The Subplot | Why the Budget could kill the Grade A office

This month’s long read

• Oops!: could the Budget have inadvertently kicked the legs from under the high-spec office market?
• Elevator pitch: what’s going up, and what’s heading the other way

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THE LAW OF UNINTENDED CONSEQUENCES

Save our pot plants

Did chancellor Rachel Reeves’ first Labour budget inadvertently upend the swanky well-being-focused office market? Maybe so, if you think Labour’s massive tax hike is going to cause serious damage to the labour market.

Life is one long lesson in unintended consequences. Politics and economics, even more so. One of them could be that the newly reinvented post-Brexit, post-Covid office market has just had the rug pulled from under it by the rise in employers’ National Insurance contribution, plus a Labour budget that (says the independent watchdog) isn’t going to produce any economic growth in the next five years. If you’ve 10 minutes to spare, try this argument out for size: you may be hearing a lot more of it fairly soon.

It’s ok, for some

So, where does the office market in the North start this argument? Answer, in a fairly good place, if you squint. CoStar data, released this week, tells the tale. UK office take-up in the third quarter of 2024 was up 25% year-on-year as business confidence grew, and up 15% on Q2. Manchester, a monster office market, did particularly well – recording its largest office letting in a decade as Bank of New York Mellon took 199,000 square feet at 4 Angel Square. This deal propelled Manchester office take-up to a seven-year high, and up 61% compared to the summer quarter.

Prime rents up

Rents are up, too. Just last week, Place North West reported that CBTax had signed up 5,400 sq ft on the 13th floor of No1 Spinningfields in Manchester, paying £42.50/sq ft in a deal with Schroders Capital. This is just a shade below the £44/sq ft S&P Global will pay at No1 St Michael’s.

The bigger picture

Better still, the good office market news stretches well beyond Manchester: BNP Paribas Real Estate reported that office market activity surged in most of the Big Ten UK markets in Q3: Leeds Q3 figure was 146,000 sq ft, up on the five-year average, and rents held steady at £39/sq ft. Sheffield saw Q3 up 25%, but it’s a complicated market so judgements should be cautious. Liverpool and Newcastle were the exceptions. In Liverpool, take-up was down 16% on this time last year, and 38% on the 10-year average. Some work to do there. Newcastle was down too, but a lack of Grade A floorspace seems to be the problem – which plays to the narrative that occupiers want fancy new floorspace.

Big spenders

This narrative is playing out in real-time. Last week, Parthena Reys revealed plans to rethink the 350,000 sq ft former NatWest office in Manchester’s Spinningfields. One Hardman Boulevard will have a roof terrace, lots of jutting-out interior terraces over a big central atrium, and will “set a new standard for the city.”

But also this

All this happy news comes with some caveats, and again CoStar has the data. Despite the big jump in the third quarter, national office take-up was still 13% below the pre-pandemic five-year quarterly average of 12m sq ft, a figure no quarter has hit since the pandemic began. Meanwhile, net absorption, a more accurate measure of demand that takes into account space being vacated as well as new space occupied, not only stayed deeply negative, but got worse in the last two quarters. The vacancy rate is 8.5% and rising, its highest since 2013.

Remember the new normal?

Conclusion: the office market is okay in parts. So let’s rewind and see how we got here. The background is this: pandemic chatter about a “new normal” in which offices were downgraded, or smaller, or would be out-of-town, turned out to be overblown. Instead, having spent two years locked up watching lifestyle programmes on TV and binging on Instagram, employees and bosses alike wanted to go back to work – albeit only three days a week – and they wanted cool well-being havens, not white-collar factories. No nasty bugs, no nasty coffee. Thus offices died, and the modern workspace was born.

It’s all about the workers

Behind all this was a labour shortage. Recruiting the right people got harder – partly because employers got picky – but mostly because there were plenty of jobs to go around. Brexit and various social trends did some of the damage, but about a fifth of the workforce dropped out to become economically inactive, and the pandemic shares a lot of the blame. Thus, yesterday’s work-a-day staff became tomorrow’s precious talent, and famously the war for talent was everything. If giving them handsome non-wage benefits like nice offices and flexible working was the price businesses had to pay, so be it. The corporate world also bought heavily into ESG/sustainability – how deeply is a moot point – and it provided a pull-factor at the same time as the shortage of talent provided a push-factor. Result: demand for offices-as-hotels grew sharply.

