Ever since the Brexit starting gun was fired back in June 2016 there has been much speculation surrounding the impact that exiting the European Union will have on business in Scotland. We have explored the impact on various sectors of Scotland’s commercial property market, considering the risks the industry faces and where the opportunities may lie, following our review of recent industry reports and market intel.
Business as usual?
In the immediate aftermath of the 2016 vote the Financial Times reported there was an ‘sinking’ in the number of commercial property deals across the UK with London and Scotland hardest hit as properties were withdrawn from the market and deals aborted. Despite this initial market slump, with two months to go until ‘Brexit Day’, market analysis suggests that Scotland’s commercial property market was unexpectedly steady over 2017 and 2018 with deal volumes maintained and increased investment. Indeed, the volume of demand for investment property across the market reached a four-year high in 2018.
It is, however, clear to see that some sectors are performing better than others and we now look at these in turn.
Quality office space
The office space sector is an area that has held up well so far. Historically, demand for Grade A office space has been high in Scotland and industry reports suggest that this demand still exists, particularly in Edinburgh and Glasgow who have produced Grade A office space developments such as the Mint Building in Edinburgh and Buchannan Wharf in Glasgow.
Although demand for Grade A space suitable for investment is high there are concerns that interest – and values - may drop following Brexit.
There has been suggestions that previously overlooked Grade B commercial property might become more attractive post Brexit, while investors and developers take stock of the economic climate and look for cheaper alternatives to high end Grade A property throughout Scotland.
This trend may prove particularly prevalent away from Edinburgh and Glasgow where there is already a lower demand of Grade A commercial property – though Edinburgh and Glasgow may also see this trend given that there has been a relative shortfall of provision over recent years in the two cities. If purchasers see less risk in Grade B quality stock, the knock on effect may well be improvements in the quality of that stock if they are prepared to make some investment. That may provide opportunities for owners and landlords of Grade B buildings as well as future investors as values increase.
Decline of the high street?
In contrast to the buoyant office space sector, market trends show that the retail sector continues to struggle. With reports that busy shopping districts are facing an ‘exodus’ of shops and consumer spending in Scotland remaining below levels seen in 2015 there are real concerns for Scotland’s retail sector. It is unclear, whether this decline is a direct result of the ‘Brexit effect’ or an example of the reported wider impact that changing consumer behaviours and online shopping are having on the high street and the retail sector. Concerns are that Brexit might just exacerbate an already difficult position.
The recent rateable values review and ongoing challenges to empty rates relief on empty buildings has increased pressure on landlords whose retail units lie empty. Recent reports have claimed that there has been a ‘take over’ on the high street by businesses such as charities shops, driven in part by landlords accepting no or very low rents just to ensure that the rates are taken care of.
In an attempt to combat the decline the Government has announced various measures with the aim of improving or reinvigorating our high streets including proposals to allow the redevelopment of under-used retail space into homes and offices, providing help to restore High Street properties and putting historic buildings back into use.
What is clear is that – Brexit or not - the way people shop is changing and the retail sector of Scotland’s commercial property market is feeling the effects.
Demand for warehouses at ‘fever pitch’
In contrast, there has been an unprecedented increase in demand for warehousing in Scotland’s property market with industry reports suggesting that current demand for industrial warehouses and storage facilities in Scotland is at ‘fever pitch.’ Colliers report that demand for retail warehouses in 2018 in Scotland surged to £330m, twice the 2017 figure and the largest amount invested in the sector in over a decade.
This recent upsurge in demand for warehousing has, however, exposed a number of challenges facing Scotland’s commercial property market, highlighting a national lack of capacity for warehousing and storage facilities of suitable quality following years of lack of investment in some areas. It appears that the rise in demand stems in part from manufacturers’ concerns around the supply chain in light of a possible no-deal Brexit, leading to a ‘stockpiling’ of goods where the supply chain is not local. It is one thing to store ‘traditional’ goods such as building materials but the stockpiling of food has different requirements such as dry storage facilities and chilled, refrigerated or frozen storage facilities. Unfortunately, these specialist food warehouses appear to be in short supply relative to demand.
The recent demand may well impact on tenants of warehouses and storage facilities with the market values of rents of retail warehousing and storage expected to soar over the next 6 months leading to greater upfront costs for new leases as well as increases at rent review where rents are linked to open market values.
Such rent increases will be good news for landlords who will benefit directly from the increases in the investment value of their portfolios and from ‘knock ons’ such as better loan to value covenants in any lending.
There may also be indirect benefits for landlords where increased demand leads to tenants accepting lower quality stock and making improvements to the same in order to make it work for them. We have recently acted for investment clients who, unable to secure suitable Grade A industrial property have instead opted to purchase Grade B property with the intention of improving stock and tenant mix to improve the value of their investment.
This shortfall could also well have an interesting effect on the businesses of local suppliers. Where, formerly, local suppliers may have been priced out of the market place by cheaper supplies from further afield, if that supply is proving problematic then perhaps local suppliers might rebuild local networks and get back into the market. Could that also be a solution to the local retail crisis mentioned above if, for example, demand for units increases to support this?
Uncertainty, uncertainty and more uncertainty: the position after 29 March?
Whilst the increase in demand for retail warehouses spurred by the fear of a ‘no-deal’ Brexit may provide some positive news for landlords and owners of retail warehouses in the short term, the impact of Brexit after 29 March is still very uncertain.
Property investment Property Company, Ediston has warned that the property market is likely to ‘pause’ after March as investors take stock and access the long-term economic impact of Brexit. Scotland’s commercial property market is extremely resilient and has overcome tough economic adversity many times before but the uncertainty Brexit delivers will no doubt shape its immediate future.
Much will depend on the wider political picture and whether a clear timetable for the exit from the European Union is executed effectively. There is still time, although, with 29 March fast approaching time is running out!