best performing locations, both enjoyed higher ERV growth in 1987 than in the previous five years.
Whether 1987 enters the history books as the year of the Great Office Boom depends on what happens next. So far in 1988 fears of a slump in the market have been confounded by continuing strength of demand, particularly among professional office users in London. Meanwhile, some of the less financially orientated office users in London have begun to show signs of a tendency to move into less expensive and congested areas of the country. Business parks are likely to be popular locations for companies wishing to obtain a more pleasant environment at lower costs, a development which has been made more practicable with the new Use Classes Order establishing a single “business class”.
The London rent increases show no sign of abating, though there is a considerable supply of newly developed office space in the pipeline for the near future; it has been suggested that by 1992 there will be an extra 8m sq ft of office space in and near to the City, and another 14m sq ft in Docklands, while the King’s Cross development should add 6m sq ft. Although there is little doubt that space will be hard to let in London at the end of the decade, the present situation of short supply seems set to continue for 1988.
Looking to the more distant future, much depends on whether the City of London continues to enjoy its European hegemony, especially as 1992 approaches and the issue of involvement in EMS becomes more pressing. More generally, the question of the sustainability of Britain’s economic revival must be considered in the light of recent balance-of-payments statistics; this is likely to affect office demand in the provinces. At the moment, however, it seems more likely that 1987 will be identified with the beginning of a few years of rapid growth rather than an isolated and short-lived boom.