Occupiers in the South East are set to experience a chronic shortage in office stock with strong sustainability credentials, according Knight Frank’s annual M25 and South East Office Market Report.
With attainment of 2050 net zero targets dependent on reducing energy use intensity of operational buildings by more than 60%, regulations are likely to set a mandatory B EPC rating requirement for buildings by 2030.
The stipulation of this minimum EPC rating would dramatically alter the dynamics of the South East office market, exacerbating the current under supply on new, best-in-class space that meets necessary sustainability credentials. Data from Knight Frank shows that of the 11.3m sq ft of vacant space listed in the South East at the end of Q1 2021, only 6% had an EPC of A. If the B category were to be included, this reaches just 34.5%. If the remainder was stripped out to align to the desired EPC categorisation, the market vacancy rate falls to 2.3%, a level that has never been recorded.
Slower development pipeline
The 40 months from the beginning of 2018 to Q1 2021 saw 2.3 million sq ft of speculative space enter the market, lower than the 2.5 million sq ft completed in 2017 alone. As a consequence, the total availability represented in new, best-in-class space across the region, was 8% at the end of Q1 2021; the lowest level for 15 years.
This follows a busy Quarter 1 which saw 784,170 sq ft of space leased across 44 transactions, representing the highest quarterly take up since Q4 2018. The number of deals in Quarter 1 for space over 50,000 sq ft, was higher than for this size bracket throughout all of 2020.
The total amount of space under construction across the South East stood at 1.6 million sq ft at the end of March 2021, with 0.7 million sq ft (47%) of this space already pre-let, further tightening supply. With 2.4 million sq ft of speculative development having proposed start dates within the next 24 months, total completions could add a maximum of 3.3 million sq ft of new office space over the next four years.
Emma Goodford, Partner, Head of National Offices at Knight Frank, commented: “The leasing activity we witnessed in Q1 demonstrated a continued commitment to offices, particularly in Thames Valley locations with an established ecosystem. Despite the uncertainty around the role of the office and the expectation of dynamic and hybrid work patterns, take up during the quarter was consistent with the 10-year average and vacancy rates have remained below the long-term trend.
“Going forward, net zero targets will be an increasingly significant factor in lease negotiations given that sustainable real estate is critical to meeting the UK’s 2050 target. As the regulatory framework to decarbonise the sector continues to tighten, a greater proportion of occupiers and landlords will need to assess and disclose their carbon footprint. With low vacancy rates in the highly sustainable office stock categories, and a slower development pipeline, we expect to see a shortage in new best-in class space continuing to characterise the market until at least until 2025.”
Simon Rickards, Partner, Head of South East Offices Capital Markets at Knight Frank, said: “It was encouraging to see Q1 investment turnover reach £482M, the highest level since the pandemic began, as sentiment continued to improve in the South East. Furthermore, there is approximately £700M currently under offer in the region, which points to a strong Q2.
“We are seeing a real focus on prime fundamentals, both in terms of real estate and for income deals, with the life sciences sector commanding record yields for the right opportunities. We believe that this flight to quality will continue for the foreseeable future, potentially to the detriment of the secondary market where yields may continue to slip.”
Knight Frank’s M25 Innovation Index identifies innovation-led locations in the South East, that offer the greatest prospects for resilience. The top 5 locations identified by the index are Cambridge, Oxford, Brighton, Reading and Guildford, with each featuring superior innovation infrastructure (such as universities, research institutions, start-up-accelerators, and funding bodies), alongside well-established entrepreneurial populations and highly skilled local talent. Identifying and gaining exposure to innovation-led locations is becoming increasingly important for investors, as these ecosystems will be a key driver of economic growth whilst generating opportunities for future development.
