At the top of the office development pipeline is a very real tap: it isn’t marked hot or cold, it’s labelled ‘money’. David Thame explores what is turning the funding tap on – and off – in today’s tricky office market.
Every single square foot of office floorspace represents somebody’s calculated gamble.
Of course, some property market gamblers are playing with higher, racier odds than others – but they are all taking a risk to some extent.
Grasp this – and the extent to which the men and women with the money are risk-averse or risk-friendly – and everything in today’s spluttering UK office development pipeline becomes as clear as water.
There are three property investment types – the core investors, the value-adders and the opportunity-seekers (see sidepanel over the page). But with an uncertain Brexit coming up, workplace trends in flux and memories of the last catastrophically over-optimistic property boom still too fresh, nobody (much) is interested in the high-odds office schemes. The risk profile has shifted up a notch: yesterday’s opportunity-seekers are now today’s value-adders.
For an insight into the way the value-adders are thinking – and, in turn, how they are controlling the flow of office floorspace in the development pipeline – turn to Liverpool.
Earlier this year, CERT Property – which owns office and residential spaces across the North and Midlands – acquired 27,000 sq ft at Centric House, right in the heart of the central business district, next to Moorfields underground station. They paid £3.3 million after the previous owners fell into administration.
The aim is now to add-value by bringing the building up to modern workplace standards – and embracing the changes in working practices that are shaping today’s office market.
Refurbishment will produce suites from
86 sq ft to over 11,000 sq ft as CERT dips its toe into the flexible short-term office market, with prices starting at £149 per desk for fully serviced accommodation, and the offer of more traditional deals for those that want them.
‘As the working world continues to evolve, we have recognised the growing demand for adaptable and serviced office accommodation,’ says Howard Lord, Managing Director of CERT Property. ‘The working world has evolved and we’ve seen a huge shift away from the same old carpet tiles, white walls and bland corporate office spaces. The demand now is for more stripped back, clean, contemporary styles. What we and our clients look for are office fit-outs which use natural materials, incorporate heritage of the buildings and local areas as well as showing a touch of quirkiness. Investors and tenants want an impressive reception when they walk into the building and communal areas that are more than just a place to make tea and coffee.’
Value-adders like CERT are the dominant force in today’s office supply pipeline, says GVA National Offices Director Charles Toogood.
‘The value-adders are the people behind the office refurbishment sector, taking buildings that don’t meet today’s market, investing to improve them, and then letting. A classic example would be Ashby Capital’s acquisitions of the 300,000 sq ft Colmore Building, which, before they took control, was a bit of a disaster,’ he admits.
Ashby paid £3.5m to refurbish the common areas and add modern amenities like a coffee shop and treatment rooms. Today just 40,000 sq ft is still to let, with rents up around 10%.
‘Importantly for investors like Ashy – and all value-adders – what the refurbishment achieved is to improve the weighted average unexpired lease term – WALT – which is how one measures success. That’s because existing tenants were inspired to extend their leases. In effect, it makes the property more valuable,’ Charles says.
Value-adders are prepared to take a calculated risk: core investors, who currently power most of the high-end Grade A market, don’t like the word ‘risk’ at all.
Stable long-term cash-flow and capital growth are the priority of this group – and they only turn on their money-tap for the surest of sure things.
‘These are the investors who want very risk-free, very prime, long-term income. A good example would be Legal & General who have done a series of lettings around the country to HM Revenue & Customs. At Arena Central in Birmingham, Legal & General funded a 240,000 sq ft office scheme with HMRC as tenants. This is as secure as property income gets – and, even better, it means inflation-linked rises in rental income every five years. This makes it less like a property deal, more like an annuity,’ Charles explains.
For now, all three investor-types are playing a cautious game. The UK economy is hard to read – and Brexit, Trump and the slow unwinding of the low interest rate regime of the last decade all make it much harder to read in the future.
The three investor tribes have largely taken their hands off the money-tap at the top of the office supply pipeline. And if, this long, hot summer, the market feels a little dry, this is why.
The three tribes
The risk takers. Opportunistic properties tend to need significant rehabilitation in order to realise their potential. These assets will often be fully vacant at the time of acquisition or the operator will seek to develop raw land from the ground up. These types of projects offer the highest level of return if the business plan is successful, but also bear the most risk as the properties have little to no in-place cash-flow.
If a building already has cash-flow (meaning, paying tenants) but that cash-flow could be increased, either by letting more floorspace or nudging rents up, then the value-adders are the guys to talk to. Improving the WALT is a key variable, generating fast returns on funds often borrowed on medium to high leverage, and selling the block once the good work is done are all typical value-adder strategies.
They want to play safe with Grade A buildings in the best locations – and they want the best, most reliable tenants, too. Their aim is to hold property long-term and they hope to preserve capital value (better still, to grow it). Predictable cash flow over decades is what they prize most.