Back in June 2016, there was little reason to be optimistic about the outlook for the UK office market.
It was widely accepted that uncertainty over the UK’s future relationship with Europe would cause businesses to postpone or abort operational decisions such as relocations, and leasing activity would fall. This was also expected to lead to a rise in the supply of office space as firms were displaced to the continent.
Crucially, Brexit has not yet happened. However, we can apply what we have learned about occupier and investors’ attitudes to the UK office market to make some predictions about how the market will perform after Brexit.
On the eve of the EU referendum the UK had been the fastest-growing economy in the G7. The latest GDP figures suggest that the UK is now growing at a slower rate than any other G7 economy, growing at 0.7% for the three months to August 2018. Estimates suggest that the UK economy was between 1.0% and 2.5% smaller than it would have been without the Brexit vote.
In addition, UK wage growth accelerated at its fastest rate since the global financial crisis while inflation fell back to 2.4% in September.
Until there is clarity over the nature of our departure from the EU – a deal or no-deal scenario – forecasting economic growth is difficult. Strong growth in the global economy has arguably offset the negative effects of Brexit uncertainty; should global economic growth weaken, the effects of Brexit on the UK economy could be significant.
The most recent consensus of 14 independent forecasts published by HM Treasury, which was released in August 2018, suggests GDP will increase in 2019 to 1.6%, gradually increasing thereafter to 1.9% in 2022. For the time being, the economy looks stable.
Employment & headcount
The UK unemployment rate is currently at its lowest level since 1975 at 4.0%, which may be surprising given Brexit uncertainty.
While this supports the strong levels of office take-up and falling supply in the UK office market, it does create its own problems. The UK economy is approaching full employment, which is accepted to be a stable rate of unemployment of around 1% – 2%. As the economy approaches this point, the creation of new jobs must necessarily slow, leading to slowing demand for additional workspace. In fact, forecasts suggest that the unemployment rate is likely to remain stable at just above 4% for the next three years.
This time last year, the Bank of England predicted that Britain could lose as many as 75,000 financial services jobs because of Brexit. At the time, this was the worst-case scenario, based upon leaving the bloc with no deal in place. A number of commentators have discredited this forecast, pointing to the fact that relatively few financial services firms have so far left the UK; we must remember, of course, that Brexit has not yet taken place.
There is cause for optimism. Importantly for UK offices, relatively healthy employment growth is forecast for the business services sector, with technology and professional services picking up any slack from job losses in the financial sector.
Occupier demand – technology sector
The business sector that has seen the most impressive growth since the referendum is technology. Venture capital investment into the UK tech sector totalled $4bn in 2017, almost double the 2016 level.
The UK’s status as one of the world’s top technology hubs looks set to continue. KPMG’s latest Global Technology Innovation report has ranked the UK as the third most promising market for innovation, disruption and technology breakthroughs after the US and China. Outside Silicon Valley, London is the most connected tech ecosystem in the world; a third of all tech firm customers are based outside the UK. To some extent this insulates the tech sector from the effects of Brexit.
So, what will happen to the tech sector after Brexit? Talent acquisition and retention is a key factor in the growth of successful tech firms, and many in the industry fear that an inability to hire foreign skilled workers after Brexit will lead to a skills shortage.
The most severe effect is likely to be felt in the small and medium-sized enterprises, for which Brexit uncertainty means they are unable to invest in future growth. While detrimental to the traditional office market, this uncertainty may provide a boost to flexible workspace providers.
Conversely, the FAANG companies have continued to grow their London footprint since the referendum, signing long-term commitments to remain in the UK. Tech businesses of scale will continue to grow in the UK, not least due to the ability to acquire smaller businesses and consolidate.
Occupier demand – professional services sector
In normal market conditions, the professional services sector has traditionally been one of the fastest growing sectors, and in the context of Brexit uncertainty, could continue to outperform.
In the longer term these firms risk losing headcount due to automation, however in the immediate future, demand for accountants, lawyers and management consultants will strengthen as firms seek help navigating Brexit.
The UK’s top 100 law firms generated £24.1 bn of revenue in 2018, a 10% increase on the previous year; the overall 5-year revenue growth was an impressive 28%. Since the referendum, the legal and regulatory environment has become more complex, and will continue to do so beyond March next year. In addition, there is likely to be an increase in M&A activity as businesses look to strengthen their positions in preparation for ‘worst case’ scenarios.
Management consultants are also in line to benefit from the implementation of new strategies to cope with a post-Brexit environment. The government is already reported to have paid McKinsey and Bechtel £1.9m to design and install a computer system to help deliver Brexit on time.
Accountancy firms have already reaped the benefits of helping clients Brexit-proof their businesses and prepare for life after March 2019. A study of the UK’s top 100 accountancy firms by Accountancy Age found that fee income increased by £1bn over the 2017 figure, and was £2bn up on 2016.
Occupier demand – flexible offices and co-working
The considerable increase in flexible offices across the UK represents a systemic change in the working environment. Estimates suggest that the UK freelance economy has grown by over 25% since 2009, and now accounts for around 2 million workers. While the outlook for the UK economy remains uncertain, established firms will hire a greater number of freelancers for the flexibility they offer and the ability to reduce fixed costs such as payroll and real estate.
In addition, established companies are likely to incorporate flexibility into their real estate strategies, generating demand for project space and touchdown space for teams without a business need for permanent workstations. This will increase demand for flexible work environments.
However, the possibility of a hard Brexit also presents significant disadvantages for flexible office providers. In the event of a severe slowdown in economic growth, providers with excessive debt could be put out of business, which may trigger a fall in rates, which will impact profitability. Moreover, camping out in a coffee shop is likely to be more attractive to the freelancer than paying for a dedicated co-working space, in the context of a weak economy.
Real estate investment
Investor demand for UK commercial property has remained buoyant throughout the two years since the EU referendum. Interest from overseas buyers has continued, although in reality these investors have enjoyed a currency advantage since the global financial crisis; the triggering of Article 50 simply provided an additional discount through further weakening of the pound.
A great deal of overseas capital has targeted the UK due to its relative political stability, transparency of law, common language and diversification from the US dollar; over the last three years overseas purchasers have accounted for more than half of all capital invested in UK real estate. Despite Brexit, these broadly remain relevant, and equity-backed overseas purchasers still consider the UK an attractive investment environment. Furthermore, the search for yield has continued to draw investors to the UK.
After Brexit, these factors are still likely to attract overseas investors looking for safety and yield. However, lenders across the world will most likely view Brexit as a significant increase in risk, which will suppress the availability of debt to both overseas and domestic buyers.
Overall, the global weight of capital chasing UK assets and the market’s liquidity should protect against any significant outward shift in pricing in the short-term, although yields will soften in most markets should interest rates rise.