Rocketing costs for refurbishing or building a new office block in the South East are outpacing rental returns and threatening spec building.
A rent of £25 per sq ft is necessary to make a new-build viable in the South East, if the land cost is low. If the land price is high, then rent of £30 per sq ft or more is required.
And if a profit margin of 20% is assumed, then rising costs can push a scheme off the drawing board.
What economists call “price discovery” has become more difficult with rising construction costs putting the most pressure on pricing decisions. Costs have risen from around £150 per sq ft new build in 2013-14 to £190 per square ft today.
At its root is a shortage of skilled tradespersons, which has forced a rise in labour costs. KPMG predicts further price rises during 2016 until the shortage of skilled labourers is resolved.
In addition, occupiers’ and landlords’ expectations about rental growth are drifting apart. Buoyed by the investment market and continued yield compression, landlords are more likely to hold their position on the quoting rent when they see the value of an empty building rise, alongside the rapid yield compression the investment market has seen.
Around 4.6m sq ft is under construction in the M3, M4 and M25 markets, equivalent to 1.6 years’ supply in the M4 corridor, and just over six months’ supply around the M25.
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