Office

Liquidity in the office investment market will return when interest rates start to fall in the second half of 2024. Take-up of office space in UK markets will improve over the course of the year and prime rental growth is forecast for most markets.

Key Takeaways

1. The interest rate environment has dominated the office investment landscape since they started rising in the second half of 2022, severely constraining volumes. This will ease in the second half of 2024, but investment volumes in the first half will remain low.
2. Having moved out in 2023, prime office yields in most markets will start to compress by the end of 2024.
3. The impact of interest rate rises will halt the expansion in the office jobs market. Following healthy increases in the last two years. we expect office-based employment to remain largely unchanged in 2024.
4. Despite slowing jobs growth, UK office take-up in 2024 is expected to increase relative to the levels seen in 2023.
5. Demand for the best quality buildings in the best locations will remain robust in 2024. This will lead to rental growth in most UK office markets at the prime end of the spectrum.

Investment to remain subdued; leasing will improve

Interest rate rises dominate the market

The office investment market in 2023 was severely constrained by the steep increases in interest rates. The first three quarters of 2023 saw £6.5bn invested in the UK office market, with a further £3.1bn expected to transact in the final quarter of the year. This would take 2023 office investment volumes to their lowest level in 20 years.  

The increase in interest rates caused a repricing of office assets in the UK during 2023. Prime yields in all office markets tracked by CBRE will end the year higher than they ended 2022, with average yield expansion of 75 basis points across the UK office markets.

Our forecasts suggest the Bank of England base rate has peaked and will remain at 5.25% throughout the first half of 2024. However, there is the real prospect of rate cuts in the second half of 2024, with base rates ending the year at c.4.75%. Moving from an environment of expected rate increases to an environment of expected rate cuts will filter through to the cost of debt. The full cost of debt for prime stabilised office assets is forecast to fall from the Q3 2023 level of 6.9% to 6.2% by the end of 2024. 

The fall in interest rates will see UK office yields stabilise during 2024 and will start to compress from the second half of the year in most UK office markets.

Figure 7: All-in cost of debt (%), prime UK office

Source: CBRE Research

Volumes will increase in 2024, but remain low relative to trend

The combination of yield stability and falling debt costs will stimulate investment activity in the UK office market in 2024, with a weighting to the second half of the year once interest rates start to fall. Full-year investment volumes for 2024 are expected to increase substantially from 2023 levels but will remain low relative to the 10-year average level of £22bn.  

Weaker jobs growth in 2024 

After having seen substantial increases in 2023, office-based employment growth is expected to halt in 2024 as the impact of interest rate rises takes effect on the UK economy. Current forecasts suggest zero net growth in office-based employment in the UK office markets tracked by CBRE.  

Despite the slowing of employment growth, take-up in the UK office market for 2024 is expected to increase relative to the levels seen in 2023, as macroeconomic volatility diminishes.  

Supply and demand imbalance will drive rental growth 

There was a clear flight to quality in 2023, with demand for the best quality, best located, most environmentally sustainable buildings outstripping supply. This partly reflects occupiers using their buildings to attract employees to the office in a hybrid working world. We expect this trend to continue into 2024 and beyond. 

Elevated demand for the best quality space has depleted the development pipeline. Of the space currently under construction across the UK office markets and due for completion in 2024, a total of 37% has already been acquired by occupiers. The continuing depletion of the development pipeline will create competitive tension for the best quality buildings and will increase rents at the top end of the market.  

Rental growth is expected in all UK office markets in 2024 at the prime end of the market. Forecasts for full-year rental growth average c.3% across most UK markets, building on a year of strong growth in 2023. Most markets saw new record headline rents achieved in 2023 and this is likely to be repeated in 2024. The best located buildings offering exceptional amenities and access to outdoor space will see super-normal rental growth. 

Figure 8: Office-based employment growth, UK office markets, 000s jobs

Source: CBRE Research / ONS

Return of creatives

Creative industries will return to the market in 2024

The creative industries sector, especially those which are US headquartered, have been the slowest to return to the office post-pandemic. As a result, demand for new space from that sector is significantly down from its pre-COVID norm. Since the end of lockdown, the share of UK office market take-up represented by the creative industries has been steadily falling. In the 12 months to the end of Q3 2023, it represented 13% of the market, almost half the level seen on average pre-2020. 

However, a combination of factors is leading to an expectation that 2024 will mark a turning-point in demand from the creative and tech sectors: 

• While retrenching from the standard office market, creative firms have been focusing their demand on flex space. In 2023, the creative industries represented 45% of all flex deals transacted by CBRE. Although the outlook for flex demand remains positive in 2024, many creative occupiers use flex space as a short-term solution. 2024 will be the year that they seek a more permanent solution
• Towards the end of 2023, a number of the largest US tech companies implemented strict return to office policies. This has had a positive impact on the office occupancy of many of those occupiers’ UK premises. Some large tech occupiers will need to acquire new space in 2024 to accommodate the large net increase in staff they now have relative to the levels pre-pandemic
• “Office-sceptic” US-based boards are realising that the malaise in the office sector in the US is not replicated in Europe, and will be more inclined to agree to office leasing transactions in 2024 than they have been at any point since the pandemic

Figure 9: Take-up of space by Creative Industries, rolling 12 months, sq ft and as % of total

Source: CBRE Research