Shifting dynamics
in the UK's regional office market
The UK's regional office market has undergone a significant shift over the past year, with the pandemic accelerating hybrid working trends, leading to a fundamental change in occupier demand. Furthermore, the increasing focus on Environmental, Social, and Governance (ESG) obligations has intensified these changes. Q4 2022 was the second busiest of the year in Bristol with city centre demand increasingly focused on best-in-class space. Whether supply can keep pace with these changes remains the biggest threat to the office market in 2023.
Three key drivers have emerged:
1. Flexibility
The levels of general uncertainty engendered by the pandemic led to a trend throughout 2020 and 2021 toward shorter lease commitments. This trend is likely to continue throughout 2023. This is likely to be unwelcome news for risk-averse landlords who favour security of income but well-received by tenants who view the need for agility as a vital requirement for business survivability in the medium term.
2. Super Prime
Businesses are under increasing pressure to provide the best possible environment for those returning to the office. As one of the key tenets of sustainability, employee-focused workspace is now a priority, with wellness areas, leisure facilities, and collaboration spaces becoming commonplace. Consequently, the demand for super-prime offices is expected to grow, leading to a widening gap between prime and standard grade A classification. We expect to see demand for the best-in-class buildings surge this year, whilst unremarkable offices in suboptimal locations will continue to suffer from subdued demand and increasing void rates.
3. MEES
The Minimum Energy Efficiency Standards (MEES) introduced in 2015 have significant implications for office buildings in the south west. From April 1, 2023, it became unlawful to let out commercial buildings with an Energy Performance Certificate (EPC) rating of F or G.
Many office buildings in Bristol were already compliant with MEES prior to its introduction, but for those that weren’t there are significant financial implications - landlords have had to invest in upgrading building services, insulation, lighting, and other energy-saving measures to ensure their properties comply with MEES. Additionally, the minimum EPC rating requirement is expected to be raised to C or higher by 2027, presenting challenges for owners of older offices.
Our office agency team has already seen the effects of this play out in the market. They are receiving increasing numbers of requirements stating minimum EPC levels. The well-advised occupiers are looking to safeguard their offices against this future standard.
Growth potential in Bristol’s office market
Despite the threats, Bristol's office market is poised for growth as the city continues to attract investment and talent. The shift towards shorter leases and increased flexibility presents opportunities for landlords who can cater to these preferences. Bristol, renowned as a hub for tech and creative industries, experiences high demand for quality office spaces. Major regeneration projects, such as the Temple Quarter Enterprise Zone redevelopment, are set to transform the city and create new opportunities for businesses.
During 2022, Bristol recorded the highest level of annual rental growth of any regional city. Grade A rents have increased to £42.50 per sq ft in Bristol city centre, whilst out-of-town rents have remained steady at £23.50 per sq ft.
City centre take-up in 2022 was just above the 10 year average and 7% up on the 5 year average.
Grade A availability at the end of Q1 2023 was a mere 0.5 per cent of total stock, which remains close to an all-time low.
Tenants who entered into lease agreements for office space in 2018 and 2019 are likely to have committed to five or 10-year agreements. In the wake of the pandemic, many will be left wondering whether their current office meets their evolving needs.
Too much space?
From an occupier perspective, the rise of hybrid working has left many businesses occupying more office space than they require. If they do not have a break option or expiry on the horizon, it can lead to them paying rent, business rates, and service charges on underutilised areas. This is money that could be better deployed elsewhere within their business.
However, there is always opportunity. Alienation clauses (which most leases contain) offer potential solutions; namely sub-letting or assignment of the lease. There is also the option of negotiating an early surrender. However, in the current market, this is mostly only feasible when an alternative tenant has been identified for the landlord.
Too little space?
Tenants looking to expand are well-placed to take advantage of others looking to downsize. Alienation provisions may allow neighbouring tenants to assign or sub-lease space to one another. Landlords may view this favourably, as it reduces remarketing and void costs.
Just right?
There will be plenty of businesses for whom their current office perfectly meets their requirements. This in itself creates a huge opportunity for both landlords and tenants:
Selling breaks
For occupiers who do not need to retain flexibility, removing a break clause from the lease may be appealing. A longer term-certain will improve a landlord’s investment value because it reduces risk. In the current market, landlords are becoming increasingly open to tenants “selling” their breaks in return for a period of rent-free, creating a win-win situation.
Reversionary leases
Similarly, for occupiers who know they want to stay in their premises beyond expiry, landlords have been accommodating the early agreement of new leases. In exchange, tenants receive a rental inducement that can be enjoyed immediately. This is a great way to give short-term cash flow a boost whilst improving the landlord’s investment value.
With companies taking stock of their position and reassessing their business plans, there are opportunities for occupiers who can commit to longer-term plans for their office accommodation. It is always advisable to seek experienced and professional advice when considering how to deal with what - for many businesses - is their second largest cost, after staff.
James is a director in the National Offices team with an extensive professional background spanning more than 24 years. Since joining Colliers in August 2008, his focus has been on facilitating a wide range of property transactions in the South West region. Throughout his career, he has successfully managed numerous disposals and acquisitions on behalf of a diverse range of clients, from major funds like M&G to private individuals seeking real estate opportunities.
Janek is an associate director working in Business Space Lease Advisory, specialising in the office and industrial sectors. He regularly advises occupier and investor clients on lease renewals, rent reviews and lease restructuring. He is adept in identifying opportunities to realise value from existing leases – either by lease extension or negotiating an early surrender - tailored to the needs of each of his clients' objectives.