IN FOCUS | Will spec office development make a comeback?

Next year will be another lean one for new-build office development across the North as encouraging rental growth fails to outpace build costs and investor uncertainty keeps yields soft.

However, a lack of Grade A space coming online in the North West, Yorkshire, and the North East presents an opportunity for the refurbished market to soak up some of the pent-up demand.

Supply and demand

Ask any office agent and they will tell you that the availability of Grade A office space outstrips supply in regional cities.

Take Leeds, where the supply and demand dynamic is becoming more unbalanced by the month. Only 75,000 sq ft of new-build space is expected to complete next year while take-up this year has risen 8% to around 500,000 sq ft.

As a result of this imbalance, the appetite for recently completed or soon-to-complete Grade A office schemes across the North has been strong this year.

Bank House, part of the Rueben Brothers Pilgrim Quarter in Newcastle has let well, attracting DAC Beachcroft, Barclays, and law firm Knights since completion.

In Leeds, One City Square, which completed earlier this year, was 85% full before contractors handed over the keys.

The real winner this year has been St Michael’s in Manchester, which is being developed by Relentless and KKR.

The building is fully let to the likes of Hill Dickinson, Pinsent Mason, S&P Global, and Channel Four, and has broken the city’s record rent three times in the process.

Going into next year, developer Vastint will be hoping for St Michael’s levels of lettings success at 190,000 sq ft of recently completed office space at Aire Park in Leeds

Michael Cronin, head of portfolio at Vastint UK, said: “Occupiers in 2025 will be continuing to look for high-quality office space which boasts leading sustainability, wellbeing, and connectivity credentials [and] are rightly becoming increasingly more discerning in terms of what they require from their office space.

“When discussing requirements with businesses, we’re seeing a greater focus on how the space will help them attract and retain talent.”

Vastint believes its Aire Park, which benefits from having an eight-acre park on its doorstep, can tick the boxes tenants are looking for.

The 190,000 sq ft Aire Park first phase is ready for occupation. Credit: via Aberfield

Why no spec?

With a clear demand for Grade A space, why are more developers not pulling the trigger on office schemes?

“The appraisal looks too risky,” said Will Lewis, director at OBI Property.

“The biggest risk on spec development is leasing [the building] but if a developer builds a good building in this market they will lease it.

“But trying to get someone to take that leap of faith is the challenge.”

In Manchester’s Parsonage regeneration zone, four major office developments are currently on hold as a result of prevailing market conditions.

Bruntwood SciTech’s Alberton House, Property Alliance Group’s Reedham House, Oval Real Estate’s Albert Bridge House, and Investec’s proposed House of Fraser regeneration all have planning permission and could deliver more than 1m sq ft of workspace into a city that is staring down the barrel of a lean new-build pipeline into 2026/2027.

However, an imminent start on site for spec office schemes is “highly unlikely”, according to Property Alliance Group chief executive Alex Russell.

He is predicting only a “snail’s pace improvement in sentiment” among developers next year.

Put simply, these schemes and many others like them across the North, do not stack up due to an unholy trinity of contributing factors. As Lewis said, the appraisal looks risky.

“We need to see a combination of rental increase, levelling or reduction in build costs, but most importantly a yield shift, which will come from rate drops,” Russell explained.

Plans for Bruntwood SciTech’s Alberton were approved in 2022. Credit: via Citypress

If Manchester, where rents are high, is struggling to spec, the rest of the North will find it even harder.

Igloo Regeneration, the developer behind the 100,000 sq ft One Founders Place in Newcastle has said it won’t build the scheme on a speculative basis, while in Leeds BAM received planning permission for the 200,000 sq ft Latitude Yellow in April but its target of starting on site this year looks destined to slip.

The most likely Northern contender for spec development in 2025 is Landsec at Mayfield, according to various people Place spoke to.

The developer said it is “confident” of a start on site in 2025 but also said that about 2023 and 2024.

Rental tone

For projects to become viable and rise out of the ground, PAG’s Russell and his developer peers are looking for rents of £55/sq ft. That is the magic number.

It is a leap of faith but one that occupiers, in Manchester at least, will be willing to pay, according to OBI’s Lewis and LSH, which recently published its regional cities report, anticipates Manchester will break the £50/sq ft ceiling in 2026.

If rents higher than £50/sq ft is one of the ingredients needed to get office development moving, Manchester’s regional rivals will have to wait a little longer.

Leeds is close to achieving £40/sq ft, while Newcastle is at £32/sq ft.

But increased rents alone will not be enough. Jeff Peavy, head of JLL’s Leeds office, said that rental growth across the big six regional cities had been “unprecedented” in recent years and was doing “a lot of the heavy lifting on appraisals”.

However, it will take much more than punchy rents to convince developers to crack on.

