‘Slotting’ in with new developments?

As most of us are aware, over the last few years there has been very little new office development in the UK outside of the capital. In fact in 2012 only four schemes in the Big 6 regional office centres started speculatively, and all of these were refurbishments rather than new builds. Average Grade A vacancy rates across the Big 6 markets fell to just 2.9% by the end of 2012.  Occupiers seeking to upgrade workplaces to drive productivity and transformation have few readily available options. Without question, this supply challenge has a direct impact on the ability of occupiers to make cost savings.

But now, as the path ahead looks slightly more positive with sentiment improving one wonders at what point a development response might be seen within the regional office markets.  It is likely that developers will be cautious in pressing the button given the difficult last few years and ongoing challenges with finance, but it is likely that a response will be in evidence over the next 12-18 months.

Of course this is not without risks.  Triple dip, further event risk in the Eurozone or the impact of fiscal austerity all provide threats to occupier confidence and hence demand, which in turn may serve to reverse any momentum in the development market.  But there are other, less obvious, risks emerging too.  Take as a case in point the Financial Services Authority’s (FSA) new capital rules for the banking sector – somewhat dubiously known as ‘slotting’.

Under the new rules (designed to ensure risks arising from property lending are covered), all UK banks will be required to assign one of four different weights, ranging from 50% to 250%, to all property loans on their books. Each risk weight determines how much capital the bank must hold against potential losses on that loan. Despite industry concerns, the FSA has confirmed that all UK banks will be forced to apply the new capital rules. Banks have been given until this summer to categorize all their loans in this way unless they can demonstrate any alternative model is accurate and conservative.

Although designed with good safe guarding intentions in mind, it is anticipated that ‘slotting’ could essentially lead to a doubling of the cost of borrowing for property companies and investors. The process is unsurprisingly therefore causing much concern amongst the property industry. In a recent FT interview Peter Cosmetatos, from the British Property Federation, argued that slotting would have “unintended and potentially dire consequences” for the regional property market in the near term.

Some of the significant implications include:

  • Curbing of lending for new developments (particularly in regional locations where more challenges exist to investment and return).
  • Higher costs to landlords in the regions, where economic uncertainty and a lack of foreign investment could push large volumes of property into the high-risk category
  • An increase in the number of landlords forced to sell as banks try to rid themselves of unsustainable property loans
  • A general decrease in property values in all but the best locations
  • An increase in borrowing from alternate lenders rather than banks – such as specialist debt funds and insurers.

So despite a slowly improving economic picture, there are still grey clouds looming over the UK regional development markets.  Chief amongst the clouds is the threat of ‘slotting’ which if implemented fully as proposed will only serve to ensure a continued dearth of development finance.  Prime office shortages are only going to intensify, creating an even greater set of challenges for corporate occupiers seeking to drive productivity and transformation through high quality premises.