‘It’s all in the price’: Schroders’ Nick Montgomery offers real estate health check

Peering into its crystal ball, the global asset management company debated the future of the property scene at its Manchester Investment Conference at The Lowry Hotel in Salford.

One of the star turns at the event on Tuesday was Schroder Real Estate fund manager Nick Montgomery’s TED Talk, which touched on the move towards sustainability in the built environment.

Fresh from stepping off stage, he sat down with Place North West to share his views on a range of topics from the health of the office market and the need for retrofit to why Schroders is avoiding investing in smaller regional cities.

What follows are Montgomery’s words, which have been edited for clarity and brevity.

Retrofit or new development?

It’s all in the price. If you read the press generally you’d be forgiven for thinking the office market is completely dead and very polarised.

Manchester city centre is a world away from Warrington, or Bolton, or Wrexham, or Bradford – these places that are satellites of the bigger cities like Leeds or Manchester.

We are seeing the rent behave in a very different way. There’s a chronic lack of new supply, so even in Manchester you can look at void rents and see the void rate for prime is about 4%.

If you go back to the early 1990s or the crash of 2009/2010 there’s a void rate of 10%. In some parts of Manchester, we went out of town and you couldn’t give it away.

The dynamics are as such that there is a lack of Grade A space.

NOMA is probably the best example at the moment. They were talking of doing a deal with the Bank of New York for about £45/sq ft.

Manchester rents, when I was up here, went from £30/sq ft to £35/sq ft. What tended to move was the incentive rather than the rent. But what’s happening on the new-build side is developers just can’t build it for any more than £45/sq ft, so if you want that brand new space you’ve got to pay up. So at our building in Spinningfields, which is probably still the best building in Manchester and the regions, we’re getting rents up in the £40s for secondhand space.

Because there’s that shortage of Grade A, Manchester City Council and councils more generally are very quickly getting their policies around whole carbon and embodied carbon in much better shape. They are increasingly challenging ground-up development.

We think there is an opportunity to exploit the fact that, for example in Manchester, almost 70% of existing building stock is over 15 years old. In Edinburgh, it’s something like 80%. So basically you’ve got a load of poor-quality buildings in a market where development is becoming increasingly harder, the opportunity is to buy Grade E buildings and reposition them.

St Ann’s House – we bought it about 18 months ago for a yield of about 8.5%. We think we can refurbish it and get £28, £30 a ft.

I think some investors look at that and think ‘I don’t want to take the risk, I’ll just buy prime’.

We’re beginning to see interest at No2 St Peter’s Square, for example. There’s a potential deal there. Investors are saying the gap between prime and secondary yields has never been as high.

In the last five years, total stock has fallen and the pipeline of new development is very constrained.

My preference would be to buy Grade B and use our asset manager’s expertise, particularly with boots on the ground here in Manchester, to reposition them.

Equally what we’re seeing at No1 Spinningfields is that we brought up an average rent of £30 five years ago, we’re now doing deals at £42.50.

The health of the market and potential change of government

If you reflect on the last 10 years in real estate,  the market is in a very decent place. Although rates may not fall as quickly or as sharply as markets were expecting six months ago, they’re going to come down.

Inflation, CPI is running at 2%. It might go back up again but it’s not going to be going back up to what we’ve had in the last few years.

If you’ve got that combination of growth, inflation coming under control, and interest rates falling – even that will provide support to real estate values.

Levelling up as it has been described by the current government hasn’t really delivered what it promised, for reasons that I think in some cases are quite reasonable – we’ve had the pandemic, the fiscal position has been challenging.

But if you look at what Manchester has achieved with the Northern Powerhouse, it can be done. Labour has committed and Michael Gove has made a commitment, maybe not to levelling up as defined but to more broad spread regional growth. That has to happen.

Manchester is almost doing it itself, without any really significant wider UK government intervention. It’s very much standing on its own two feet. You can see all the residential schemes being delivered.

The Resolution Foundation report talked about how the UK could recover its productivity, the key recommendation was to grow the big regional cities and I’m 100% behind that.

It’s about developing better quality, more affordable housing in the city to bring people in. It’s about improving the infrastructure to make it easier for people to get in if they are living out of town. It’s about the growth of local businesses, public sector partnerships, universities.

Our admin centre at No1 Spinningfields has 1,000 people there now. It’s amazing. I’m optimistic that with a change of government or the same government, we will see the continuation and focus on not just the growth of London but really importantly the growth of the regions.

Demand for office space

What we’re seeing on the ground is that London is pretty much back to normal. In our office now, Tuesday through to Thursday is pretty rammed.

In real estate, this tendency is probably higher than anywhere else because it’s unacceptable as a real estate investor to be sat in the Home Counties, and if we’re not in the office we’re on the road.

In London, the hotels are rammed, the flights into Heathrow are back at pre-pandemic levels, the retail spend at Oxford Street and Bond Street is right up where it was.

I think in the regions it’s more polarised. Central Manchester seems to be getting back to where it was but there does appear to be more of a spread between companies prepared to allow the flex.

But what we’re seeing is that it is not affecting market rents. If anything, what occupiers are wanting is better quality space and better amenity to attract talent and give that incentive for people to come back in.

As a city, Manchester is still surprisingly car-dependent.

If you’re in a South Wales or less populated part of the North East and you’ve got a local authority building, that’s where the return to work rates are much lower and it’s understandable as they don’t have the same pricing power.

In many cases, those local authorities are the leading employer in the town. We went over to Birkenhead because I wanted to look at a deal and they’ve built this beautiful new council office, and the town centre was very quiet because the staff weren’t back. To the guys who own the café, the bar, the dry cleaners, in those smaller towns it makes a big difference so that is a challenge.

We have deliberately not invested in the smaller regional cities.

Manchester plans

At St Ann’s, we are beginning to work up a design so you’ll see that come through.

At City Tower we’re working very closely with the council on the square as well because the council is about to appoint an architectural firm to do a full study of how they can make Piccadilly Garden more of an attractive entry point to the city.