“The viability gap is still so powerful that even with a pre-let in tow it might not be enough to start a development,” Peary said.

“For the lifeblood of the business community within regional cities, we really need a healthy office pipeline.”

While rents are rising across the board, some are moving quicker than others. In Liverpool, which has had no new-build office stock delivered since the Spine in 2021, the headline rent is stuck in the mid-twenties.

The headline prime rent in Newcastle is £32/sq ft. Credit: LGIM

Shifting yields

There is also an enduring uncertainty about the future of offices, which is turning investors off. LSH’s report found that institutions are exiting offices en masse; 2024 saw a net spend of -£438m in the sector from institutional investors who have found safer places for their cash.

“Investor preference to the sector remains negative,” said Bill Page, head of research at Legal & General Investment Management.

“Investors do not operate in a sector vacuum and perhaps the bigger risk to office investment volumes is better than expected performance – or lower risk – from other sectors.”

Nobody, including investors, is quite sure where prime office yields currently sit. The sharpest we have seen this year is 5.85% for the Mint in Edinburgh, a 70,000 sq ft scheme acquired by Almack and Pontegadea.

Adopting something close to this figure as the barometer of the market could be key to unlocking spec development in regional cities in 2025, according to Will Kennon, executive director in CBRE’s capital markets team.

He claims investor sentiment towards offices has “materially improved” in the last six months in spite of the Budget, which has been followed by sluggish GDP growth and a rise in inflation.

“If investors are willing to underwrite development with a 6% exit yield, with the hope that the yield might recover to 5.5% [once complete], your metrics of performance are going to look incredibly favourable,” he said.

“With yields at 6%, development is going to become viable again because the occupational market is accepting of the need for rents to jump.”

While the investment market is showing signs of increased confidence in offices, the return of spec new-build development in 2025 will likely be limited to certain regional cities.

Manchester, Birmingham, and Leeds, due to their comparatively sharper yields, are the best placed, according to Kennon, while Page said cities with a strong talent pool will be most attractive to investors.

“Most investors have a longer-term horizon and would look for areas with a growing economy and more specifically areas that can retain a higher proportion of students; this is a good predictor of subsequent jobs growth,” he said.

Build costs

With rents going up and yields sharpening, the final stumbling block standing in the way of new-build office development is build costs.

There is bad news on that front. Rather than coming down or even flattening, the Building Cost Information Service predicts prices to keep going up. A 15% increase over the next five years is not as steep as it could be but still not ideal.

It costs around £330/sq ft to develop an office building right now. Before the pandemic and all of the economic upheaval that followed, it was more like £220/sq ft.

In this inflated market, developers should be “incredibly careful in choosing contractors and not be tempted by the cheapest bid”, Page warned.

If movement in yields and rents is enough to make projects viable, margins are likely to be slimmer than developers would like as long as the cost of materials and labour remains stubbornly high.

Parthena Reys is embarking on a comprehensive overhaul of One Hardman Boulevard. Credit: via RDPR

2025 – the year of the refurb

New-build office development in 2025 will be severely limited but the “acute supply of future-proofed stock provides considerable opportunity to reposition secondary offices”, according to LSH’s report.

Parthena Reys, which acquired the 350,000 sq ft One Hardman Boulevard a year ago, recognises this and is planning to pull the trigger on a comprehensive refurb next year.

The long-term view this investor takes means it is less impacted by soft yields. It also helps that Parthena got a good deal on the building when NatWest was keen to offload.

Elsewhere in Manchester, AM Alpha has already begun another mammoth office scheme – the redevelopment of the former Debenhams department store on Market Street.

These large schemes will come online at around the time Manchester’s new-build pipeline is due to run out, according to Lewis.

“Those that are brave now will win,” he said.

While new-build development has faltered over the last two years, refurbs have continued. They are generally cheaper and quicker to deliver and many landlords are taking the view that, if the building is going to sit there empty, you may as well do something with it.

3 Victoria Place and Rose Wharf in Leeds are both due to complete early next year providing 85,000 sq ft of refurbed space, while Igloo’s quirky Pattern Shop is now available. All are well-placed to soak up some of their cities’ pent-up demand.

Bruntwood, a long-term holder of assets, has been cracking on with refurbishments throughout the volatility of recent years. It is the company’s new-build projects – Ev0 and the aforementioned Alberton – that have stalled, although No3 Circle Square is nearing completion with Autotrader committed to around 130,000 sq ft.

In the coming years, we will see more businesses approaching lease events gravitate towards second-hand space in the face of limited new-build options.

Environmentally conscious businesses who might have preferred an operationally outstanding new-build will happily flip the narrative to suit their decision-making and satisfy ESG-conscious stakeholders.

After all, the most sustainable office is the one that already exists, right?