The Subplot | Should we be worried about office vacancy rates?

This month’s long read

• Pretty vacant: do more empty offices mean more trouble?
• Elevator pitch: your guide to what’s going up, and what’s heading the other way

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THE OFFICE MARKET PUZZLE

The mystery of the forever-rising vacancy rate

Vacancy rates are still climbing in the North’s major office markets – and they probably haven’t peaked. But landlords, agents and investors are upbeat, declaring the urgent need for new supply. Should they be so confident?

The volume of empty but on-the-market office floorspace in the North’s major cities has been growing for the last four years. The trend shows no sign of slowing. CoStar mined the data for Subplot and reports that Manchester’s vacancy rate has climbed steadily, more or less month by month, from a Q1 2020 low of 5.1% to today’s 9.5%. In Leeds, the same journey has a steady climb from 4.1% to 7.2%, and in Newcastle, it is 6.7% to 8.9%. Liverpool and Sheffield landed at 7.2% and 8.1%. This is all bad.

The upsides

The best you can say is that the rate of growth is slowing, but that’s about it. “The vacancy rate has risen in all markets over the past four years between 200 and 430 basis points, amid relatively strong deliveries and weak net absorption, as occupiers moving out of space have outpaced leasing activity,” says Giles Tebbitts, CoStar’s director of market analytics in Manchester.

We don’t care

The agency world is by no means downhearted. That’s because the top end of the market appears to be doing okay. Yes, the future of a lot of lower-grade office floorspace leaves them chin-rubbing – much of it will have to leave the market forever – but overall they’re chipper.

Some Manchester occupiers who’ve been in the market for literally years – like Autotrader and Bank of New York Mellon – appear to be on the brink of landing, signing up for 130,000 sq ft and 200,000 sq ft, respectively. Others, like IT business Arm, are expected to increase their floorspace, roughly doubling it to 60,000 sq ft, or so the story goes.

Nice numbers

Looking at the numbers from a take-up rather than the vacancy angle makes everything look better. First half 2024 take-up in Manchester was 32% up on the same period last year, and there are rather more than 500,000 sq ft of deals about to land.

“There is only 376,233 sq ft of Grade A new build current and committed supply. Given the average annual Grade A take-up is 500,000 sq ft, this leaves under a year’s worth of Grade A supply,” says John Ogden, CBRE’s head of UK regional markets.

Okay, so vacancy levels are relatively high, says Ogden, but vacancy levels in Grade A space are relatively low. Hence lots of interest in creating good refurbished space like 1 Hardman Boulevard, Sunlight House, and 35 Fountain Street. This is no time for landlords to dither.

Not yet, please

However, landlords are likely to dither. For instance, there is a widespread suspicion that Landsec is soft peddling at the 2.5m sq ft Mayfield development. “Lots of leaps of faith are needed” Subplot was told about Mayfield.

Meanwhile, some of the really big refurbishment opportunities in Manchester are maybe too big. The Rylands Building (Debenhams), the former Kendals on Deansgate, and even the former Royal Bank of Scotland offices at Hardman Boulevard, are monsters. With refurbishment costing upwards of £250/sq ft, a 350,000 sq ft block adds up to a fortune. With construction costs high, and money expensive, that’s not something to consider lightly. Splitting the huge cost into phases is the obvious answer but even here it’s tricky.

“It’s the sheer size that makes them head-scratchers,” says Knight Frank Manchester boss David Porter. “Great buildings, good locations, and they can’t be knocked down. But it’ll mean a clever story to get it redeveloped because how do you do phasing on a single building?”

Yorkshire grit

Leeds is a bit different. The second quarter office take-up was disappointing at just shy of 100,000 sq ft, less than half that recorded in Q1. City centre office take-up in the first half of 2024 totalled 348,332 sq ft, down 15% on 2023. A lack of new stock has been blamed.

So build!

On this widely shared view, the problem in the Northern markets isn’t high vacancy rates but slender development pipelines. Eyes are turned enviously to the residential property sector where the Greater Manchester Combined Authority’s housing investment loans fund has been priming the pump. Perhaps they could do some office market pump priming, too?

Try these numbers instead

The alternative view is that the property market is looking at the wrong numbers. Instead of focussing on take-up figures which are, in any case, unclear, they need to look at net absorption. The result would be a useful change of perspective. The spokesman for this case is Les Lang at Till Asset Management, whose business presides over Salford’s Exchange Quay and the Manchester International Office Centre, among others.

We all know

“It’s like being at a party, and everyone knows something about one of the guests, and nobody is saying,” says an exasperated Lang. “The big agents don’t talk about net absorption, and it’s very frustrating.”

Lang has the take-up figures in his cross-hairs. “So Manchester city centre saw 330,000 sq ft take-up in Q2, but about 100,000 sq ft of that is management agreements. That means space that’s not been disposed of, not let.”