Protect our wages!

All of which raises the question: what happens if the labour market changes, or reacts differently? Is there evidence the labour market is on the turn? Yes, there is. Whilst the Office for National Statistics’ labour market survey shows stability, the more reliable wage data shows a consistent pattern: wage growth is slowing, suggesting the labour market is less hot. Over the summer, wage growth dipped and average total earnings dipped even more.

“In real terms (adjusted for CPIH inflation) earnings growth remains weak and also slowed. Real-terms regular pay growth stands at 1.9%, down from 2.2% last month, and real-terms total pay growth fell to 0.9%, down from 1.1%,” said Income Data Research, who keep an eye on these things.

Wonks agree

The Institute for Fiscal Studies agrees. Its recent analysis talks of “excess labour demand – present through 2022 and 2023” that is now being eliminated. The labour market is loosening, they say, and unemployment will begin to rise from 4.9% next year to 5.3% in 2026. In other words, the red-hot war for talent is largely over. The result is slower wage growth and a dent in consumer confidence.

Pay us more, forget about the pot plants

This is where the hike in employers’ National Insurance contributions joins the party as one among a constellation of labour market pressures.

In the background: chancellor Rachel Reeves’ budget makes it more likely that UK interest rates will stay higher for longer. Rates will also come down slowly, if it all, in the US where a re-elected President Trump’s fondness for tariffs and borrowing will stoke inflation. Lower real-terms income, slowing wage growth, rising unemployment, higher taxes: none of this is likely to make employees feel fancy-free and foot-loose. If trading in the pot plants and nice office furniture keeps their wages up, they will probably take it.

The bosses say yes

Until now the bosses’ calculation has been that it’s worth pressing on with the non-wage elements of employment (like fancy offices), but what if the priority is keeping wages up? To keep wages up, employers will have to swallow the cost of the NIC hike – why not cut out fancy offices? If both sides make this calculation, the office market’s post-pandemic reprieve could get a chill. As winter deepens we will soon find out.

ELEVATOR PITCH

What’s going up, or heading the other way

Co-living in Leeds makes a juddering ascent from the basement to the lower floors – will it get any higher? Meanwhile, Peel has offloaded the final slice of MediaCity Salford, raising hopes that may not be entirely justified.

Ducks’ backs

It’s probably water off a duck’s back for Peel, but reading the below-the-line comments on Place North you could begin to think they weren’t a very popular developer. The gist of the complaint is the slow pace of progress.

So good news for Peel, which may have bought itself some popularity by bailing out of the 52-acre Media City development in Salford Quays, selling its remaining 25% stake to LandSec for £83m. They sold the other 75% in 2021.

Hopes are high that the consolidated ownership will mean the breaks are off, and MediaCity swiftly turns into something more dynamic. Around 800,000 sq ft of commercial floorspace is on the cars, one day.

Whether LandSec is, in practise, keener on risking an enormous out-of-town office development than Peel is something we will soon discover.

Come live with me

The slow-moving co-living bandwagon has moved on, this time trundling through Leeds.

Watkin Jones is looking to convert the former Direct Line offices at Headrow House. They will pay £2.45m in lieu of on-site provision of affordable homes for the pleasure of doing so.

Office space will be converted into 230 co-living studios, on designs by Swap Architects. It follows similar Watkin Jones projects in the South West.

The 10-storey building has been empty for three years, so redevelopment is more than welcome.

As has become traditional in the world of co-living, planners pressed for bigger units. Watkins Jones, taking the worldly realist view, agreed. Studios will now be 307 sq ft each.

There may be powerful economic arguments for this kind of graduate-retention floorspace – if you assume graduates are fairly well paid – but planners remain cautious. Although the British Property Federation repeated its call for the government to offer firmer guidance by including co-living in the revised National Planning Policy Framework, Subplot could find no words in the consultation draft to bring them comfort. Officials are reconsidering the draft, an outcome is expected before the year end.