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Development pipelines: What can commercial clients expect?

High-profile losses among top developers have only compounded concerns in a nervous sector. So what do commercial clients expect next?

Three major commercial developers posted losses that soared into the millions after their assets dropped in value.

British Land, Great Portland Estates and Land Securities reported pre-tax losses collectively totalling more than £362m, after their portfolio valuations dropped by between 1.8 per cent and 3.7 per cent.

The figures are a reflection of the unease in the market following the UK’s decision to leave the EU and the resulting uncertainty ahead of Article 50 being triggered. 

So with unpredictability forcing developers to rethink plans, where is the market headed?

And what do the recent trends tell us about future office development in London and the regions? 

Building a business case

Lipton Rogers co-founder Peter Rogers says it is more difficult for clients to develop a business case for development in the current climate. His company is currently developing the 22 Bishopsgate commercial development in the City, which has been the subject of much speculation following the referendum vote.

22 Bishopsgate Monument view CREDIT Hayes Davidson

22 Bishopsgate Monument view CREDIT Hayes Davidson

Source: Hayes Davidson

Peter Rogers says major challenges remain despite the commitment to 22 Bishopsgate

Rumours around whether the scheme would go ahead were rife for months, before investor Axa Investment Management finally committed to the project last month, with Multiplex signing the main contractor deal.

Even with this confidence boost, Mr Rogers says the challenges of developing in the City remain significant, with price continuing to rule the market.

“Everything is price-driven and if you look at the London market at the moment, you have still got lots of different prices and everything is going up,” he says. “Developers are getting a double-whammy because contractors are not cutting their margins and [that is then] mixed with inflation from the stuff that comes from overseas.”

The impact of this has fallen particularly hard on cladding packages, with the majority of large commercial schemes sourcing cladding from overseas. 22 Bishopsgate, which has a construction value of between £500m and £600m, has been hit by rising costs, Mr Rogers says

“Everything is price driven and if you look at the London market at the moment, you have still got lots of different prices and everything is going up”

Peter Rogers, Lipton Rogers

“On a fresh job, 80 per cent of your cladding costs will be European, with 20 per cent for the erection in the UK, so you can imagine there are some pretty nasty numbers coming out [in the marketplace generally].”

He adds that the overall market is tougher, with returns going down and cost going up. “So either land values have got to come down, which takes a while, or people are going to hang on and do less.”

Other factors such as rising or falling rental values will also play a role in a client’s business case for development. Blue-chip clients such as Land Securities are predicting a general weakening of rental values due to market uncertainty.

One client, who asks not to be named, tells Construction News this will only make it more difficult to develop, particularly in the capital, and advises contractors to find commercial work outside of London.

Regional outlook

Regional hotspots for office development can be found in Birmingham, Manchester and Leeds.

In Birmingham, Savills expects average rents will pick up, with more high-quality refurbishment schemes being delivered in the next 12 months, while top rents will remain at £32.50 per sq ft throughout next year.

And with less than three years of Grade A space remaining on the market, clients are likely to see the city as a key growth area.

Tightening supply is also evident in Manchester and Leeds, with 51 per cent of Manchester’s office pipeline up to 2018 already pre-let, while 40 per cent of office developments under construction in Leeds are pre-let, emphasising both strong demand and a shortage of available space.

Refurbishment and globalisation

Opportunities for contractors lie not just in different regions but different project types, Derwent head of development Richard Baldwin points out. He expects an increasing number of clients to turn to refurbishment to avoid the costs associated with new build.

“You spend less and you do the project quicker. Also if you are doing rolling refurb, you can keep the building income going, so I think you’ll see more people looking a lot more carefully at refurbishment.”

Figures from Deloitte’s Crane Survey certainly echo this sentiment with more than 70 per cent of the capital’s office starts coming from refurbishment rather than new build.

Deloitte Real Estate head of insight Will Matthews points out that “the share of new starts that are actually refurbishments has been increasing”.

“If you are doing rolling refurb, you can keep the building income going, so you’ll see more people looking carefully at refurbishment”

Richard Baldwin, Derwent

“When you go back to when some of these schemes were kicking off [in the last six to 12 months], you had a market that was quite undersupplied with vacant space and a relatively short window to deliver new schemes into the market and capitalise on forthcoming rental growth.”

This could be music to ears of contractors such as ISG and Morgan Sindall – the latter of which posted further growth in its fit-out arm for H1 2016, with adjusted operating profit up 11 per cent to £11.5m.

Mr Baldwin also makes the point that contractors would be wise to start diversifying their global portfolios where they already have connections overseas. He uses the example of Skanska in the Nordic countries and Bouygues in France as firms that could use their connections abroad as leverage to expand.

Foreign investment

One client says contractors should be keeping an eye on developers that have overseas funding, coupled with UK expertise, such as Stanhope, which is backed by Japan’s Mitsui Fudosan and Canada’s Alberta Investment Management Corp.

This is supported by the RICS Q3 commercial market survey, which showed that foreign investment appetite is on the up.

Wanda One Nine Elms 2

Wanda One Nine Elms 2

One Nine Elms has exposed the difficulties of UK firms and new entrants partnering on major schemes

It says that overseas purchasers are looking to capitalise on the opportunity to buy prime assets given the significant discount provided by the weaker pound.

However, the client adds that contractors need to be wary of the risk profile attached with overseas clients, given that some are new to the UK market.

Chinese developer Wanda One has so far failed to agree terms with two separate preferred bidders for its £900m One Nine Elms scheme – a demonstration of the difficulties UK contractors and new entrants can face in partnering to deliver big commercial schemes.

“Yes they’ve got cheap money but the return is in sterling, which has been devalued, so although the initial investment is less, what they are gaining is less as well” 

Peter Rogers, Lipton Rogers

Despite this, overseas investors could provide ample opportunity for the UK commercial market.  Projects such as 1 Undershaft (now known as the Trellis), which is being developed by Singapore-based Aroland Holdings, is moving forward having secured approval this week.

Likewise, Singaporean UOL Group looks to be pressing ahead with its £300m Heron Plaza scheme in London, while other projects supported by overseas investment such as the Malaysian-backed Battersea Power Station are also well under way.

However, Mr Rogers points out that even with access to “cheap money”, overseas investor/developers will still get their return in pounds, which could make development less attractive.

“Yes they’ve got cheap money but the return is in sterling, which has been devalued, so although the initial investment is less, what they are gaining [is less as well]. So if you’re a Japanese investor, what you are returning to Japan is devalued,” he says.

There are reasons for firms to be cautiously optimistic over the coming months, with new entrants active in the market offsetting an expected decline in blue-chip clients.

Diversifying into other sectors and regions could also be a smart option for contractors at this time, but the right opportunities still exist.

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