Property investors warm to UK regional opportunities

Previously ‘unfashionable’ regions are now on the radar of international buyers
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England’s regional commercial property markets are once again starting to gain interest from investors.

Regional commercial property has been deeply unpopular as an asset class in the past few years, in sharp contrast to the boom in London. But, according to analysts, this is beginning to change.

“Now might be a good time to look at the unfashionable regions,” says Mat Oakley, director of commercial research at Savills, the estate agency. “Office take-up rose in the first half of 2013 across the majority of [English] cities and availability is falling. The proportion of investment that is outside London also rose in the first half of 2013.”

Take-up in the first half of 2013 is nearly a quarter higher than the long-term average, according to CBRE, the commercial property group, with more than 3.8m square feet acquired by occupiers. Adrian McStay, CBRE national team managing director, says that Leeds, Manchester and Bristol have fared particularly well.

“Since March we’ve seen a good uptick in both occupation and investment. Big corporate [tenants] have strong balance sheets and are now looking at their real estate strategies,” he says.

There are three main reasons for investors’ change of heart towards the regions. First, the UK’s economy has begun to claw its way back to growth this year, rising 0.7 per cent in the first half, which is feeding through to demand for office space.

Intense competition among investors in the London market is also pushing demand outwards in a search for other opportunities. Third, supply is falling as new development remains frozen.

As a result, yields are beginning to fall. According to BNP Paribas Real Estate, prime regional office yields have dropped to 5.75 per cent from 6.75 per cent at the start of this year.

“At the start of the year we forecast investment starting to flow into the regions and that is now happening,” said John Slade, BNP Paribas Real Estate chief executive. “We have seen a real move out into the regions, not just by UK money but also overseas investment. Two years ago you couldn’t even find a buyer for some regional offices. The market picked up last year and now yields are falling and are under pressure to fall further.”

Darren Yates, partner at Knight Frank, the estate agency, agrees “locations outside central London are now on the radar of international investors”. He cites Manchester and Leeds as being particularly well-placed “due to their very diverse commercial base”.

By contrast, Liverpool and Sheffield are seeing less demand, he says, noting that the economies of these two cities are more reliant on a public sector that is facing spending cuts.

“We will see yield compression in the next six to 12 months, and the prospect of rental growth in the medium term, perhaps as early as next year,” Mr Yates says.

Perhaps most crucially for future prospects, supply remains subdued, with little new space under construction other than in parts of southeast England, which is strongly influenced by the London market.

Figures from IPD, the property value benchmarking group, show that the likes of Cambridge, Guildford and Brighton are doing particularly well – partly thanks to their proximity to the capital.

Just six speculative office developments are planned for completion in the next two years, according to Knight Frank, all of which are in Manchester, Glasgow or Bristol. The developments will deliver less than 1m square feet of space between them. Manchester is the only regional city to have more than 200,000 sq ft of new space under construction.

Rising demand in recent months has eroded an overhang of supply left empty since the start of the financial downturn. So much so that Mr McStay is now forecasting a supply crunch within two years.

“In most places there has been no new development at all since 2007. Most cities now have less than 500,000 square feet remaining. That is a problem – you just need one or two big occupiers to come along and that takes up all the available space.”

Developers have started to respond. Mr McStay cites schemes in Bristol and Glasgow as the first new supply of the most prized and sought-after “Grade A” space in six years.

But the time lag between starting a new development and tenants moving in means that more needs to be done. “Construction takes a minimum of two years, and it can take three to four years depending on . . . planning permission,” he says.

There are also still reason for investors to be cautious.

While high-quality property is in demand, most regional cities still have some unwanted poorer-quality stock that is unpopular with both occupiers and investors.

Birmingham has perhaps the greatest oversupply of office space, according to data from Jones Lang LaSalle, the property group. Its vacancy rate of about 16 per cent is the highest of the UK’s major regional cities, with 3m sq ft remaining empty. “There is a lot of second-hand stock that is almost obsolete,” says Mr McStay.

This situation could be eased in the coming months by forthcoming changes to planning laws, which would permit empty office buildings to be converted into housing. Some experts predict that this could help to erode the remaining volumes of secondary- and tertiary-quality stock sitting empty in many English cities.

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