On this view, there’s a need for clarity on how much more space is being occupied (new lettings less leases that fall in). Without that, we’re flying blind. Or worse, guessing.

Caught in the net

Lang is right that net absorption data isn’t widely shared in the UK. Where it is in regular use – US cities, London – the result is a lot more realism and/or gloom. London figures produced by Cluttons show the problem – which is that a great deal of London floorspace has come onto the market, and that flow is only just ending.

Not very interesting

CoStar looked at net absorption in the main Northern markets and the result is surprisingly dull. Manchester’s net absorption from 2015 to 2019 was +204,000 sq ft, and from 2019 to today was +6,300 sq ft. That’s a move from a fairly balanced market to a very balanced market.

Leeds had a rockier time (+137,000 sq ft and then -28,000 sq ft), with Sheffield, Liverpool, and Newcastle telling a similar story. Every city except Manchester saw a net return of floorspace to the market since 2019, but it was all fairly small beer. But please note, you can calculate net absorption in different ways – potentially other methods would produce less tranquil results.

The big dilemma

So do the Northern cities need to worry about vacancy rates, or not? Vacancy rates are still going up. You might expect that growth in net demand in Manchester, Leeds, and Sheffield, combined with a relative lack of new supply, would push the vacancy rate down, but it hasn’t. Clearly something is falling between the cracks, or the data is wonky. The go-to solution for most observers is to say that this is because the Grade A market is now operating autonomously, and so all-market up-summings aren’t very useful.

It may be that real-time testing of this theory is needed before we know whether rising vacancy rates are cause for concern – or for yawns.

ELEVATOR PITCH

What’s going up, and what’s heading down

Suddenly the strong dollar might be in danger, which could be a downer for Northern real estate. Meanwhile, data centres look set to rocket. Doors closing, going up.

The dollar

Getting excited by the Trump/Harris fight for the US presidency? Maybe you should, because it could have a real impact on Northern property markets. Here’s why.

US investment in UK commercial property is at a 10-year high, the latest data shows. Not only are the cousins spending more, they are selling less, which means the net stock of US money in UK real estate is going up. CBRE said US net investment in the last two years is up £8bn. North American money bags splurged a further £2.6bn in the first quarter of Q1, says CBRE.

Analysis from BNP Paribas Real Estate puts it higher at £3bn, up from £1.9bn in Q1 2023.

Its likely Q2 will be even better: Knight Frank expects US investors to channel approximately $13bn into UK real estate throughout 2024, an increase from $10bn the previous year.

The context is that plenty of that money is heading north. New York-based KKR is behind the Manchester St Michael’s development, whilst Dallas-based Trammel Crow Company is expanding into the Manchester office market via subsidiary Contour. In Leeds, New York-based Citi Private Bank paid £38.5m of the 140,000 sq ft block at One Sovereign Street, and there are rumours of more to come.

The explanation lies in dollar/sterling exchange rates – and the strong dollar that makes buying in the UK look appealing. The spiralling crisis in the US office market adds to the appeal of transforming funds from US central business districts to (relatively safe) London, Manchester, and Leeds.

So what happens if US policymakers decide a strong dollar isn’t such a good idea? Then the relative appeal of investing in UK commercial property falls, perhaps substantially. Donald Trump has repeatedly said a strong dollar hurts the US economy – and if he wins, he’ll try to devalue. The last attempt to devalue the dollar was in 1985, and didn’t go spectacularly well, so there’s no guarantee of success. But if The Donald gets his way, watch out.

Data centres

Angela Rayner’s planning shake-up will include tweaks to make it easier for data centres to win planning consent. The sub-sector is already a nice little earner for some Northern landowners. In the last quarter, Microsoft agreed a £106m land deal with Harworth for 48 acres at Leeds’ Skelton Grange and Blackstone eyed up a £110m site at the Northumberland Energy Park, Cambois.

A surge in data-hungry AI technology, and a seriously under-supplied London market, are together driving demand northwards. CBRE’s half-year estimate was that availability – measured in power, rather than sq ft – had sunk to a six-year low of 119MW. Land, and power, is more easily available out of the South East. It is also a bit cheaper.

Rayner’s direction of travel became apparent a fortnight ago when she called in two large Green Belt data centre applications for sites in London’s leafy hinterland. Both had been rejected until she intervened.

Rayner’s Tuesday statement in the House of Commons included the line: “Alongside building the housing that we need, the government is committed to making it easier to build key infrastructure such as laboratories, gigafactories, and data centres.”

It’s not yet clear what that means, or what size thresholds will be involved. But for plenty of risk-averse Northern landowners looking at a dip in big shed activity, this could be a seriously interesting alternative.