The Subplot | Queasy feelings, Amazon, pension funds

THIS WEEK

• That queasy feeling: what happens when the floor lurches underneath you? The office market may soon find out
• Elevator pitch: your weekly rundown of who is going up, and who is heading the other way

YOUR NEW FAVOURITE WORD

What is happening to the office market?

Something peculiar is going on, and it has a peculiar name. Meet your new favourite word: hysteresis.

It sounds like the kind of tablet you take to stop itching, but hysteresis is the name physicists, electrical engineers and, increasingly, economists, give to situations where cause and effect are separated by a fairly longish gap in time. Imagine the mythical oil tanker attempting a change of direction: the captain gives the order, the wheel is turned, and only days later do you see the results. Changes of direction blighted by hysteresis involve periods of uncertainty – they might leave you feeling all at sea.

And that’s the problem: it’s queasy stuff. Because the North West office market might be in the midst of a change of direction, everyone can feel the propellers churning – only it is hard to see where we are going.

Reading the signals

You can tell something’s happening because the data has gone a little fuzzy in exactly the places where it ought to be pin-sharp. In particular, an increasing amount of good new office space – the kind we were told benefited from a “flight to quality” – is standing empty. Subplot pointed to one Manchester example last month. So, for instance, JLL’s latest Big Six regional cities report for the first half of 2022 shows that the Grade A vacancy rate (year-on-year) in Manchester is up (from 4.8% to 6.1%). The overall vacancy rate – for offices of all kinds and qualities – is up too year-on-year, but by nothing like so much (up from 6.1% to 6.4%). Knight Frank data points the same way, showing Manchester Grade A availability at a record 912,000 sq ft, up 4% year-on-year.

Flight to or from quality

This is not the story we were told to expect and maybe it is why JLL’s in-house commentary choses to talk about other data instead, stating: “The amount of vacant space on the market decreased in Q2, and the overall vacancy rate fell from 6.9% in Q1 to 6.4% in Q2. Occupiers are increasingly focused on good quality new space, especially if it can offer excellent ESG credentials. The flight to quality means that the amount of new space available remained scarce and the new-build vacancy rate edged down to 2.8%.”

A tale of two cities

The JLL official story, and the unofficial one the data also reveals, can both be true: they have different starting points. What makes the unofficial one feel significant is that it chimes with trends seen elsewhere. Look at London – these days a better approximation to Manchester’s office market than Birmingham – and you learn that office availability in central London is now over 31m sq ft, its highest in more than 15 years, and up 20m sq ft since Christmas 2019. Okay, this is offices of all types and kinds, but it is a staggering increase showing a stomach-churning fall in demand for floorspace. This is where the nausea of hysteresis kicks in.

Don’t have sleepless nights

Should that make you reach for the sick bag? The answer from the city’s office market is a firm ‘no’. Why? Because this is a blip. The Grade A availability figure shot up because 470,000 sq ft of new space recently completed, and there won’t be much more new space until next year, therefore the “impact on the vacancy rate will be minimal,” Knight Frank concludes. And yes about 300,000 sq ft of deals are pending for Grade A floorspace. But that still leaves about 600,000 sq ft of Grade A unoccupied and on the market. Which is still an awful lot (more, for instance, than any year before 2019).

Reasons to be cheerful

The consensus is very much against getting worried. Lee Treanor, director at HBD, tells Subplot: “Grade A office space, by its nature, is delivered periodically and at scale, which leads to fluctuations in supply.” Of all the transactions completed in 2021, some 27% achieved more than £30/sq ft, in comparison to 11% in 2020 and 9% in 2019, demonstrating the flight to quality that we are continuing to see. Chris Cheap, managing director of UK regions at Avison Young, explains: “The increased void is going to be a short-term position, as there is currently a significant amount of prime space under offer in central Manchester. Third quarter take-up figures will bear this out and reinforce the flight to quality argument, which is still a firm market dynamic.”

Yet more hysteresis?

Cheap points instead to another potential case of hysteresis. “With continued healthy levels of demand the bigger issue to consider may be a potential lag in the pipeline of Grade A office space beyond the current cycle,” he says. “Inflation and other macroeconomic influences make it increasingly difficult to get development appraisals to work. To an extent, continued upward pressure on rents will help, but significant work around costs will be required to maintain a healthy pipeline of workspace which delivers in terms of design, sustainability and developer return.”

None of this means doom. Treanor and Cheap are reliable guides. But remember that inflation blip that turned out to be less blippy than everyone hoped? The numbers suggests that somewhere in the deep ocean currents of the workspace economy things are changing. A hand on the wheel may be necessary – in fact, the wheel may already have been nudged (see Elevator Pitch, below). For now the best any of us can do – like passengers on the unsinkable Transatlantic liners of the last century – is listen for the sound of the propellers… and pray they don’t stop.

Place North West’s Offices + Workspaces Update on 20 October will delve more into the changing face of offices and the current market pressures.

ELEVATOR PITCH

Going up, or going down? This week’s movers

Inflation changes everything, as we are all learning. Amazon’s warehouse requirements appear to be stuck between floors, but pension fund investment in real estate is still in transit. Going up!

Pension fund investment

UK, European and North American pension funds have been one of the steadiest sources of funding for North West property. In an era of high inflation, will they still be as active?

Ortec Finance, which advises on risk management for pension funds, has been asking around. The answer is very likely yes, although the scale isn’t clear. Ortec’s international study shows more than half have switched investments to commodities (56%), inflation-linked bonds (56%) and infrastructure (51%). More of the same is coming: more than half (53%) plan to increase allocations to bonds, while nearly half (49%) will switch to commodities, and 49% to real estate investment trusts over the next 12 months.

The enthusiasm for REITs is interesting. This suggests a potentially changed, but not massively diminished, appetite for real estate. The generally fairly steady North West property market, and underinvested infrastructure scene, should be a beneficiary. Fingers crossed.

Amazon warehouse deals

Amazon has been the dominant name in the UK’s warehouse property sector for so long it is tempting to think they can’t go wrong. But data from a Canadian logistics analyst, MWVPL, suggests a modest correction in strategy.

MWVPL said Amazon overbuilt its distribution network in 2020 and 2021, adding 60% more floorspace while sales grew by 37%. The result is a programme of “cost avoidance,” which means delaying expensive greenfield developments, serving markets from existing fulfilment centres, and junking warehouse deals that hadn’t reached signature. It is not so much the floorspace they don’t want as the payroll bill and fit-out costs that go with it. Closures of existing warehouses are not expected, and Amazon hopes to grow into its new floorspace very soon.

“They are not slamming on the brakes, they are easing off the gas pedal,” the commentary says. One to watch.

Get in touch with David Thame: david.thame@placenorthwest.co.uk

The Subplot is brought to you in association with Oppidan Life.