There’s often a disconnect between the occupier and investment markets in commercial property.
On the one hand, you have a strong occupational story, with investment levels failing to match – despite the obvious attraction of rental growth from a competitive market. It works in reverse too.
Normally, there are at least two factors behind this. First, the speed at which the market reacts to changing circumstances. Quite often, by the time a bull market pops up on many people’s radars, it’s already started to cool off; but investment continues to pour in as funds follow the early movers.
Developer activity also plays a part. Builders undertake new projects in reaction to rising demand, which creates more space and chills the market – with an inevitable lag because of construction timescales. Speculative developments can then lead to an overhang of stock and downward pressure on rents as new space floods the market. And so the cycle continues. The result leads to a series of peaks and troughs on the occupier and rental side.
Clearly then, timing is everything: it’s the key to success in the regional property market. The most successful are able to spot when the green shoots of growth are just beginning to emerge and have the courage to act first. That requires an eye for the initial tell-tale signs of the right moment to invest: usually when rents first begin their slow rise. That’s the theory, but on the ground things can look quite different. Take Edinburgh at the moment: we now have the unusual situation where the occupier and investment markets are, more or less, in equilibrium. The city’s buoyant occupier situation, which is driving strong rental growth, is matched by firm interest from investors in its commercial property assets.
To a certain degree, the city is insulated from the vagaries of the development cycle – thanks, in part, to its Unesco World Heritage status. The extremes of market volatility are avoided by the lack of development land in the city centre.
What does that mean for both sides of the capital’s commercial property markets? Well, from an investment perspective the current prime yield of 5.25 per cent still offers a relative discount compared to many other UK regional cities. We have seen keener yields paid for Edinburgh offices before, although few would argue the primary reason to invest in the city is now yield movement – it’s all about rental growth.
Edinburgh’s unique position should protect this rental growth in the foreseeable future, which means it will remain an attractive proposition for investors. The occupational story is likely to follow this lead, building on last year’s more-than-a-decade high, with increased competition for space in the city centre continuing to boost rents.
This is likely to happen across the city. Occupiers will increasingly have to look to the outskirts of the capital for accommodation, particularly the west of Edinburgh. For investors on the hunt for robust returns on their outlay, the equilibrium in Edinburgh’s office market looks like a safe bet.
• Alasdair Steele is partner and head of Knight Frank’s Edinburgh office