An oversupply of poor-quality London office space will make 2022 the year of refurbishment. David Thame marks your diary for a busy year ahead.
AHMM proposal for Debenhams Oxford St. Image courtesy of AHMM.
New normal, old normal, call it what you like, but by spring 2022 the UK office market will have stabilised after two years of pandemic-inspired chaos. The likely result is a wave of refurbishment.
Why? Because London, and many of the major regional centres, have a growing surplus of older, boring office blocks.
Until March 2019, these tired office blocks had a future – one that stretched for years, even decades. The arrival of coronavirus changed all that. Too boring to attract workers back from their cosy home offices, too crowded to satisfy wellbeing and health requirements, too uninspiring to satisfy new requirements for the office to act as a fulcrum for ideas and team building sociability. Above all, too much like white collar factories. And who, these days, wants to work in one of those?
‘There is now an understanding that workforce expectations have changed, and existing workplaces may not fit the new brief. As people trial a variety of new working patterns and processes, business leaders have a great opportunity to further review plans and reinvent where necessary,’ says Shaun Dawson, Head of Insights at occupier consultancy, DeVono, whose data shows the extent of the problem.
DeVono’s analysis of Q2 2021 take-up in central London showed a market picking up speed, with lettings up 21% at just short of 2 million sq ft. But the volume of empty floorspace rose, up 7% over a single three-month period to 21.4 million sq ft. In the City of London and Docklands, where high-density white collar offices predominate, the increase in availability was even more marked, up 10% in the second quarter alone.
These are very big numbers, and landlords know that if they are to stand a chance of letting any of their floorspace, they need to rethink.
By now we should know if the office market is back off the canvas. If it is, the market will divide into two unequal groups. The smaller (but higher profile) group are looking for Grade A offices to meet their high environmental and social standards. The larger but more difficult to satisfy group will be the bargain hunters. These are occupiers who know that landlords are in a weak negotiating position.
Occupiers with an eye towards bargains tend to keep their eye on the money, which means they are likely to opt for longer rent-free periods and deeper incentives, which could include higher fit-out contributions.
However, landlords are likely to counter-offer a package including landlord-funded fit-outs – which are a more cost-effective solution from their point of view because they reduce rent-free void periods, and avoid draining upfront cash payments. It also offers landlords a quick-fix which postpones decisions on seriously expensive refurbishment until another sunnier, day.
If by March 2022 we’re seeing a high volume of landlord-funded fit-outs, you will know the market has taken a decisive turn away from the refurbishment. Landlords will have instead chosen to kick the can down the road.
By now deal making will be resuming in sufficient volume for landlords and investors to hear market signals loud and clear. The likely outcome is a wave of anxiety as many of them realise they will be out-played by newcomers with a funkier, more on-trend offer. Here’s a for instance: modern workspace can be carved out of almost anything and, by June 2022, work on site at the former Debenhams flagship store at 334 Oxford Street, W1, could be underway. Schemes like this will ring landlord alarm bells.
The Debenhams site is ideally placed close to tube stations and the new cross-rail Elizabeth Line, has the urban buzz that occupiers value and delivers a lot of funky floorspace. Capital Real Estate Partners say the proposal is for three floors of retail space below 376,000 sq ft of ‘new, flexible workspace of the highest quality’, which the promoters say will attract ‘new office occupiers and employers to this location, promoting activity and footfall in the local area’.
In late September 2021 the Greater London Authority raised some quibbles about the loss of retail floorspace, but nobody expects them to stand in the way of redevelopment. Landlords of drab office blocks will be spurred to a rethink.
We may also see signs that landlord-funded fit-outs are failing to make a decisive impact as tenants reconsider how their individual needs are met by one-size-fits-all landlord thinking.
Nick Simmonds, Managing Director at Expedite Office, reckons this is a risk. ‘Many of these refurbished spaces look great in the marketing brochures, but are often not functional for occupiers, who need to make sure they are looking properly at the space beyond the reduced fit-out cost. Furthermore, taking fitted-out and refurbished space will often mean tenants pay a higher rent level and lose other financial incentives, such as rent-free periods, while a lot of occupiers may still need to make additional amends to the space to accommodate their business needs,’ he says.
If Nick is right and the quick fix of landlord-funded fit-outs represent fails, many landlords will have to return to the drawing board.
By now, with summer behind us and three quarters of lettings data to mull over, the momentum for heavy – rather than light – refurbishment will be considerable. Today the differential between Grade A and Grade B London offices is fairly stable. Through the ups and downs of the last 24 months, the gap has not widened dramatically.
Today DeVono figures show the bandwidth of average rents range from £66 per sq ft for Grade A down to £50 per sq ft for Grade B – that’s a difference of £16, or to put that another way, a Grade B discount of 24%. Back in spring 2020 the range was £71/£54 – a difference of £17, also a 24% discount.
But if the market develops as many expect, by September 2022 rental growth on Grade B stock will be lagging behind those in better quality stock, as nine months of deal-making takes its toll.
At this point landlords’ appraisal mathematics begins to shift decisively.
Charlie Ingram-Evans, Head of Building Consultancy and Project Management at surveyors, Knight Frank, specialises in advising landlords on refurbishing office space and also works on the tenant fit-out side.
‘I think by this stage we’ll see few light refurbishments, and many heavy. Of course there are limits – if a building could be completely redeveloped in 5-8 years then maybe something low budget is the right option, pending a bigger decision. But if your building still has 10-20 years life left in it, now has to be the right time to invest,’ Charlie tells us.
‘There are push and pull factors here, all of which will affect landlord thinking, as will their appetite for spending. But the better informed will realise that a lick of paint and a few nicer loos will not cut the mustard any more. We will see a flight to quality, which means more amenity, better light, better energy efficiency – all of which adds up to heavy refurbishment.’
Will a supply chain collapse or a lockdown take the tinsel off Christmas 2022? It is too early to tell, but what we can say is that, by the time winter chills arrive in 2022, the importance of sustainability and green credentials to both landlords and tenants should be well established.
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