How to avoid a widening gap.
Investors and occupiers are increasingly prioritising environmental, social and governance (ESG) credentials as part of their appraisal process for office space across the UK. As the demand for grade A office space rises alongside the volume of ESG-related legislation for property owners, a two-tier office market of prime space with strong ESG credentials and obsolete office buildings is emerging. Owners of properties in the secondary market may become trapped in a cycle of weakening rents and lower capital expenditure, culminating in company failure, as tenants and lenders shy away from sub-prime office space.
The flight to quality
In the wake of the pandemic, office occupiers are re-assessing their requirements and demanding high-spec office space with strong ESG credentials. Today’s workforce is drawn to flexible, collaborative spaces with wellness features and amenities. As a company’s office buildings are a tangible expression of its values and ethos, businesses have increasingly been utilising office space as a tool to attract and retain employees.
This flight to quality has been evidenced by a growing imbalance between occupier demand and available supply of high-quality office space across the UK. Knight Frank reported that during Q3 2021 16.7% of available office space across London was comprised of new buildings, while secondary stock accounted for 83.3%.
As a result of the flight to quality, the disparity between the high rentals commanded by prime office space and discounted rentals offered by sub-par stock is becoming more pronounced. While prime offices are expected to witness significant growth in the mid-term, older stock will see a decline in rental income and occupancy rates. According to CBRE over the next five years, the best 25% of office space will see rent growth of 7%, while the lowest 25% will fall. Grade A office buildings have been proven to generate better returns for investors owing to higher rentals, longer and faster lettings and lower voids. Consequently, investors are increasingly adopting ESG criteria as part of their investment strategies, to better determine the future financial performance of office stock and its ability to drive stronger returns.
