These are interesting times in the commercial property market. Rents are still falling, and banks aren’t lending, but valuations seem to have stabilised and stock market investors are actually interested in the market again. But a lot of the reporting, inevitably, focuses on London. What’s happening elsewhere?

In Birmingham, Jan Thompson, head of the Jones Lang Lasalle Birmingham office, says all markets have slowed – industrial and retail as well as office. Birmingham has seen some major investment in recent years, particularly in the retail market, “Birmingham has made great strides to come up the retail league table with the development of the Bullring, but the next two developments are on the back burner.” No-one is building new. The same is going to happen in the office sector. There are still a few office developments being finished off, but he thinks once they are finished, there will be no more speculative developments. Not only is it next to impossible to secure funding, but the economics don’t work. “Construction costs haven’t come down, but rents and values have,” he says, and it’s difficult to attract tenants.

Of course the silver lining is that office stock, which has been expanding over the last few years, will start declining again. Thompson says, “That means the seeds of the next boom are already being sown – so it will be back to normal, boom and bust.”

But he believes there’s enough space at the moment to last two or three years, so we’re not going to see an immediate recovery. This is a bit different from the historic pattern. Over the past 25 years, Birmingham hasn’t had a constant supply of Grade A offices coming through, so that every time there is a boom, it results in a shortage of space and a big increase in rents. Birmingham office rents are the highest outside London and saw another boost early in this decade.

“But now,” says Thompson, “you have a good selection of buildings being made available just as demand tails off. So deals are going to have to get more attractive to tenants.” That may be through lower rents, or it may also be through higher incentives.





BIG NAMES BUT NO NEW BUILD

Over a million square feet is currently being made available; Thompson mentions Colmore Plaza (pictured right), by Carlyle Group, “which has twelve storeys and so far they’ve only let one floor”. Other developments are also failing to fill. Baskerville House, in the old Civic Centre, is about 40 per cent let; meanwhile the first building on Ballymore’s Snow Hill development has been 60 per cent let to KPMG and Barclays, but construction has been halted on the second phase, which was pre-let to Wragge & Co solicitors.

Thompson says, “That is quite a lot of stock considering that the normal take-up in the Birmingham market is round about the half a million mark.” And right now, there is relatively little private sector demand – most take-up is coming from the public sector. Rents are likely to fall. They reached £33 a square foot at the peak and though Thompson thinks landlords will still be looking for £30 plus, he says, “If I were looking I’d look for less and perhaps a three year rent free period too.” He usually represents the occupier – so Birmingham developers beware!

He admits that it is difficult to say exactly what level rents have reached, since “we haven’t seen a market-revealing deal yet.” The last, the Highways Agency letting at The Cube, was rumoured to have made £25 a foot, but Thompson points out that it’s not in the heart of the business district.

However what is clear is that the market is polarising, with an increasing gap between prime space and the rest. While central Birmingham rents are over £30 a square foot, smaller offices in Edgbaston might only achieve £8. “The smaller offices are going to be more vulnerable,” says Thompson, “and there are lots available.” Investors are interested, but activity is very low. “We’ve got people who want to buy in the prime space,” Thompson says, “but no-one’s selling. Values have shifted by 30 per cent or more, but you can’t get the kit.” The prime market in Birmingham is very small in size and there’s very little on the market. When one property in St Philip’s Square came up for sale recently, bids were submitted and, Thompson says crossly, “We were gazumped!”



A weakening market in Cardiff

Owen Young, partner in charge of agency at Alder King in Cardiff, warns that what’s true of Birmingham is not true of Cardiff. “Every one of our offices is different – the market is different in each location,” something he knows through liaising with other Alder King branches. In Cardiff, the office market has weakened, but industrial enquiries were holding up well.

But the development scene is very similar to Birmingham’s. There are ten to fifteen local developers who lead the market, and they’ve put everything on hold. “People are not even finishing off schemes,” Young says. Even schemes that have been pre-let may no longer stack up if finance is required. Newport has done particularly badly; “it’s almost completely on hold,” with the railway station redevelopment and new rugby ground both being held up.

The office sector has been weakening since mid 2008. In the first half of the year, take-up was level with 2007, but in the second half of the year it fell markedly, bringing the year as a whole below the average level of the past five years. The market for office space has become increasingly polarised, with prime space doing best. If anybody’s moving, they’re moving to Callaghan Square, Young says; that’s a prominent MEPC scheme, which has planning permission for another 500,000 square feet. Otherwise, office enquiries are few and far between, and are mainly public sector orientated. Smaller office premises are seeing a very low level of lettings and significant incentives being given to new tenants.

