Viewpoint - 16/04/2013

Addressing office obsolescence: is it time to convert?

Demand for office space in the UK is undergoing a major structural change.

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The implementation of modern workplace practices means that it is perfectly possible for a company currently occupying a 200,000 sq ft building to simultaneously upgrade their space while reducing their occupational footprint by at least 20-40%.

The mantra for large corporate occupiers and forward looking public sector occupiers is now “better quality space, but less of it”. In the last 20 years, the amount of allocated space per person in an average UK office has halved and occupiers expect this reduction to continue. Indeed, public sector occupiers surveyed for the 2012 British Council of Offices report “Change for the Good – Identifying Opportunities from Obsolescence” (of which LSH were co-authors), said that their space requirements would reduce by as much as 50% in the next five years.

There’s too much low quality space

These structural changes have coincided with a downturn in the market since the peak in 2007-08. Availability rates are already well above average in the UK and the vast majority, 73% of
this space is secondary or tertiary. A medium sized office market like Nottingham has almost a million sq ft of available grade C space, for which there is very little market. Much of it will never be let again.

The implications for the office market are clear: we have too much, low quality, obsolete office space in the UK. Offices that are either:

  • Locationally obsolete. The building is in, for example, an inaccessible, out of town location where there is no occupier demand.
  • Functionally obsolete. The building is not fit for purpose due to changing technology, new regulation or changing occupier demand, i.e. small, irregular shaped floorplates or cellular design.
  • Physically obsolete. The building’s fabric and/or M&E specification has deteriorated to the point where the cost of occupation outweighs the benefits accrued by the occupier.

27% available office stock is obsolete

Using our broad coverage of the UK office market we have estimated exactly how much obsolete space there is in the 32 regional centres we cover. Our findings suggest that there is approximately 11.7m sq ft of obsolete regional stock currently on the market, which is more than 27% of the total regional availability. This obsolete space is acting as a drag on the market, by artificially inflating the availability figures and discouraging new development in locations which have high levels of secondary and tertiary availability, but low levels of the type of office space that occupiers are increasingly targeting.

Obsolescence is not restricted to vacant stock either. Many companies occupy buildings which do not meet their requirements and that they plan to vacate at the earliest opportunity. Survey data from the BCO report on obsolescence indicated that some occupiers have portfolios where they consider up to 60% of space to be sub-optimal. In Birmingham, we estimate that over 4m sq ft, or 22% of the total office stock of 18m sq ft could be considered obsolete. Unless measures are taken to return this space to marketable condition when it becomes available, the likelihood is that it will remain on the market.

Refurbishment or conversion?

For some landlords refurbishment is a viable option – if the building is in the right location and the physical condition and layout allows it. However, there are other options available to the owner. Chief among these is the conversion from offices to another use class, whether that is residential, student accommodation, hotel or even place of worship.

The conversion of offices to another higher value use class is not a new phenomenon. Even at the height of the boom there was a trend in some oversupplied South East markets for office to residential conversions. But, in recognition of the growing problem of obsolescence, the Government has recently announced new rules, applicable in England only, that will allow office space to be converted to residential without need for planning permission.

The incentive to convert from office to residential is obviously greatest in London, where the difference in values is at its peak. Through our quarterly tracking of the investment market it is possible to identify transactions where this is the case: for example in Q3 2012 the Berkeley Group purchased an 90,000 sq ft office building in the West End for conversion to residential. In general though, planning authorities in Central London have not been receptive to the conversion process because of their desire to protect small businesses and maintain the infrastructure of London’s office-based economy. All but a handful of the 33 London boroughs have applied to be exempt from these new rules.

Rate of conversion gathers pace in regions

In regional markets though, there has already been a quickening in the pace of office conversions since the top of the market in 2007-08. Increasing availability and a decrease in demand has exposed more landlords to the problem of obsolescence and we have numerous case studies of offices in all the main regional markets being converted to alternate use. Additionally, while the gap between office and residential values in the regions is not as high as it is in London, the gains to be made by conversion are still substantial. Average capital values for the UK residential space are approximately £155 per sq ft, compared to average secondary and tertiary office values, which range from £30 to £80 per sq ft. Meanwhile, the gap between values for vacant and let offices is now extremely pronounced, which provides further impetus to look to the conversion process to realise an asset’s value.

Of the 11.7m sq ft of available stock that we believe is obsolete; 7.4m sq ft is suitable for conversion to an alternate use class. This is equivalent to 11,500 terraced houses, or a quarter of the new homes the government has pledged to build in 2013. In Birmingham 2.4m sq ft of the City’s 18m sq ft of office stock has the potential to be converted; in Edinburgh 800,000 sq ft of space actually on the market could be converted; in Nottingham the figure is 400,000 sq ft; and in Slough, which has the highest vacancy rate in the UK, 340,000 sq ft of stock could be removed from the availability register and converted to another, more profitable use.

Time to convert

With above average levels of availability in almost all markets, an accelerating process of obsolescence, changes in the pattern of office demand and a sympathetic planning system, now is the time for landlords and developers to look for opportunities to take obsolete buildings off the market and convert them to an alternate use. Not only will this benefit the UK office market, it will help with the current shortage of residential development, which is one of the government’s key priorities, and has the potential to drive much needed economic growth via the construction industry.

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