Apr

il 20

14 UK’s Big Six office markets: emerging from London’s shadow

1

London’s business activity has fallen behind the other regions. South West, South East and West Midlands look particularly strong

• London offices look expensive relative to the recent past, whileBirmingham,EdinburghandManchesterlookparticularlygoodvalue

• Total returns in South East have overtaken those of the City for firsttimesince2009

• Prime availability rates near peak in London; well below peak in mostregionalcentres

• Edinburgh,ManchesterandBirminghamtoshowstrongerrentalgrowththantheCity

Rising returns in the regionsBritain’s ‘Big Six’ office markets – Birmingham, Bristol, Edinburgh, Glasgow, Leeds and Manchester – are emerging from the shadows to offer a serious challenge to London.

The Capital’s real estate market has long benefited from a huge population, high levels of business activity and strong overseas investment demand. That, though, has pushed down yields on office investments at a time when the economic recovery has increased the attractions of the regions.

Strengthening the case for looking beyond London, total returns from offices in the South East overtook those of the City last year for the first time since 2009.

The higher returns from the regions come with a stronger economy. London’s business

activity has fallen behind the other regions, according to Lloyds Regional Business Activity PMIs. The South West, South East and West Midlands look particularly strong, with activity at or near the highest level in a decade.

Stronger business activity leads companies to hire more staff, fuelling demand for office space. The highest employment growth over the next five years is expected to come from ICT, real estate and finance sectors, followed by admin services and professional services. While these sectors feature heavily in London, they actually account for a higher percentage of the workforce in hi-tech focused Bristol and financial services dominated Edinburgh. Perhaps surprisingly, of all the cities studied, London also has the lowest percentage of graduate workers – a key consideration for employers in sectors like ICT.

Office market total returns

Source: IPD.

201220112010 2013

Tota

l ret

urns

(%)

25

20

15

5

10

0

-5

West End and Mid-town Rest of South East City Rest of UK

2

Less supply in the regionsIn absolute terms, of course, London still leads thanks to its huge population – at almost seven times the size of the next biggest cities, Manchester and Birmingham. That does mean that, overall, it has the strongest demand-side drivers. But this demand has been better met by supply than elsewhere, with London seeing twice as much construction in 2010-2013 than all the Big Six put together.

As a result of all the development, prime availability rates in central London are at or near cycle peak in contrast with the rest of the country. Top-quality office space is significantly more scarce in Birmingham,

Glasgow, Manchester and Leeds than it was at the peak of the previous economic cycle. The supply gap looks unlikely to change for now, with new office construction still very much focused on the City (where roughly twice as many square feet of space are under construction than in any of the Big Six) and in the West End.

The limited supply in the regions is supporting rental growth, reducing the gap with London. Over the next five years we expect that Edinburgh, Manchester and Birmingham will all see faster nominal rental growth than the City, and not far behind the pace of London’s West End and Mid-town.

Over the next five years we expect that Edinburgh, Manchester and Birmingham will all see faster nominal rental growth than the City, and not far behind the pace of London’s West End and Mid-town

As a result of all the development, prime availability rates in central London are at or near cycle peak in contrast with the rest of the country

Grade A availability as % of total stock

Source: Knight Frank.

London: City

GlasgowLondon: Mid-town

EdinburghBirminghamLondon: West End

Bristol Manchester Leeds

%

7

6

5

1

2

3

8

4

0

London

Big Six

5-year annual nominal rental growth

Source: M&G Real Estate.

London: City

Edinburgh Birmingham GlasgowLondon: West End

London: Mid-town

BristolManchester Leeds

Nom

inal

rent

al g

row

th (%

pa)

6

5

1

2

3

4

0

Contact

Big Six yields to contractThe low level of yields in London compared to the Big Six is a key issue. Prime office yields in Mayfair and the City Inner Core are both at six year lows of around 3.75% and 4.75%, respectively. In contrast, the Big Six are all yielding 6-7%. The spread between the lowest prime yield in a Big Six market and Mayfair has ballooned to 250 basis points at the end of 2013 from 75 basis points in 2007.

Going forward, we expect that spread to shrink as yields in the other major cities come in. Those with bigger average lot sizes – which appeal more to foreign investors – are likely to lead the way, putting the spotlight on Birmingham and Manchester.

At the same time, prime yields in Central London may well push higher, moving back towards their long-run equilibrium.

Indeed, comparing current returns with their 20-year average, London currently looks poor value compared to the Big Six. Edinburgh offers the best value according to this metric, benefiting from strong rental growth prospects for prime city centre property. Buying at today’s yields could bring superior investment performance over the medium to long term.

Manchester and Birmingham also look strong, offering bigger overall populations and the best occupier demand credentials of the Big Six.

Looking at yields further erodes London’s appeal. Prime office yields in Mayfair and the City Inner Core are both at six year lows

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20-year value in the Big Six

Source: M&G Real Estate.

London: City

Edinburgh Birmingham Glasgow London: West End

BristolManchester Leeds

Real

Ret

urn

(% p

a)

5

1

0

-1

2

3

4

-2

20-yr IRR 20-yr Req Rtn 20-yr value

Chris AndrewsHeadofClientRelationshipsandMarketing

+ (65) 6436 5331 chris.j.andrews@mandg.com

Chris NashDirectorofInstitutionalBusinessRealEstate,UK

+44 7811 928562 chris.nash@mandg.com

Stefan CornelissenDirectorofInstitutionalBusinessBeneluxandNordics

+31 (0)20 799 7680 stefan.cornelissen@mandg.co.uk