Supply increased from 925,000 to 1,189,000 sq ft by the end of 2008; Alder King’s Market Monitor forecasts that it will increase further in 2009, with the completion of space at Capital Link and 3 Assembly Square. Unsurprisingly, Owen Young says, “Rents have been slashed on offices.” Grade A is holding up, largely due to the fact that up till twelve months ago there was a shortage of Grade A stock, but secondary rents have been hard hit. For instance, in the secondary market, Gleidr House in Llanishen was quoted at £11-12 a square foot but is now at £5, while Seaview Buildings, Ocean Park was quoted at £12.50, and is down to only £6. By comparison, Grade A rents of around £20- 22 are holding, but with highly incentivised deals sometimes needed to compete.

In retail, the good news is that the new John Lewis store in the St David’s 2 scheme is going ahead, despite the retailer having cancelled a number of store openings in other locations. But Owen Young points out that, “while John Lewis is the anchor tenant, I don’t think they’ve got many other tenants signed up.” That leaves the property less than 50 per cent let. Retail incentives have increased, even where rents have been stable. Anecdotally Land Securities may be offering as much as three years’ rent free at St David’s 2.


Industrial space for a £1 sq ft

Owen Young says industrial space, particularly in the M4 corridor, was holding up well till recently. “We’ve seen a little flurry of activity at Cardiff Gate Business Park,” he says, with some good recent lettings. But he doesn’t expect to see much improvement while manufacturing closures continue to have an impact on the region. And he admits that most new industrial rentals now are for small areas of floorspace – 800 to 1500 square feet.

GVA Grimley paints a less happy picture of South Wales industrial space, having already seen a marked decline in enquiries by the end of 2008. Starting rents are now as low as £1 per square foot, compared with £30-40 per square foot before the market decline, and GVA Grimley gives a £20-25 range for current rentals. Banks have almost stopped funding industrial space, wanting to see any scheme at least 30 per cent pre-let. New development in Wentloog and along the foreshore is coming to an end and no new development is being started; it may be at standstill by the end of the year.

In such a thin market, valuing properties is difficult. Owen Young says that “comparables are very few and far between.” The mix of business Alder King is taking on has changed, with a much more significant amount of asset recovery work – valuing for liquidations and administrations. “Valuing those is a difficult job,” he says – forced sellers never get the best prices.

He also notes that in industrial space, a two-tier market has developed, with a huge difference between the prices that owner occupiers will pay and the prices developers are willing to offer. Some developers have been looking to buy up large vacant spaces and chop them up into smaller units – that can be quite profitable. But developers will not over-pay. “If an owner-occupier came along,” Young says, “ you could get £3m for the same space that you could only get £1m for from a developer. But you might have to wait a lot longer to sell it.”

Of course the other factor affecting the industrial market has been finance. While lettings are still being arranged, freehold demand has fallen in line with the scarcity of finance. Banks will have to be more willing to lend before this market picks up.


Financial taps turned off

The picture that emerges from both Birmingham and Cardiff is of very thin activity, with stocks at a record high, enquiries at a record low, and rents consequently falling by up to 50 per cent from their peak. Rising unemployment is likely to further weaken demand, and further rental declines are likely. Increased incentives are also being seen in both markets, with increased rent free periods, as an attempt to limit the damage to rental levels and valuations.

However, the development taps have already been turned off. There is relatively little ongoing development scheduled for completion later this year, so that stock levels should now have stopped rising, and will start to decline. That looks very different from the situation in mid-2008, when the market started to turn, and new space was still coming on to the market as major developments were completed. Just how quickly development stock will be soaked up is debatable, though – given the current low level of interest, it could take two or three years. Second hand stock will also be coming back on to the market – and competition from cheaper refurbished properties could erode rents further for newly developed stock. So while we may be bumping along the bottom, we certainly haven’t turned the corner yet.

Still, some investors are champing at the bit. Valuations already discount further declines in rental levels, according to the bulls of the property market. With prime office yields in many locations back to the 2003 level, it’s not surprising that investors are beginning to look for bargains. Colliers CRE said in its Property Pricing Survey in March this year that “Buying is now back on the agenda with all sectors seeing increased activity.” As yet, the level of transactions hasn’t picked up – but there is some pent up interest in good quality, fully let buildings with good tenants and covenants and a stable, secure income stream. Good to hear a positive comment!