With London and the south-east largely overpriced, property investors are looking elsewhere and helping to create a Northern Powerhouse in the process.
Although more than a few eyebrows were raised when George Osborne launched his “Northern Powerhouse” concept two years ago, commercial property investors have been won over. The same goes for Birmingham, Glasgow and other regional cities which are also in the throes of redevelopment and gentrification. Their main attractions are more attractive and affordable opportunities than the favourite hotspots in London and southeast.
These views are reflected in trade group RICS’ 2015 fourth quarter report which showed that 81% of respondents believed central London commercial property had become overpriced, up from 77% in the third quarter. Prime yields in the capital city hit their lowest levels in 2015 with the City averaging around 4% and rents between £60 to £66 per square foot (psf).
Those in the popular West End were hovering around 3.25% to 3.5% with rents at about £120 psf. Although many industry analysts do not expect yields to further compress, they all agree that rental growth will have to be the main driver of investment.
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By contrast, yields in the “Big Six” – Manchester, Leeds, Bristol, Birmingham, Glasgow and Edinburgh – are between 5% and 5.5%. Rents are also expected to continue their upward climb.Looking at particular buildings in these cities such as the 21-story Manchester One, rents rose to £21.50 last year from £16.50 in 2014, while the 18-story Castlemead Bristol has seen a 65% hike to £25 psf in the same time frame, according to Chris Ireland, UK chairman and lead director of capital markets at Jones Lang Lasalle (JLL).
Birmingham and Leeds have also enjoyed increases of 20% to 25% for the same type of quality buildings in the central business district. “There are definitely pockets of fully-priced assets in London and the south east, but I think investment will continue – although selectively,” says Chris Perkins, head of business space at M&G Real Estate.
“It is a one-sided equation though, because rental growth will be the main factor whereas in the regions, particularly the Northern Powerhouse, it is a two-sided equation – rental growth because of limited supply as well as better returns.” The benefits of living or relocating to the Big Six or the Northern Powerhouse (Manchester, Leeds, Liverpool, Sheffield, Newcastle and Hull) have been well-documented.
They not only offer a lower cost of living, rents and staffing but also growing populations and a well-educated workforce. As Perkins points out, construction costs are also less, which means it is feasible to develop a building with the same specifications as in London and generate a return as rents are at £30 psf rather than £60 or £120.
FRIENDLY LOCALS
Equally as important, business executives and local councils have seized the opportunity to promote their strengths and push productivity with growth strategies that align skills, local transport and economic renewal. In some quarters, they are also working more closely together to ensure that national and local initiatives are not just talk, but are translated into material developments.
For example, earlier this year, business leaders launched a CBI-backed lobby group called Business North to drive the Northern Powerhouse agenda.
One of the first items on its list is to certify that the so-called HS3, the new high-speed east-west rail line, remains a top governmental priority. The multi-billion pound transport plan would see journey times between the north’s big cities halved to match those in the south-east. Against this backdrop, activity has been booming, especially in the office market.
The latest report from JLL shows that 2015 was a record year for the sector with volumes in the Big Six hitting £2.76bn, up 17% over the previous year. In total, there were 11 deals over £50m and five deals of £100m and above. Global investors, particularly from Germany, Singapore, the US and Middle East, featured prominently in the second half, comprising 61% of the purchases and 81% of office deals currently under offer.
Looking more closely, some cities such as Manchester, which was first to receive ‘City Deal’ funding and regional devolution and Birmingham, are benefiting more than others. The latter accounted for £789m worth of volumes with headline office deals last year including Legal & General’s acquisition of a 50% in MediaCityUK and Singaporean REIT Mapletree’s purchase of
3 Hardman Street from Aerium Finance for £205m.
Also on the list were Deutsche Asset & Wealth’s forward funding of 2 St Peter’s Square for £100m and M&G’s purchase of 3 Hardman Square in Spinningfields from Credit Suisse at a 5.79% yield.
Birmingham saw £712m traded, with the most notable transactions being Ashby Capital’s acquisition of Colmore Plaza for £138.3m and Legal & General buying 1 Colmore Square for £87.3m. Over the past few years, the city has reinvented itself as a tech and services hub and is also gaining attention due its infrastructure facelift. The project has seen the refurbishment of New Street station, the extension of the tram line and the forthcoming HS2 high speed railway link to London which would cut the journey time down to around 50 minutes from the current 84 minutes.
TIDYING UP
A report by CBRE – Core Cities, Core Strengths – shows that Glasgow ranks as the top Scottish city and third highest in the UK outside of London in attracting commercial property investment over the last decade. It has pulled in £5.27bn while neighbour Edinburgh was fourth on the list of 12 regional cities analysed in the report at £4.88bn. They came behind Manchester at £8.23bn and Birmingham at £6.56bn.
Looking ahead to this year, refurbishment is expected to remain a big theme across the Big Six. Figures from JLL show that there are schemes totalling 800,000ft2 to be delivered in 2016, with a further 10 new schemes of one million ft2 due to start. This has resulted in strong rental growth story especially in the secondary office market and given the solid outlook for demand and tight supply, the firm expects headline rental growth across the UK to average 2.7% per annum over the period 2016-19.
Secondary assets or those outside the regional city centres also look poised for repositioning especially as there is a shortage of grade-A properties. “A huge gap between prime and secondary across all sector types opened up after 2008 and although this has narrowed it is still double from the pre-downturn,” says Andrew Marston, research director at CBRE. “We have seen demand and there are opportunities in cities such as Leeds to asset manage these properties and do a return play in areas that have not been re-gentrified.”
NOT JUST OFFICE SPACE
Although the office market is expected to dominate, other fund managers believe there are better opportunities in the logistic, industrial and student housing sectors. “We think the office sector could be challenging in that if you are paying 5% yields, you will not get that much growth off £30 psf,” says Andrew Friend, director of institutional business for investment management company, TH Real Estate. “We believe there is better value in student housing, which is yielding 5.5% and 6% in cities such as Manchester, Leeds, Glasgow, Durham and Exeter which have top local universities. We also believe logistics is a big growth area because quality properties are yielding around 5% due to the increased demand for online shopping.”
Thomas Müller, managing director and portfolio manager within Blackrock’s European real estate team also sees good prospects in student housing due to its counter-cyclical nature. “You have to look carefully though at which universities are strong performers and those that have underperformed before making an investment in a particular city. “We also like the light industrial sector
because of strong supply and demand imbalances in some select sub-markets.”
Although market participants remain optimistic about the regions, there is no doubt that the possibility of Brexit is casting a cloud. The vote is scheduled to take place later this year and as with the Scottish referendum, the uncertainty is causing investors to adopt a wait and see attitude. Investment activity has not stalled but it has definitely slowed down and tenets are less inclined to commit to big letting particularly in London.
LONG TERM OUTLOOK
“While all markets are currently experiencing degrees of volatility and uncertainty, assets such as real estate and infrastructure have been less-impacted upon than stocks and currencies,” says
JLL’s Ireland. Of course, the forthcoming European Union referendum is currently top of the agenda. For some investors it will be largely business as usual, while others will be more circumspect
about making big investment decisions ahead of the vote. But many remain optimistic. “Notwithstanding, the property fundamentals of the UK market are strong and there is a positive outlook for longterm real estate investment,” Ireland adds.
