Current Market for Inner City Commercial Real Estate

Vacancy rates in UK commercial property are at an all-time high, with over 170,000 vacant properties. This is prevalent in both retail and office space, though not logistical and industrial property. In quarter 4 (Q4) of 2021 the retail vacancy rate, which is a strong indicator of overall high street health, was recorded at over 1 in 7 by the British Retail Consortium and Local Data Company (BRC-LDC) Vacancy Monitor. Carter Jonas LLP ‘London Office Market Report’ for the same quarter says discounts of between 4% and 6% on advertised office rents are common.

The most obvious cause is the acute effects of the COVID-19 pandemic. Between February and May in 2020, the proportion of online shopping rose from 19.1% to 32.8% and the proportion of people working from home rose from 27% in 2019 to 37% in 2020. Together these factors caused a massively reduced demand for commercial property, for example, office rents fell by as much as 15% in the City of London, with smaller reductions elsewhere, and an increase in vacancy. These effects were mitigated for companies in retail, leisure, and hospitality by a business rate holiday and a ban on commercial evictions, which will end in March 2022.

However, there are tentative signs of recovery. In quarter 4 of 2021, UK retail vacancy rate was 0.1% lower than 14.5% in the previous quarter. This is the first decline since 2018, but it is still above the pre-pandemic trend. Moreover, commercial rents are edging upwards.

Retail recovery has been strongest in smaller cities and towns, with the top 3 cities for sales recovery as of 14th February 2022 being Wakefield, Huddersfield, and Telford, according to the Centre for Cities. Both Birmingham and London are in the bottom 10 cities, with in-person sales over 20% down since 13th February 2020, the index date. This can be attributed to continued home working and so people shopping closer to home.

In offices, the occupancy rate has risen to 27%, from a pandemic low of under 10%, though this is still less than half of the occupancy rate from 2019. Large sales, such as the 820 million GBP Scalpel tower, Google’s purchase of its leased 750 million GBP office, or UBS leaseholder changing hands, indicate an abnormally strong market for large office blocks, and thus confidence in the sector. Overall investment in central London offices was slightly higher in 2021 than 2019 and Savills PLC regional reports indicate a national rebound outside the capital. However, this resurgence only extends to A grade, newly built offices. Older premises, which make up most of the current stock, are struggling to find leaseholders due to non-compliance with current and planned environmental regulation; incompatibility with companies’ environmental, social, and corporate governance objectives; or because they are unattractive to potential recruits.

Grade A property is prioritised over location, for example, the City of London and Docklands are expected to be the regions of London slowest to recover and Goldman Sachs opened an office in Birmingham in 2021. Even among grade, A developments, Carter and Jonas LLP identify downsizing, shorter leases, and a tenant’s market, as trends that will continue through 2022. On the other hand, Savills PLC states that companies are not looking for smaller space but looking for flexible offices with more meeting rooms, lounges, and ‘burst spaces’ for spare office capacity.

Ultimately, there is uncertainty about how the use of offices will change in the future and turn how this will affect demands for office space. Some companies are encouraging full return to the office whereas other companies are leaning towards a more flexible approach, it is unknown which path will become standard.

As a lot of city retail is dependent on office workers, for example, Pret a Manger lost 58% of revenues when offices closed in 2020. If home working remains common, retail may become less concentrated in larger cities and more dispersed around regional high streets.

However, high streets must also contend with the long term decline due to online shopping. Online shopping has been rising as a share of sales by a little over 1% per year since the early 2000s and it has generated new retail giants such as Boohoo Group PLC and The Hut Group which have no high street presence and led to the collapse of, for example, Debenhams and British Home Stores. As online shopping becomes more dominant the need for physical shops falls.

Many local councils and the central government have attempted to revitalise high streets. Measures include pedestrianisation, town markets, and turning empty units into community spaces. Historically, prominent shopping for leisure destinations like Bond Street in London has proven resilient from the effects of online shopping, and independent retailers are also strong. The UK government’s ‘Build Back Better High Streets Report’ celebrates an over 200 million GBP redevelopment of Bishop’s Auckland, County Durham – including a museum, pedestrianisation, and events – as a case study in revitalising town centres.

Despite alternative commercial uses, online shopping has reduced the number of commercial properties needed in modern high streets. To solve this oversupply the government in July 2021 announced its intention to relax planning regulations to make it easier for disused commercial property to be turned into homes. This has also been stated as a way out for holders of lower-grade office buildings, instead of expensive refurbishment.

Overall, the long-term effects of the COVID-19 pandemic on working and shopping habits will dictate the future for high streets. Currently, new office real estate has a significant interest, but the current stock of lower-grade buildings may need alternative use. High streets will likely become smaller as they contend with ever-increasing internet competition.

By James Miller

Sector Head: Charlotte Snell