Investors focus on UK regions to boost office returns
By Matthew Peake, Partner, Cluttons Investment Management – Whilst Central London continues to attract significant global capital, investment in the regions over the last two years was up on 2016, with overseas investors accounting for a significant proportion of that.
Investors from the Far East have been particularly active in London, investing over GBP5 billion in 2018, but there is evidence of overseas money being placed elsewhere in the UK. The Kuwaitis for example committed GBP90 million to offices in Manchester and Stockley Park, near Heathrow last year.
So, what is driving investor appetite for regional offices?
There is no doubt that the dynamics of supply and demand play a big part. New job creation aided by the much publicised private and public relocations has led to increased take-up. This, coupled with a lack of new development and conversion of older stock to residential use through permitted development rights, has strengthened the prospects for rental growth.
Regional office markets are not as exposed to Brexit-related concerns as London as they are less reliant on inward investment and more reliant on local economic dynamics.
Whilst devolution of decision making for taxation and spending powers from central government to local authorities has been put on the back burner for now, councils have turned to property investment as a way of raising additional income and taking strategic control for assets in need of regeneration.
Spending on new infrastructure provision is helping to attract international business to the regions. Major projects such as HS2 will connect some of the Northern Powerhouse economies with Birmingham and London and their surrounding areas. The expansion of Heathrow will boost the growth of some regional cities.
Pricing is clearly a key driver. Offices in the top regional centres offer a greater yield discount than those in London and other European cities for product of a very similar quality and income duration. Ordinarily this is needed to compensate for lower rental value growth prospects. However, the latest IPF Consensus Forecasts suggest that regional office rents will out-grow those in London over the next five years, with higher prospective annualised total returns compared to the City and West End over the same period.
We believe that office investments in the top regional cities and parts of the South East offer better relative value than Central London at this point in the cycle. The challenge is sourcing appropriate stock. As the UK faces a period of political uncertainty, we are no different to any other long-term institutional investor in seeking high quality, liquid assets for our clients backed by a stable and sustainable income profile. This will be key to the investment’s performance in a low return environment.
As returns from offices in London soften, investors may look further up the risk curve to enhance performance. Development opportunities with a degree of leasing or construction risk, or more secondary assets offering scope for improvement through refurbishment or redevelopment, will be a target for those with a shorter-term performance horizon. Accurate, up front analysis of the costs involved in refurbishing or redeveloping will help to ensure that these risks are minimised and returns are maximised.