Demand for prime placing downward pressure on prime yield
Investment volumes reached £1.1 billion at the end of Q1 2022, which represented a marginal increase of 1% from Q1 2021 but 26% and 28% below the five- and ten-year averages for the first quarter. There was limited stock brought to the market in Q1, which resulted in below average turnover with the number of deals recorded 31% below the five-year average. There has, however, been an uptick in activity at the start of Q2 2022, with £943 million traded between April and May, and £1.1 billion of stock placed on the market in the same time period.
Investor demand continues to be focused on prime stock, with downward pressure being placed on the prime regional office yield, which currently stands at 4.75%. Manchester and Edinburgh prime office yields are both 25 basis points below this level at 4.50%, which is the lowest level recorded for these markets. The yield gap for prime and secondary offices is expected to widen with the rental growth outlook for prime green offices in undersupplied locations remaining compelling. Savills forecast 2.9% rental growth per annum for 2022–2024 for prime regional city offices underpinned by the continued imbalance between supply and demand for prime regional city office space with strong ESG credentials.
Overseas investors continue to be the most active in the market
Overseas investors were the most active investor in Q1 2022, accounting for 51% of total investment in the regional office market. This trend has been evident in recent years, with non-domestic investors the most active purchasers in four of the last five years. The strong activity from overseas investors has continued from 2021, where £3.6 billion of capital was deployed into the regional office market which was the highest quantum ever recorded from the subsector.
Prime long income opportunities have predominantly been targeted by overseas investors with interest deriving from all continents resulting in downward pressure being placed on the prime regional office yield. There was notable activity from European investors with Immobel acquiring a 50% stake at White Rose Office Park, Leeds for £107 million, reflecting a yield of 6.75% as part of their Green Office Strategy and La Francaise Real Estate purchasing Gilbert House and 41 Corn Street, Bristol for £20.65 million reflecting a yield of 5.75%. There has also been demand from Middle East and Far East investors seeking to gain exposure to the regional office market.
Despite the yield compression occurring in the regional office market, prime yields are attractively priced when compared to other major European cities. Prime office buildings across Europe’s major office markets are trading at yields between 2.40% and 3.50%, providing a 125–235 basis point premium when compared to prime regional offices.
The continued polarisation in demand for office space has resulted in the greatest differential between average Grade A and B & C rents recorded in the last five years. Focussing solely on the Greater London & South East office market, average Grade A rents were 53% higher than average Grade B & C rents at the end of Q1 2022. There were 13 submarkets which achieved record-high rents in 2021, and this has continued into 2022 with Putney and Croydon achieving their highest rental levels ever recorded.
The occupier preference is for prime Grade A office space which can satisfy ESG credentials and occupiers are prepared to pay a rental premium to secure this space. This trend has also been evident across the regional office market with Bristol experiencing 12% prime headline rental growth in 2022.